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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Comments

  1. “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 own rise in the ‘Great Strategic Game’ far outweighs BHP’s or RIO’s desire for a profit. Because the political desire outweighs the economic one. Otherwise, how to explain vanity?

    I hope Marius Kloppers & Tom Albanese truly know this. I can’t speak for them, so I don’t know and will not provide any opinion on this.

    Either way, the Chinese will not be too happy perceiving that they come second best on the negotiation table. Let’s hope that they understand that it would be far more costly for both sides to pursue the alternative route to negotiation. Negotiation, given the oppportunity, will provide both sides what they want.

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  2. 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 would find ourselves with 2 allies against Chinese military incursion.

    The real risk is them performing a much more subtle infiltration of our companies (buying it, in part or whole) or taking a more long term view, flooding our shores with immigrants to try and colonize us under our noses. Obviously that’s not so easy either.

    I think China may be in a situation where they may not like the negotiation results, but are stuck when it comes to changing the situation. BHP knows this. RIO knows this. The Australian gov knows this.

    Unpopular Truth
    April 16, 2008
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  3. U.T Nicely said but i would still be watching on how much of that iron ore starts going into boat [ship] building

    Diggin it!
    April 16, 2008
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  4. 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, look as Gazprom from Russia. Those guys now have the legal right to have their own security force to guard assets abroad, according to Russian law. Thats code word for ‘corporate army’. Guess who are major shareholders in this company? Pretty much every politician, up to and including Vladimir Putin in the ruling Russian political party.

    They’re not playing on a level playing field with protected monopolies so there’s no point treating them the same way as Westerners treat other business (in terms of governance & corruption).

    Unpopular Truth
    April 16, 2008
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  5. We didn`t stop the Japanese buying in during the 80-90s what makes you think the Government will stop the Chinese?

    Diggin it!
    April 16, 2008
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  6. China will need to bring its population here – the world needs China and not Aus or its stupid populous

    Charles Norville
    April 16, 2008
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  7. 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 todays garbage dumps are tomorrows mines. Essentially Aus need not trade at all with nonotech because all you need with this technology is 1.resource and 2.lots of energy to work it you don’t need money that much unless you dont have the first two things.

    Therefore China needs to act within the next 10 years, we are not economically aligned and so China will slip in and if need push the process along. Oh China and BR of BRIC will cut loose India because they are in competition for resources with essentially China, but also Brazil and Russia. China will dispense with our northern pesty neighbour Indonesia.

    Sovereignty is a myth we give it away every chance we get. So get used to the world not liking Aus and liking China.

    Ok look at the big picture do you think US is going to be on top they are to busy building jails to house their population. What would happen if China floats up its currency by 40% threatens to float the US $ – instant buy up of Aus including the depressed housing but then everything would be 40% cheaper. Maybe BIS Shapnel may have a point about big increases in housing.

    The world needs China it does not need Aus and its stupid populous no offense poeple, just the Aus resources which we live off.

    Ok we can have our long weekends, footy, ANZAC day, a smaller B-B-Q on the balcony of a high rise.

    Look we are part of globalism social and corporate we have to move over we have been softened up but need a bit more – I don’t like it one bit I have two son’s.

    Do you think the world takes poor Kevin Rudd seriously, lets get real.

    Someone will produce a modern plague that will decimate perhaps be gene specific. We are all insignificant and in the end world history will start anew, a golden age of cognisance

    Charles Norville
    April 16, 2008
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  8. 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.

    Unpopular Truth
    April 17, 2008
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  9. 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!

    Diggin it!
    April 17, 2008
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  10. 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 than a market to market type. This is the beginning.

    Nanotechnology is here already and its the only technology that is going to save the planet from being consumed by human waste. I know its difficult to understand but Nanotechnology will make the cost of labour irrelevant (re Engines of Creation by Eric Drexler) in fact large human populations will become superfluous, think about it you won’t need large population to have a successful economy or to protect it, large populous defence becomes supefluous – it’s scary to the US. As well capitalism will be changed probably turned upside down (China has a form of capitalsim it’s government is the biggest corporation on the planet) because there is no other way of controlling the masses at present the pundits are scarred.

    Think of a massive technology that requires a minimum labour force but huge resources and huge amounts of cheap energy. IT IS GOING TO HAPPEN. [The economist I would say are going to have to go back to school, they don’t like nanotechnology either, because economic school is boring – lol]

    NOW FOR THE OPINION – There is much obscene wealth about, democracy and the implementation of human rights are slow reactions, economy moves faster with far more emphasis on control of the masses, you can change the focus on the importance of human behavior under the banner of economics. The importance of Australian culture and its people as a society is irrelevant to world economy, inferior cultures can be wiped out because you can always apologise later. And while we are at it the excessive behavior of the US is irrelevant to world economy, the US still think otherwise to their peril. Do you think the US is going to apologise for any outfall they produced?

    FEATURE ARTICLE – DAILY RECKONER by Dan Denning – “Thomas Malthus and the Global Food Crisis” A man that understood in 1798: quoting excerpt “Thomas Malthus died in 1834. He had already prepared a revised second edition of his “Principles of Political economy” which was published by William Pickering in 1836. It is, however, the Essay on Population, 1798, which first states the Malthusian argument:
    “The power of population is indefinitely greater than the power in the earth to produce subsistence for man. Population unchecked, increases in a geometrical ratio. Subsistence increases only in an arithmetical ratio. A slight acquaintance with numbers will show the immensity of the first power in comparison of the second.”

    NOW FOR THE CONSPIRACY – Get this, we have to control human population we have to reduce it drastically if the world economics can not do it, and by all account it won’t or can’t, because no one really wants to think about it, then there will be an intervening medium to do so. Even David Suzuki in his book “Genethics” (1st edit 1988) was concerned about specific genes being targeted for susceptible disease – “ethnic weapons” and the like. Moot your own conspiracy if you like, debunk it with your present happy life. Maybe its not just the economy (“stupid”) but rather the impact of population – another quote I=PAT or IPAT look it up.

    Maybe your not scared a bit, you might think it’s all fiction, can’t happen, but stand back from the white board of scribbled human endeavor and tell me your not tempted to get an eraser and rub it all out and start again? Maybe not all because we don’t want to go back to the stone age………….what bits would you leave alone – not easy is it?

    Yea its all a bit grey to me too and if it all incoherent then i’m sorry for those who think so, but I am thinking of a better future for Australia and the World and ALL its inhabitants animal and vegetable.

    Charles Norville
    April 20, 2008
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