Replies to post #66 on The Rising Influence of Rising Affluence

[DewDiligence]

Today’s moves re BHP-RTP JV:

BHP +7% (+150% from 2008 low)
RTP +6% (+220% from 2008 low)
VALE +2% (+125% from 2008 low)

It’s impressive, IMO, that VALE is up 2% today given that its two largest competitors just joined forces. VALE has the best quality iron ore in the world and hence doesn’t have to take a back seat to anyone, even a JV that will now produce slightly more ore than VALE does.

[DewDiligence]

Sometimes a bad article can be more informative than a good one,
and this piece from Barron’s is a case in point. The article vastly
overstates the role of China in the worldwide market for iron ore,
and it improperly views the Chinese “monopsony” as permanent
rather than a temporary phenomenon caused by the recession
in Europe and North America.

http://online.barrons.com/article/SB124415639960586887

›Rio Tinto: Not Strong as Steel

JUNE 5, 2009
By TIERNAN RAY

Investors cheered this morning as two of the world's biggest iron miners, Rio Tinto PLC (RTP) and BHP Billiton (BHP) said they'd form a joint venture, which could arm them against China's desire to push down prices for iron.

But China, the world's biggest steel producer by a wide margin, still holds the most important cards in this game. Its dominance of commodities consumption bodes ill for Rio and BHP and Vale (VALE), the world's biggest miner.

China is a voracious consumer of iron, buying more than half of what Rio and BHP and the rest of its competitors can dig up. Without China, these companies have nowhere to find growth in a global recession.

"I think given the worldwide economic slump, China has huge pricing power here," says Scott Black with Delphi Investments in Boston. "You have a surfeit of iron ore, and for that to change, you need a worldwide recovery and steel demand to pick up."

London-based Rio, whose American Depository Receipts were up 6% in early afternoon trading at $193.81, have doubled this year and are up over 50% just in the last two months. It seems highly likely the shares will cool off from here.

Today's surge owes to investor's belief that Rio, the number two worldwide producer of iron ore, by taking $5.8 billion from Melbourne-based BHP, the third largest producer, will be able to pay off a chunk of its $40 billion in debt.

More important, Rio was about to take a $19 billion investment from Chinalco, China's state-owned Steel producer, before BHP swooped in. To help offset the absence of Chinalco's investment, Rio announced a $15.2 billion rights issue.

By avoiding Chinalco's control, it's thought that Rio and BHP can stand firm on iron prices.

Rio Tinto tried to set worldwide prices two weeks ago by negotiating a 33% price cut with the Japanese, but China immediately demanded Rio go further, cutting prices 40%.

As the Financial Times points out, the Rio-BHP joint venture will be the world's biggest iron ore producer, which could enhance the two companies pricing control.

The problem is that China's status as a monopsony tops that of a duopoly. China still holds sway in iron ore demand, and as such, it may still extract price cuts from Rio and BHP and Vale.

China's steel is what's keeping iron alive. China continues to build its internal infrastructure, supported by government economic stimulus packages, and its steel output is the only global bright spot.

Chinese steel production in April fell 3.9% year over year, far better than the 24% dive for overall global steel production. Japan, which negotiated those price reductions with Rio, saw steel production fall 44%, and the U.S. and Germany each saw production fall about 53%.

A slide presented by BHP to investors this past spring showed worldwide steel production is down to the level it was from 2004 to 2005, even with China going full-tilt.

Evidence is mounting, too, that the Chinese steel-makers have been stockpiling iron ore well in excess of their actual demand for the metal.

Whether that's to have pricing control or because the country's going to shift its reserves from dollars to commodities, it's testament to China's huge and growing sway over Rio and BHP and Vale's business.

Musical chairs at Rio and BHP are a distraction from the unavoidable fact that China is the iron ore market in this economy and it is the growth opportunity. Until global manufacturing demand is back to health, China's strong influence on price will continue to dog these stocks.‹

[DewDiligence]

BHP, Rio Tinto Tout Benefits of Australian JV

[What makes the JV workable from an antitrust standpoint is that each company will retain its own marketing business; thus, the companies will argue that the JV is essentially no different from having each of the parties buy its iron ore from a common third-party supplier.]

http://www.ft.com/cms/s/0/903840f2-550b-11de-b5d4-00144feabdc0.html

›By Peter Smith in Sydney
June 9 2009 17:53

As Don Argus ponders whether to step down as BHP Billiton chairman at the miner’s annual meeting in two months he can do so knowing the long-term goal of combining its Western Australia iron ore assets with those of Rio Tinto is closer to reality.

