Mining groups and metal makers got themselves in a pickle a year-and-a-half ago when commodity prices collapsed across the board. But the experience proved particularly hurtful for the Anglo-Australian Rio Tinto since just ahead of the world slipping into a crippling recession it bought the Canadian aluminium maker Alcan at top dollar of $38 billion. That left it with a debt mountain of $39 billion.
As it started living with the draining takeover experience – Rio’s acquisition was soon to coincide with the world resting over 5 million tonnes aluminium capacity in the face of rapidly falling price – it itself faced will-they-won’t-they nerve raking kind of bid from the mightier industry peer BHP Billiton. This became a story of many twists and turns with Rio first seeing in Chinalco the white knight and then turning away from China’s leading resources group to form an alliance with BHP in mining of iron ore in Australia’s Pilbara region. Rio’s relationship with China got further soured when last year four of its employees were arrested suspected of espionage.
But if one’s bread and jam is in iron ore then rest assured that sooner than later, one will make up with China, the world’s largest importer and processor of the mineral. Rio and Chalco, a Chinalco subsidiary which with nine per cent is the single largest equity owner of Rio, have entered into a joint venture agreement to develop Africa’s largest integrated iron ore mine and infrastructure project at Simandou in Guinea.
Let’s consider their compulsions to start working together. In the words of Rio chairman Jan du Plessis, “Developing our relationship and business links with China are key priority. This agreement takes our relationship with China to a new level.” As for China, Chinalco is state owned, the ownership of 44.65 per cent of Simandou venture with capacity to raise 95 million tonnes of ore will give a sense of security in supply of steel industry’s principal raw material as it also hopefully lays the ground for further such collaborations.
It is principally on the back of iron ore making a resounding break from last year’s slump that Rio and the Brazilian Vale, the world’s biggest ore producer, are seeing renaissance in their fortunes. Indian exporters of the 63.5 per cent grade ore saw the price going up rapidly in the last few weeks to now over $150 a tonne. Unfortunately, however, Goa-based exporters are badly stuck because of Beijing fiat on traders not to import ore below 60 per cent iron content if they haven’t got back to back sale contracts with steel mills. This explains why Sesa Goa, a Vedanta group unit, is easily able to sell low grade ore in China and could, therefore, report a more than three-fold jump in its net profit in the June ended quarter to Rs1,302 crore.
Announcing the highly encouraging second quarter result, Vale CEO Roger Agnelli said his company was in a very strong position. “I should say that we are in the best moment of our history. The scenario is very positive.” Similarly, Rio’s half yearly net more than tripling to $5.8 billion compared with $1.6 billion for the corresponding period of 2009 is 70 per cent on account of iron ore where the spot price now is more than double last year’s. The ore division of Rio, which also has significant presence in aluminium and copper, is enjoying as high a profit margin as 68 per cent.
Because of the sheer size of its steel industry and volume of its ore imports, China should normally be bearing upon heavily on the mineral prices. In the first seven months of 2010, Chinese imports of ore totalled 361.2 million tonnes. See this against leading shipbroker Clarkson’s forecast that global shipments of ore this year will advance six per cent to 961 million tonnes. Ore price movements are not necessarily in sync with the steel industry’s ground level reality. Like, ore pries have remained strong even while the Chinese July production of crude steel of 51.7 million tonnes was 3.9 per cent down on June output. Production may not rise this month and also in September as Beijing is pushing for phasing out 35 million tonnes of old, inefficient and polluting steel capacity. Last year, China shut 21.1 million tonnes capacity. As against this, ore producers will argue that Chinese production rising 21.8 per cent to 323 million tonnes in the first half was enough justification for advancement in mineral prices.
But why is not China’s near record inventory of 80 million tonnes of ore at different ports reining in the mineral prices? The big inventory will suggest that the actual iron ore demand is not growing as fast as prices. What is also not factored in is the prospect of property prices in China falling further and the country not easing growth curbing measures soon. Construction accounts for 70 per cent of China’s steel consumption. Any further slide in the property sector could wipe away recent gains in Chinese steel prices.