If the BHP Billiton bid to take over Rio Tinto is scary, the reported plan of Chinese steel makers, although being denied vehemently by a few concerned, to get into the race to acquire the company with a much larger counter bid, should be a massive headache for the steel makers outside of China, as also to the iron ore industry elsewhere.
The move to acquire Rio Tinto by BHP Billiton (BHPB) has shaken most steel makers, except those with access to captive iron ore. The steel industry has had enough in the process so far, with the iron ore industry getting increasingly consolidated, with few behemoths exerting their pricing power in a clear oligopolistic market. If there is one more merger, the trouble for the steel industry will increase. Also, BHP Billiton and Rio Tinto have massive coking coal businesses.
The timing of the BHPB move is just ahead of the negotiation for iron ore contracts for the coming year. Any speculation or fear of supply can weaken the bargaining position of steel. While iron ore supply is being augmented and is meeting current demand, it is falling behind the growth in demand, and one will see a much longer queue for iron ore. Iron ore production could be increased with greater efforts. But, the prices have risen to this height because of a regional mismatch between demand and supply and higher ocean freight. China?s steel production growth is not backed by local iron ore. While they get it fairly cheap from Australia, their critical dependence of Brazilian ores, which are to be hauled a long distance at a massive cost, paves way for Indian origin iron ore prices to rise to extraordinary levels. This sets the spot market benchmark. The situation will not changefor Chinese mills, now. In fact, a merger of BHPB and Rio can trigger a total collapse of the country?s steel industry, if they have to pay more consequently. Many of them are already the highest cost producers in the world.
The only option for the survival of Chinese mills is, therefore , to buy Rio or BHPB. They can buy many smaller players such as Grange. But, it won?t help them as much. Chinese steel makers after all may not be so interested in buying Rio. But, they are certainly sending a signal down to the iron ore negotiating table. Again, to gain something this time around.
However, if a Chinese company backed by the country?s sovereign funds, buys up Rio, their iron ore insecurity is over forever. The reduced dependence on the spot market will significantly weaken Indian origin iron ore prices. Perhaps Indian miners will have to look for opportunities outside of China in such an event.
The author is Strategy Consultant: Steel, Minerals, and Coal