Who is the predator and who is the prey? That is what we wonder today. Is China preying on BHP Billiton (ASX: BHP)? Or is BHP preying on Rio? Who are the barracudas and who are the minnows?
First, the big fish. “With iron ore prices rising explosively,” says China’s National Development Reform Commission (NDRC), “many domestic firms are very enthusiastic about investing in overseas mines, which needs strengthened macro guidance from the country.”
Macro guidance is about what you’d expect from a nation that has methodically and with stunning success, pulled itself from centrally planned poverty to centrally planned prosperity (at least for some). But what does ‘macro guidance’ mean? GPS? RFID?
Today’s Australian has all the intriguing details on China’s Grand Strategy towards Australia in a story titled, “Beijing takes over BHP raid plans.” The comments from the NDRC are a fascinating take on how at least some Chinese officials think capitalism works. “Globally, iron ore mines that are of high quality and easy to exploit are basically in the hands of major multinational companies. Our firms need to pay a high cost to mine iron ore resources abroad. Their exploitation risks and costs are increasing.”
Is it really ‘exploitation’ to pay the market price for natural resources? Or is that just the language of socialism? Perhaps a crash course on free market economics is in order for the NDRC.
Not to sound too condescending (this coming from someone who uses the royal We), but you have to wonder if there is some wishful thinking going on in Beijing. Or maybe, after having lost money in Blackstone and Bear Stearns, state backed firms are wary of buying equity chunks in public companies. Maybe they want a different arrangement.
Either way, it is clear the Chinese have woken up to the fact that the century is theirs for the taking. But there seems to be some confusion about what rules the century is going to operate under: will it be mostly free market rules…or other rules. The market price for the resources China wants is rising. So it would prefer to not pay the market price.
By the way, we reckon free markets are headed for a bit of a bear market. Globalisation, in the bastard form we find it (where trade isn’t really free and currencies are manipulated regularly) has produced US$114 oil, massive inflation, the worst credit crisis since 1929, food riots, and a growing popular backlash. Expect more direct government intervention and regulation in financial markets and, perhaps, resource markets. That should play right into China’s hands, actually.
This latest line of probing rhetoric coming from China is not exactly a new line of attack. After all, the resources are there for the taking on the public markets. There’s no need to attack at all. But it does feel like an attempt to flush out Australia’s politicians and get them more involved in China’s plans for Australian resources. The government is already involved, of course, with the Takeovers panel quashing the bid by Shougang Steel and APAC resources to take a 40% stake in iron ore up-and-comer Mt. Gibson (ASX:MGX).
Let’s put this whole affair in the context of steel and GDP. We found the chart below yesterday while preparing for a radio interview with a Canadian business show. The host wanted to know how steel companies could afford to pay a 300% increase in coking coal prices and a 75% increase in iron ore prices. We asked him to picture the chart below.
Source: Mining and commodities exports, Angelia Grant,
John Hawkins and Lachlan Shaw, 2006
The chart shows that world steel production leapt ahead of GDP growth during the two big periods of Asian industrialisation of the last 50 years, in Japan and Korea. With China now industrialising, and coming off a much lower base in steel production, a period of growth in steel production that exceeded world GDP would be quite the spectacle. It would also mean China’s consumption of base metals is just now hitting high gear.
From an Australian perspective, what’s so flabbergasting about the chart is that both Korea and Japan have been devoted customers of the black coal from the Bowen Basin that is so well suited for coking. They’ve also been tied up for years as customers of Rio Tinto and BHP for the iron ore that comes from the Pilbara. Now you add China to the queue.
Despite its surge to the top in terms of global steel production, China’s individual steel firms are still smaller, at least according to the latest figures from the International Iron and Steel Institute, than Japan and Korea. Nippon Steel, Posco, and JFE are all bigger producers than Baosteel. Keep in mind, however, that as recently as 2002, China was a net steel importer. It’s now a net exporter.
Source: International Iron and Steel Institute
You could argue that Japanese and Korean steel production might decline as those economies age and become more service oriented. Yet major industries in both countries, including ship building and heavy equipment, are massive users of steel. And as of 2005, Japan ranked behind the EU as the world’s second largest exporter of steel.
More likely than declining steel production by Japan and Korea is that they will compete for market share with Chinese producers. And the producers in all three countries don’t seem to have batted an eyelash at higher input prices. That may be because they’ll simply pass those higher prices right on customers. Steel prices are up by about 10% this year already.
But if you’re wondering why steel producers don’t seem panicked by rising coal and ore prices, there’s probably a simpler explanation: there’s a bull market in steel. When you combine the industrialisation going on in India and China with the massive commercial, residential, and industrial build-out in the Middle East (rebar prices are up 65% in the UAE this year), you get a pretty bullish case for steel producers. Consumption is rising at an enormous rate.
