BHP & China's iron

John Garnaut
November 23, 2007 - 8:43AM
BHP Chief Marius Kloppers has ignored expectations that he would placate the world's most powerful steel industry, promising instead to smash China's preferred iron ore price setting system whether or not he succeeds in swallowing Rio Tinto. The move demonstrates how a BHP-Rio merger will transform the global commodities trade - and reveals the quietly-spoken, strategic aggression of Mr Kloppers. He told steel makers and officials in Beijing yesterday that he would create a new iron ore market place, managed by a third party, which would trade real ore shipments as well as "derivatives" on a futures exchange. The market would be open to hedge funds and investment bankers, who are clamouring to buy into the commodities trade but lack liquid investment options. The system would also be a back-door way of introducing a huge "freight premium" for Australian ore over Brazilian ore, because contract prices would be set at a north-China port of delivery rather than the West Australian or Brazilian port of origin. Deliveries to Korea and Japan would be benchmarked to the China price. The pledge displays Mr Kloppers' confidence that his bid for Rio Tinto will fly despite deep opposition in China and elsewhere - because he believes there is nothing any of his key customers can do. It is only a month since the peak Chinese steel industry body told The Age that BHP would be acting "dishonourably" if it broke the long-standing system of annual contract negotiations, led this year by Brazil's iron ore giant CVRD and China's BaoSteel. Mr Kloppers also indicated in meetings this week that competition authorities outside Australia would be powerless to stop the merger. Regulators in China, Europe and elsewhere will only have power to stop imports - an action no region can afford to take against their dominant supplier.
Iron ore is only BHP's fourth or fifth most profitable commodity in North Asia. But Mr Kloppers is exclusively visiting iron ore consumers because Chinese politicians and policy makers tend to be obsessed with the steel makers who are driving the country's ongoing industrial revolution. Both parties are deeply resentful of their current negotiating terms, and yet entirely dependent on the other. BHP and Rio Tinto accounted for 38 per cent of the world's iron ore trade this year - an imbalance exceeded only by China's share of world demand. Within three years, China is on track to import more iron ore than the rest of the world put together. BHP and Rio supply an even higher proportion of Japanese demand, at about 60 per cent.Chinese policy makers and steel chiefs appear to unanimously oppose the merger proposal, but have so far revealed no way that they can stop it. To date, there has been no unified Chinese response and nor has there been a physical meeting between high level steel executives and government officials, according to China Iron & Steel Association deputy director Chen Xianwen.Speculation that China will spend some of its enormous capital reserves - and its limited geo-political capital - on buying Rio shares and obstructing BHP does not appear to have any basis at this stage. Mr Kloppers pitched his new deal to steel makers on Wednesday in Shanghai, including Bao Steel's chief Xu Lejiang.Yesterday he met a vice-president of China's commerce department and a more junior official at the National Development & Reform Commission. At those meetings he gave new logic to the improbable line that reducing the world's three dominant iron ore players to two would actually be good for steel makers. Mr Kloppers appears to have downplayed the infrastructure "synergies" that were emphasised in talks with shareholders last week. Instead, he based his claim to Rio's assets on a promise that he would manage them far more aggressively and productively than Rio's management team would do if left in place. In a profound U-turn for BHP, and one that has implications for Australia's lethargic export performance, Mr Kloppers conceded both of Australia's giant miners had been too slow and too conservative in responding to the fact of China's extraordinary awakening.He told Chinese representatives that BHP management had learnt from its mistakes, while Rio's lackluster investment record showed that it had not. Mr Kloppers can lay some claim to being an early and true believer in the Chinese-driven commodities super-cycle, as his 11 and 13-year-old children already speak fluent mandarin Chinese.