Rio and BHP already rank second and third respectively in the global trade for seaborne iron ore behind Vale but the new venture – covering the whole of both miners’ iron ore assets in Western Australia’s Pilbara region – will leapfrog their Brazilian rival.

Based on current estimates, the venture would produce about 325m tonnes of iron ore in 2009 – 130m tonnes from BHP and a further 195m tonnes from Rio, which already has several strategic partners in the Pilbara.

Vale is expected to ship about 220m tonnes of iron ore in 2009.

Analysts estimate that Rio and BHP could supply close to 75 per cent of China’s iron ore imports this year, helped by the closer proximity of Australia to China compared with Brazil.

Inevitably Japanese and Chinese steelmakers have lined up to oppose the BHP/Rio combination on the grounds it will restrict competition. The main obstacle, though, is antitrust clearance, particularly from European regulators, and Australian government approval.

Marius Kloppers, BHP chief executive, is confident, however, that the venture will clear those hurdles and come into being in the middle of next year. To address competition concerns, he stressed BHP and Rio had formed a “production joint venture” that would preserve each group’s marketing arrangements with respective customers.

The joint venture will also establish a separate “marketing” company that could sell up to 15 per cent of production on the spot market.

The venture will operate as a “cost centre” and deliver iron ore, in equal volumes, to ships designated by BHP and Rio via their marketing groups.

Combining the adjacent iron ore assets in the Pilbara was a central motivation of BHP’s failed take-over attempt of Rio last year and securing a deal is all the more remarkable considering Rio’s previous hostility to BHP.

To compensate Rio for its larger assets, BHP will pay its rival $5.8bn to lift its stake in the venture from 45 to 50 per cent, valuing the entity at $116bn. Assuming targeted revenue synergies are achieved, as well as cost and capital expenditure savings, that value rises to $126bn.

Glyn Lawcock, UBS mining analyst in Sydney, said the venture would be positive for both miners and importantly does not preclude BHP from a fresh Rio takeover bid.

He said: “From a strategic perspective ... the iron ore joint venture does not remove the potential for a full BHP bid for Rio at some point”.

Mr Argus first raised the prospect of BHP and Rio combining their iron ore assets hours after Jan du Plessis was elevated to the role of Rio chairman in April, but it was Mr Kloppers and Tom Albanese, Rio chief executive, who took on the heavy lifting and stitched together the deal over the next two months.

Under the terms of its deal with Chinalco, Rio was unable to “shop” its assets to other parties but it was not prevented from being able to “listen”.

The talks between BHP and Rio were advanced by Mr Kloppers when he sensed Rio’s deal with Chinalco was in danger.

He said: “This deal has been more than 10 years in the making ... it has been worth the wait.

“Combining these assets and associated infrastructure [rail and ports] which operate side by side [will deliver] very, very substantial production, development and financial synergies.”

Mr Kloppers said he did not expect a backlash from Chinese customers aggrieved after Chinalco’s attempt to inject a $19.5bn investment into Rio, which would also have included a 15 per cent stake in Rio’s Hamersley mining assets in the Pilbara, ended last week.

The new venture will be chaired by Sam Walsh, Rio’s head of iron ore, who was last week promoted to the Rio board, while Ian Ashby, BHP’s iron ore president, will be the venture’s first chief executive.

To underline both miners’ commitment to the venture, a mutual break fee of $276m has been agreed, payable in the event either party does not honour specified commitments.

BHP was advised by Goldman Sachs and Gresham, the Australian boutique, while Morgan Stanley acted for Rio.‹

[DewDiligence]

BHP-RTP’s iron-ore JV announced in Jun 2009 is dead, according to the WSJ and other sources:

http://online.wsj.com/article/SB10001424052748704361504575552261931607460.html

The idea of allowing two of the world’s three-largest iron-ore producers to combine upstream operations never got off the ground with regulators.