Commodity Blog

Metals markets could see longer-term prices move up if BHP Billiton Ltd.’s (BHP.AU) sweetened $147.7 billion takeover bid for rival global miner Rio Tinto Ltd. (RIO.AU) proves successful.
The key synergy and future money spinner for the merger is still iron ore, where longer-term prices are likely to rise, but there is also upside potential for alumina and copper on a regional basis, analysts said.
A takeover would create a $336 billion mining giant with a leading position in iron ore, copper, coal, alumina and aluminum.
When BHP announced its initial and informal bid proposal back in November, commodity consumers led by China cried foul fearing consolidation would give the company unprecedented pricing power in iron ore and other raw material markets.
A merged entity would control 36% of the global seaborne iron ore market, coming in just behind Brazil’s CVRD, the global number one with a 300-million-ton annual production.
This is indeed a worrying development for Asian and European steel mills, but BHP on its part has been on a charm offensive since then, talking to Chinese steel mills among others and placating at least some.
More importantly, Aluminum Corp. of China, or Chinalco, along with U.S-based Alcoa Inc., has taken 9% stake in Rio Tinto which it bought from the open market for $14.5 billion.
State-owned Chinalco has said it doesn’t plan to make an offer for the whole of Rio Tinto, or seek a seat on the company’s board, but the stake has effectively given the Chinese a seat at the negotiating table as well as more say in pricing matters.
That has put the focus back on BHP’s offer price, rather than the bigger market share it would command, should the merger goes through.
Interestingly, BHP’s Chief Executive, Marius Kloppers has said the latest offer represented the best price based on information currently available, hinting the miner could sweeten the offer if it saw greater synergy in the deal.
The implication is that if Rio wants more money, it will need to open its books and share information with BHP to allow the identification of further synergy, said ABN Amro analyst Warren Edney.
It was also significant that Kloppers said the miner could have necessary regulatory approvals by the second half of this year. “Following detailed analysis, we believe that any regulatory concerns can be addressed without meaningfully impacting the benefits of the combination,” he said.
While competition issues will be “a reason why there won’t be a quick deal,” concern over antitrust issues “appears to be overdone,” said ANZ Commodity Strategist Mark Pervan.
Many see Chinalco Rio Tinto buy as an admission that fighting the merger from a regulatory angle to prevent further consolidation in the already highly concentrated iron ore market won’t be easy.
“There’s no international regulatory body for the Chinese to turn to,” said Commodity Analyst Tom Price at Merrill Lynch.
Regulatory concerns at the ACCC, the Australian Competition and Consumer Commission, will be limited as the body focuses on domestic issues, and the vast majority of Australia’s iron ore is for export.
Complaints by European steel mills lack teeth because they import iron ore from Brazil rather than Australia.
Iron Ore Prices To See The Biggest Impact
Despite lower first-half profits of $6.02 billion, down 2.4% on year, BHP Wednesday said it was positive about the outlook for its products while Asian economies showed little sign of slowing.
Even amid mounting concerns about the U.S sliding into a recession and the International Monetary Fund downgrading its forecast for global economic growth, BHP in January announced it signed a revised iron ore sales agreement with Chinese steel maker Boasteel, to supply 10 million tons a year for the next ten years, up from an earlier agreed 6 million tons a year.
However, many forecasters have scaled back expectations for Chinese growth, with Barclays Capital cutting its 2008 growth forecast to 8.85 from 10.2% earlier.
But for commodities, that slowdown will have little impact, analysts such as Yingxi Yu at Barclays Capital say. Even in single digits, China’s growth is still far stronger than elsewhere and large-scale Chinese infrastructure projects that are independent from export markets will still go ahead.
While the fundamental outlook in the industry hasn’t substantially changed since BHP first announced its intention to buy Rio, a merger could also act as a hedge, should there be a slowdown.
If demand does weaken from current levels, this new generation of mining giants may use their size to fight off lower prices, said Peter Richardson, a commodity analyst at Melbourne-based resource fund Craton Capital, which has assets worth around $350 million under its management.
Steel mills may not see an immediate impact, but in the long run, BHP will have the ability to squeeze production to support prices, despite Kloppers’ assurances that BHP/Rio would raise raw material production, and make it cheaper.
“BHP is pushing for an iron ore index as a proxy for spot prices rather than (have) annual contracts. They would only do this if they believe they have sufficient control over supply,” said Merrill Lynch’s Price.
Alumina, Copper Pricing To Change Too
Rio’s own $38.1 billion acquisition of Canada’s Alcan in November would mean a combined BHP-Rio would have a stranglehold on much of the world’s supply of alumina, the raw material used in the production of aluminum.
Alumina prices are currently linked to metal prices on the London Metal Exchange but that may change.
BHP wants to dismantle that linkage, favored by integrated producers such as U.S-based Alcoa Inc. Kloppers has argued that, like previously with iron ore and steel prices, the current pricing for alumina doesn’t reflect the market’s supply and demand fundamentals.
“In iron ore, spot markets trade at a sizable premium to contract prices, and act as a bellwether for contract prices,” said Pervan. “Delinking alumina from the aluminum price would be bullish for alumina and would pressure high-cost smelters,” he said.
In copper, BHP/Rio’s potential control of 13% of global copper mines wouldn’t be of concern given Chile’s state-owned copper giant Codelco claims a similarly dominant position. But the merged entity would control around half of copper concentrate imports into Asia, potentially worrying smelter costumers there, said Price.
BHP and Rio co-own Chile’s Escondida mine, the world’s largest copper mine with a capacity of 1.2 million tons and producing about 9% of global copper consumption. “That doesn’t sound like much but Escondida accounts for about half of copper concentrate supply into Asia,” said Price.
BHP owns 57.5% of Escondida and Rio 30%. The remainder is held by a Japanese consortium led by Mitsubishi Corp. which has 10% and the International Finance Corp. which has 2.5%.