>> ASIAONE / NEWS / THE STRAITS TIMES / STORY

Lodes of opportunity
Andrew Symon Tue, Nov 27, 2007 The Straits Times
AUSTRALIAN minerals giant BHP has come a long way from those days over 120 years ago when sheep station boundary rider Charles Rasp discovered what would prove to be one of the world's richest lead-silver-zinc deposits. What Rasp, a German immigrant educated in chemistry, found in 1883 at a place called Broken Hill in the far west outback of New South Wales would become the foundation for the company he and six partners from the Mount Gipps station established in 1885 - the Broken Hill Proprietary Company. Known today as BHP Billiton, the world's largest mining group now wants to create an even greater behemoth through a merger with the Anglo-Australian group Rio Tinto, another huge mining firm. Such a merger would result in a group with a market capitalisation of more than US$350 billion (S$505 billion) and unprecedented production strength, if not dominance, in a host of important mineral and energy commodities. These range from mines and plants in more than 25 countries - iron ore, bauxite, aluminium, copper, nickel, titanium, cobalt, manganese, lead, zinc, gold, silver, diamonds, uranium and coal. (BHP Billiton also has petroleum interests which, while significant, are not large in multinational company terms.)

No wonder China, with the world's fastest-growing demand for many of these commodities, feels vulnerable. In the case of steel, for example, where China produces more than a third of world output, it would face a BHP-Rio producing 40 per cent of the world supply of iron ore.

China's concern over such a prospect was seen last year during its iron ore negotiations with BHP Billiton, Rio and other producers. Beijing, worried about the sharply higher prices facing its steel mills, threatened to impose a price ceiling on its purchases. But it backed down in the end, with producers arguing that such a move would be against China's World Trade Organisation obligations.

On the international minerals supply side though, the WTO does not appear to have any mandate.

BHP Billiton has already been quick to assure Chinese, Japanese and other buyers that a merger would, in fact, be to their benefit as it would mean lower production costs and more output to meet demand. Buyers would benefit.

But what cannot be denied is that a BHP-Rio merger would create a group of such a size that the conventional economics of the minerals and commodities markets would no longer hold - at least for the time being.

And it is difficult to see what national competition regulators could really do. National regulators can intervene only if the mines are producing for their domestic markets. But most mines in countries where these companies operate are export-oriented.

The various segments of the mining industry have generally operated reasonably close to textbook models of competitive markets. There are many producers and many buyers and none is big enough to influence prices. The product, a commodity, is standardised, so producers cannot gain any market leverage through differentiation of their products.

A tonne of iron ore is pretty much the same whoever produces it. So producers have operated in a world where they have had to accept the prevailing market price. The name of the game then for mining managers is to reduce costs as far as possible so as to maximise returns, given that market price.

But a BHP-Rio entity would, by the size of its production and scale of its reserves in several important mining segments, be able, if it wished, to influence price. At the bargaining table, it would be in a good position to dictate prices and contract terms.

The proposed merger is a culmination of a trend over the past two decades for the aggregation of mining concerns. Companies have merged with and taken on others as a means of cutting costs through economies of scale and reducing market risk by diversifying their production portfolios.

In the case of BHP, this can be seen in its merger with the British (originally Dutch) group Billiton in 2001, which resulted in a dual listing in London and Australia, but with its corporate headquarters remaining in Melbourne.

Then in 2005, BHP Billiton acquired Australia's Western Mining Corp and, with that, the world's largest uranium mine - Olympic Dam - in South Australia. So a merged BHP-Rio entity would produce more than 25 per cent of the world's uranium oxide supply.

These moves were part of a great rejuvenation of the company's energies in the last decade, after a crisis in the mid-1990s, when what has long been known as the 'Big Australian' found itself stumbling, with profits and share prices plummeting after several big investment blunders.

In 1998, BHP's CEO and chairman fell on their swords. The board then established a new and more visible leadership under an American CEO, Mr Paul Anderson, who was previously from Duke Energy in the United States.

Mr Anderson shaped a new BHP - helped by booming mineral prices as a result of China's rising demand - handing over the reins after the Billiton merger to Billiton's Mr Brian Gilbertson.

The latter fell out with the board after six months and was succeeded in 2003 by another American, Mr Chip Goodyear, who maintained the momentum created by Mr Anderson. Mr Goodyear retired earlier this year and was succeeded by South African Marius Kloppers, a chemical engineer who came to BHP via the Billiton merger. And now Mr Kloppers wishes to make his mark on BHP.

Rio Tinto, similarly, has enlarged itself through major acquisitions. It recently took over Canada's Alcan, making it the largest aluminium producer in the world.

Rio was originally formed by British investors, including the famous Rothchilds bankers, in both London and Paris in 1873 to take over mines opened in ancient times in southern Spain. A century later it established what would become a large Australian- based company, Conzinc Rio Tinto, through acquisition of Australian mines. Like BHP Billiton, Rio has a dual listing on London and Australian stock exchanges, but with its headquarters in London.

Also driving the formation of these mega mining firms are demand-side factors: Smaller mining companies have long complained of the bargaining strength of large buyers, especially the Japanese, and now the Chinese, who may act effectively as consortia in negotiations to gain leverage over a more fragmented mining world.

If a BHP-Rio entity were created, the tables might be turned. But for how long?

Ultimately there are no high barriers to entry in the mining industry. Mining technology is advanced but not restricted. It is a capital-intensive business and economies of scale do help, but there are still generally abundant mineral resources around the world that can be tapped by other companies.

And markets, driven by Chinese demand plus that of other industrialising giants such as India and Brazil, will continue to grow strongly.

What we might then see is China's mining companies, backed by their state banks, scrambling to gain alternative sources of mineral supplies, particularly in Africa and Central Asia.

The writer is the Singapore-based South-east Asia manager for Menas Associates, a British consultancy with a focus on the energy and mining industries.

NO LACK OF SUPPLY AND DEMAND

There are still generally abundant mineral resources around the world that can be tapped by other companies. And markets, driven by Chinese demand and that of other industrialising giants such as India and Brazil, will continue to grow strongly.