Australia & China: Already Partners in the Commodity Boom

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BHP Billiton (ASX: BHP) may already be taking advantage of that massive 240% price increase in coking coal it scored last week. Turning coal into cash, that gives BHP anywhere from US$5.5 to US$7 billion in 2008 revenues it didn’t have before.

By contrast, Rio Tinto’s (ASX: RIO) exposure to rising iron ore prices may “only” deliver an extra US$1.5 billion to 2008 earnings. BHP could use the coal cash to sweeten its share offer for Rio. The current ratio between the shares is 3.32, slightly below the 3.4 share offer that BHP put on the table.

Our technician Gabriel Andre has been tracking the ratio recently to see if there is a premium or discount in either company. The red line on the chart marks the 3.4 level of the formal offer. You can see that since the offer was made in November of last year, the ratio hasn’t deviated much. This current dip doesn’t put any pressure on Rio’s management to accept the offer. But more weakness-where it takes fewer BHP shares to buy one Rio share-could.

The BHP Billiton/ Rio Tinto Share Ratio

There was a small story in the Australian last Friday that the China Development Bank floated a proposal that China and Australia develop a long-term plan for, “Chinese investment in Australian mineral resources?” There wasn’t a lot of detail about the plan, like how it would work and whether it would replace the current system.

The current system, of course, is the share market, where if you want mineral resources you pay the market price for them. The market price for coal, iron ore, and copper is going up, of course. It would be much nicer, if you’re a customer of those things, to NOT pay the market price and pay, say, a contract price, or have some other kind of joint venture deal.

Australia and China are already joint venture partners in the commodity boom. But if China is suggesting a government-to-government relationship over resources and not a market-to-market relationship, well that’s different kettle of fish altogether isn’t it? Is it a proposal? A suggestion? Or an indication of how China would like things to be in the future, in order to remain a reliable customer for Aussie resources?

The Australian article says China would like to reach a “consensus” over Chinese investment in Australia for the next five to ten years. Finance Minister Lindsay Tanner did not agree saying, “We are committed to the long-established foreign investment review framework, which operates on a case-by-case basis governed by national interest considerations… The proposal floated by the China Development Bank would involve a dramatic deviation from those principles.”

Just something to think about. In an integrated global market for commodities where there are plenty of buyers and sellers, the market price prevails. But with the bear market in credit and the “Triple F” crises we mentioned yesterday, there may be fewer cashed up buyers of key global commodities.

Sellers in possession of key strategic tangible resources will have an interesting option to consider. With scarcity, the market price of most resources will go up. But if you want price certainty (or to use your resources to your national advantage), you might choose to sell only to certain clients and not others. If that were the case, you might move to contract pricing and not market pricing.

Take oil. The crude futures contract began trading in 1983. In early trading the futures price was lower that the price OPEC had set with its pricing mechanism. As the world’s largest supplier of oil at the time (it sill is, but less so as a percentage of total crude production thanks to the North Sea, the North Slope, and Russia), OPEC had all the pricing power in the oil market.

The futures contract changed the pricing mechanism for oil because it established a market price. And as it turns out, that pricing mechanism has worked better for OPEC in the last five years than any arbitrary ability to fix prices could. You get a bidding war for what you produce.

The only risk to the market price today is that bidding wars precede shooting wars. There is, after all, already a war in the Middle East that began in 2003. At what point does possession of a valuable strategic go resource change from having a prime position in the marketplace to having a big fat target on your back from larger, resource hungry neighbours?

One day your neighbours ask for more formal arrangements in your amicable trading relationship. The next day they stop asking. And the day after that?

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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10 Comments on "Australia & China: Already Partners in the Commodity Boom"

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kojacq
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“One day your neighbours ask for more formal arrangements in your amicable trading relationship. The next day they stop asking. And the day after that?” This is especially apt when it comes to China, and the Chinese, who consider themselves very, very tough negotiators, and they do not like to lose on the negotiating table. However, when it comes to the balance of negotiations regarding Chinese interests in Australian resources, it is obvious that those who have ‘the stuff’ in the ground that the Chinese want, are the ones with the upper hand. This is because China’s vent for it’s… Read more »
Unpopular Truth
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I wouldnt worry about china invading Australia for our resources :) They dont have enough boats to move their army across to Taiwan, never mind across the ocean to our shores. They lack the logistical ability to get troops over fast enough before we got our allies in between the two countries (and trust me the US would love an excuse to tangle with the Chinese on this level). Then you have the other interested parties such as Japan and India who will be damned if they let their economic and cultural rivals secure all the natural resources, so we… Read more »
Diggin it!
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U.T Nicely said but i would still be watching on how much of that iron ore starts going into boat [ship] building

Unpopular Truth
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Yes well, it pays to pay attention, but its hard to hide enough boats that can carry a million troops and tanks. The main thing other countries need to watch out for is the growth of the so called sovereign funds of countries such as china (and Russia, India and Saudi Arabia for that matter) who are nothing more than a protected branch of the government masquerading as free enterprise. Allowing these companies to buy other companies is basically allowing foreign governments to buy strategic assets in your backyard. if you want to see how bad the situation is getting,… Read more »
Diggin it!
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We didn`t stop the Japanese buying in during the 80-90s what makes you think the Government will stop the Chinese?

Charles Norville
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China will need to bring its population here – the world needs China and not Aus or its stupid populous

Charles Norville
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The Chinese will take Aus without the aggressive status quo – wars are for people like the US (& Aus but we are learning fast). Call it an economic coup, it can happen in a multitude of ways because economy and finance are better designed than a hundred nuclear powered aircraft carriers which China needs to build to supposedly invade us. Nanotechnology will make large armies and work forces superfluous and China and the rest of the world cannot allow a small populous – maybe too big now – like Aus to keep all the resources for its self NB… Read more »
Unpopular Truth
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Was there a point to that incoherent rant? really I’ve read it twice and still can’t work it out mate.

If I read correctly that you think China will invent nanotechnology and not need anyone else again, I think you have a while to wait.

Diggin it!
Guest

I read it three times? O.K i agree they will try and buy Aust- before they try to steal it, but if they buy it with USA $ isn`t that stealing it anyway? As for the rest of it it was a bit grey!

Charles Norville
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What is coherent about a room full of economists that can’t agree on any thing of substance. But there are certain facts to understand. China’s industrial might is no miracle it is forged on cheap labour and resources. It needs cheap food to feed its labour force and cheap raw materials and energy – its running out of cheap access to these but not the will to use world politics and economics to get what it wants. It is already known that the Aus Govt have been approached by China for a government to government relationship to resource acquisitions rather… Read more »
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