Australia Grapples with Chinese Influence

By Steve Fiscor, Editor-in-Chief

Last month, E&MJ offered details on the $19.5 billion strategic partnership between Aluminum Corp. of China (Chinalco) and Rio Tinto. The proposed deal would give Chinalco substantial interest in some of the Anglo-Australian miner’s iron ore, copper, and aluminum operations, but Rio Tinto would retain operational control. It would also raise Chinalco’s equity interest in Rio Tinto to 18% from 9.3%. This deal has some major implications for the global mining business and how it interacts with local governments and state-owned companies.

Rio Tinto sees the Chinalco partnership as a way to ease its $38.7 billion in debt. It also strengthens its relationship with China-the leading consumer of the raw commodities that Rio Tinto mines. Another aspect of the deal gives Rio Tinto access to mines inside of China with a joint venture for exploration activities. The deal has raised a lot of questions from shareholders, who are concerned about being treated fairly, so much so that the company now has a new chairman. Rio Tinto recently named Jan du Plessis as its new chairman. He takes over for Paul Skinner who had planned to step down later this year. In January, Rio Tinto named Jim Leng as a replacement for Skinner, but Leng resigned following a rift over the Chinalco deal. “Our immediate flcus must be on giving Rio Tinto the best possible platform to create shareholder value and to weather the tough and uncertain global economic conditions,” du Plessis said.

The deal is subject to approval by shareholders and regulators in Australia, Canada, China, the U.K., and the U.S. It is one of three mining related deals sitting before the Australian Foreign Investment Review Board (AFI). During mid March, the AFI said it would extend its regulatory review of the Chinalco-Rio Tinto deal by 90 days to enable due consideration of the proposed deal. The board is also reviewing the $1.2 billion Hunan Valin Iron & Steel bid for Fortescue Minerals. As this edition of E&MJ was going to press, the AFI reportedly blocked China Minmetals’ $A 1.1 billion takeover bid for OZ Minerals. A key principle concerning the country’s consideration of foreign investment, according to AFI, is the independence of the investing company from a foreign government.

From an iron ore perspective, Chinese steelmakers purchase about ½ of the world’s iron ore exports. About 75% of that iron ore trade is controlled by three companies: Vale, BHP Billiton, and Rio Tinto. For years, prices were set first by BHP and Japanese steel makers, and other deals followed suit. More recently, the negotiating process adapted to accommodate the largest consumer (China) and largest supplier (Vale). As E&MJ reported last year, the iron pricing systems is already showing signs of strain. Last year, there was a big departure is prices between what Vale and Rio Tinto negotiated. This year Vale decided to sit out and let Rio Tinto do the bidding. The bidding process has now become a regional affair between Australia (the largest supplier) and China (the largest consumer). This deal may hasten a move by the iron ore trade to a spot pricing system.

If the Australian government does not approve the deal, Rio Tinto has $10 billion debt due in October. Speaking at the Asian Mining Congress in Singapore during late March, Guy Elliot, CFO, Rio Tinto, said the company has contingency plans to cover the 2009 debt exposure. In its annual report, the company will have to raise funds from asset sales and other sources, or it will be forced to renegotiate debt at more “onerous” terms.

China is using its clout during a period of soft market conditions to integrate vertically by purchasing mining and mineral processing operations. Some have speculated in the Australian press that the AFI decision on OZ Minerals was a message to China that it will not always get its way with natural resources deals, no matter the cost. As a country, Australia is currently trying to negotiate a free trade deal with China, while balancing its concern about a state-owned group increasing its interest in Australian mining.