Features | Economy | East Asia

Master of the Universe

Diplomats, politicians and mining executives like to say that there is always heat and colour in the iron ore trade and this year is no different to any other.

By John Garnaut for

Diplomats, politicians and mining executives like to say that there is always heat and colour in the iron ore trade and this year is no different to any other. But the annual contract negotiations have never drifted on for so long without a resolution.

The Chinese Government has never before sent so much capital overseas as it did this year to intervene in BHP Billiton’s takeover bid for Rio Tinto. Resource prices have never been this high for so long, helping to make inflation the number one concern of the Chinese people, according to the Chinese Premier Wen Jiabao.

And Chinese industry leaders have never black-balled Australian exports and hurled insults at Australian mining executives quite like they have this year.

“Their brains are bloated and their heads are full of water,” said Wu Xichun, the former chair of the powerful China Iron & Steel Association, referring to Rio Tinto holding out for a bigger price rise than the 65-71 per cent already agreed by Brazil’s CVRD.

Australia and its key trading partners in Northeast Asia are playing a game of brinkmanship that could easily spill over into the political arena.

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Most of Australia’s long-term iron ore contracts will terminate on June 30 if no annual price agreement is reached by then. Nobody quite knows what will happen if the Australian majors then move to place huge volumes of ore on to the white-hot Chinese spot market, as they will be legally entitled to do.

Nobody knows how China will react if the Rudd Government rejects a major Chinese investment bid, or how Japan will respond if China succeeds in “locking up” key supplies by buying a major Australian miner. And nobody knows whether steel makers in China and perhaps elsewhere can dilute Australia’s market share by boosting supplies from elsewhere in the world, or if they can drum together an import cartel to fight what they see as a dangerous mining company oligopoly.

Demands by Chinese steel officials for “an orderly market” – code for asking for the Australian Government to somehow intervene to give China discount iron ore – are unrealistic. But Chinese corporations are occupying the high, open-market ground when they question why so many Chinese investment applications are stuck without resolution inside the Foreign Investment Review Board and the office of Treasurer Wayne Swan.

Swan has failed to make prompt decisions on a range of Chinese investments that are too small to conceivably challenge Australia’s national interest. His real test will come when Chinalco asks to increase its 9 per cent stake in Rio Tinto, or a Chinese company applies for permission to buy a major stake in Australia’s “third force” iron ore company, Fortescue, or an overseas steel maker moves to take a significant stake in BHP.

China’s top steel maker, Baosteel, is indeed toying with the idea of buying a chunk of BHP Billiton, although how and to what ends is far from clear.

“Large Chinese companies like Baosteel, Wugang and Angang hope they can come together to take a significant stake in BHP,” a top Chinese mining and steel official told The Diplomat. “But organising this is not easy.”

It seems that Chinese steel makers feel they need “to be at the table” even if that would give them no obvious power to affect the merger or resource pricing decisions when they get there.

Swan and his investment review board would then ponder whether such a Chinese shareholdings could influence management decisions and, if so, they whether they would threaten the national interest and should therefore be rejected. Already, Chinese corporate leaders wondering whether their investments are welcome in Australia anymore.

A senior executive at Shenhua Group, the giant Chinese coalminer, confronted Mr Rudd on the subject in Beijing in April, according to another Chinese executive who was at the meeting.

“Chinese companies have got a kind of feeling that we are encountering unfair policies,” said the executive. “We don’t want any preferential policies, we just want fair and open competition.”

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Some suspect that the Rudd Government’s anxiety about Chinese investment reflects the lobbying interests of BHP more than any clear-eyed analysis of Australia’s national interest. The BHP board does not want Chinalco to raise its stake in Rio at a time when BHP is trying to buy the company, and nor would it be comfortable with a major Chinese investor on it own share registry.

Indeed, people close to BHP have been arguing that “the Ruskies or Chinese” will grow to dominate the world’s mining industry if BHP Billiton and Australia do not do so first. A similarly crude and improbable argument has been heard emanating from inside Australian ministerial offices, if not so poetically expressed.

“Don Argus has argued very persuasively to both the Howard and Rudd governments that the merger will deliver a national champion too big to be taken over,” says Max Suich, a former Sydney Morning Herald editor who previously reported on the early Australia-Japan resources trade from Tokyo. “The line is that it will preserve influence and profits for Australia,” he says. “The silence from Canberra on the merger suggests tacit approval and that Argus has won the argument.

“The last time we heard about national champions was from Rex Connor,” he says, referring to the notoriously protectionist former treasurer and prime minister.

Robert Macklin, who was Jack McEwen’s media adviser in the late 1960s and is now writing a history of BHP, says the company has always been an exceptionally powerful lobbyist.

“They always wanted protection of some kind,” he says. But Macklin believes Rudd has a “broader vision of Asia” and he has been captured by BHP.

Professor Peter Drysdale of the Australian National University warns the Rudd Government to learn from Australia’s mistakes during the commodities booms of the 1970s, which he believes led the country to forego investment and market share.

“In the 1970s prices went through the roof and then we went over the top on interventionism,” says Drysdale, listing Australian moves to renegotiate long term contracts, intervene on foreign investment and introduce government surveillance of price settlements.

“The proper approach is for the government to stand out of the market – we seem to have learned that position in principle but not necessarily in practice, especially on the investment side.”

Drysdale says the argument that China’s state-owned companies should not be welcome investors in Australia is misguided.

“The whole thrust of policy and institutional development is to entrench the market as the driver of Chinese enterprises,” he says.

And Drysdale says it is also wrong to argue – as some close to BHP have been arguing – that a Chinese state-owned company can’t be trusted to charge market prices for Australian resources sold to Australia. He says it is up to regulators like the Tax Office to ensure profits aren’t illegally transferred from Australia to China, just as it does with all multinationals that operate in Australia and might be tempted to transfer profits to holding companies in low-tax jurisdictions.

It is not just China that is nervous about two of the world’s three largest mining companies combing. Japan, Korea and Taiwan are just as worried. Unlike China, these countries rely on Australia for the bulk of their steel-making coal as well as iron ore.

Officials in Japan, Korea and Taiwan are privately dismayed at what they believe is the Australian Government’s blind support for an anti-competitive merger. One senior official in the region says a merger will be harmful to Australia even before international repercussions are taken into account. “It will produce a monster company that is beyond government control and market competition,” he says.

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The official believes the merger will hurt Australia’s international diplomacy and trigger retaliation from key trading partners. “If the BHP-Rio merger is realised, many countries will think the Australian government has given up the doctrine of free markets,” says the official. “Steel makers of Japan, Korea, China and perhaps the EU may take counter measures like forming their own international import cartel?”

Many buyers and officials in North Asia believe Australian companies have over-played their hand and that steel mills may combine to punish them whenever the market turns in their favour.

Australia has so far failed to generate any serious debate about the BHP-Rio merger proposition and the wider repercussions of a more aggressive marketing stance. Suich is surprised the media and commentators are treating it as merely a stock market story. “There’s been no discussion about whether this merger is a good idea,” he says.

BHP argues that merging with Rio will enable the two companies to optimize their use of infrastructure and therefore increase exports. There are many investment analysts that agree. But Suich agrees with Asian importers that the merger would only “exacerbate and highlight a cartel that has existed for some time.”

Amid all the international acrimony over the corporate mining wars there is one thing on which the Japanese steel industry and BHP Billiton agree. If the world resources trade is going to be dominated by one player then it may as well be Australian rather than Chinese.

“Do we really want Baosteel to intervene in the BHP take over of Rio Tinto, so we are dependent on China rather than BHP for our iron ore?”, says a Japanese industry official.