Australia ranks 22nd in terms of global steel production. Despite having an abundance of the two main inputs (coal and ore), the country, alas, has only 20 million people. Its demand for steel is low, which is why no single Aussie firm dominates the global steel-making stage. And so Asian steel producers have essentially outsourced their raw material requirements to the Pilbara, the Bowen Basin, and the Hunter Valley.
If you want to keep tabs on this three way competition for Aussie resources, watch the battle for infrastructure project at Geraldton. This projects brings rail and port access together to open up the lower-grade iron ores in the Mid West.
One project, put together by Yilgarn and Midwest (ASX:MIS), is embroiled in all sorts of intrigue. But with Sinosteel as the main JV partner of Midwest, this can be viewed as the Chinese project. The other proposal is backed by Murchison Metals (ASX:MMX) and Mitsubishi. It’s the Japanese project. Korea is not represented, as far as we know.
To what lengths will Rio Tinto (LON: RIO) go to fend off the BHP takeover offer? Rio shares were up in London overnight by 6% on rumours that BHP would raise its share offer to 4-1 (currently 3.4 for 1) or ad some cash into the pot.
Rio and BHP keep quarreling over whose assets are better. With crude oil futures in New York cresting US$114, BHP is playing up its oil and gas assets. Rio managing director Tom Albanese is having none of it. He presented production figures from Rio’s first quarter poured a cold latte all over BHP’s oil story.
“I’ve seen numbers that would indicate to me that BHP Billiton’s oil business is about 60th ranked in the world in terms of size…I would certainly rather be the leading player in the aluminium sector than the 60th ranked company in the oil and gas sector.”
That’s a nice quote. But it’s a bit disingenuous isn’t it? Size doesn’t matter so much in terms of production. It’s what you’re getting for what you make. Just ask the coal producers on the East Coast. They’re actually producing less coal for export this year due to infrastructure bottlenecks and flooding. But with higher contract prices, export earnings will go up on declining production volumes. That’s not exactly how you’d draw it up. But you’d take it, wouldn’t you?
Rio is even talking up its zircon assets in an effort to bolster its defences. The company revealed it found a big deposit of zircon-rich material in Victoria in East Gippsland. We laughed at this because we joked around the office yesterday about rising zircon prices. Mineral sands are intriguing, not least because James Packer and his lot have recently sold off their position in Iluka (ASX:ILU).
We are not so much interested in zircon as we are in rutile, titanium, tantalum, and lithium. We’ve been digging through the juniors in our research at the Australian Small Cap Investigator and have found the pickings slim, although there are a few plums there. Rio rightfully calls itself a world class explorer. But we doubt its zircon assets are going to fend off a persistent BHP.
The real bombshell from Rio’s announcements yesterday is that it will sign a deal with Saudi Arabian Mining Company to build a giant aluminium complex in the Kingdom. The complex will include the whole aluminium chain, a power generation facility, an alumina refinery, and an aluminium smelter.
As we argued in a recent newsletter, aluminium is the most energy-intensive of the metals. Its production is migrating from cheap energy-challenged areas (China and South Africa) to energy-abundant areas (the Gulf States). The Saudi smelter will produce 617,000 tonnes of the metal each year, making it one of the world’s largest. It will cost US$7.5 billion to build.
Rio didn’t say how much it would get of that US$7.5 billion. But between Rio, Worley Parsons (ASX:WOR), Leighton (ASX:LEI), and a host of other Aussie mining services and infrastructure companies, the move by the Saudis into minerals and metals production should be good news for Aussie firms. Our preferred play on aluminium continues to be bauxite, the ore from which alumina is made, which later is smelted into metal.
The votes are running 20-1 in favour of more technical analysis. Ask, and ye shall receive, only it will probably be over at Money Morning. We want to make a home for Gabriel Andre’s analysis of global indices, Aussie indices, and individual shares. But after careful thought, we believe that kind of approach is more suited to our sister e-letter, Money Morning.
The DR will stick with its skeptical end-of-the-worldism while Gabriel and Al Robinson over at Money Morning track money flows, moving averages, and the technicals (which are often described as the ‘language of the market’. Watch this space for further details and feel free to write in with your suggestions to firstname.lastname@example.org
How do you become a Decamillionaire? Easy! Move to Zimbabwe. Maybe it should be called a “Zimmillionaire.” Reader Luke in WA recently came into possession of a paper currency note from Robert Mugabe’s fiefdom. It had no watermarks and an expiration date. Luke placed it next to a gold coin to show DR readers the difference between real money and government fraud. Thanks Luke!
The Daily Reckoning Australia