Why Rio Tinto and China are at loggerheads
CHINA DOES not like to feel jealous of Japan. But in the case of iron ore it has plenty to envy. Back in the 1960s, when Japan was building up its steel industry, the world’s supply of the stuff was so fragmented that Japan could play off producers in Australia and Brazil against each other. China, now the world’s biggest steelmaker, does not have that luxury. Though it imports 70% of the world’s iron ore, most of this comes from three companies that in the intervening six decades have become titans. They are Rio Tinto and BHP, two Anglo-Australian firms, and Vale, a Brazilian one. They have brought about consolidation in the industry. They benefit from high barriers to entry. None is keen to undercut the other two. That puts them in a far stronger position vis à vis Chinese customers than their predecessors were with the Japanese.
China wants to change that. It is in the odd position of having world-leading technology companies but barely a toehold in one of the most basic industries of all, iron-mining, at a time when prices above $100 a tonne are throttling its steel mills. It has long hoped to alter the balance of power by backing the development of a vast iron-ore deposit in Guinea called Simandou, in which Rio Tinto has a joint venture with Chinalco, China’s state-owned aluminium producer (and Rio’s biggest shareholder). For years, Rio has subtly thwarted China’s ambitions by keeping the west African project on the back burner. But since last year a China-backed consortium in Guinea has upped the ante by pledging to push ahead with its own $14bn project to develop Simandou’s two northern blocks. Rio and Chinalco control the southern ones.
That creates a conundrum: should Rio double down on Simandou, sell out, or somehow continue to play a waiting game without offending either its Chinese customers or the Guinean government? It will fall to whoever replaces Jean-Sébastien Jacques, the outgoing boss of Rio whose departure was announced last month in the wake of the disastrous destruction of a 46,000-year-old Aboriginal site in Western Australia, to grapple with it.
Simandou, a forested mountain in inland Guinea, comes with 2bn tonnes of some of the world’s highest-grade iron ore—and a ton of trouble. In the decade since Rio forged its joint venture with a unit of Chinalco, the pair have been stripped of half of their concession, Rio tried and failed in 2016-18 to sell its share of the project to Chinalco, and the legal quagmire surrounding the whole Simandou saga has been so deep that Paul Gait of Azvalor, a fund-management firm, likens it to a John Grisham corporate thriller.
Adding to the drama, SMB-Winning, Guinea’s biggest bauxite exporter, which counts Shandong Weiqiao, a Chinese aluminium producer, as an investor, in June won Guinean government approval to develop the northern part of Simandou. It is also to build a 650km (400-mile) railway from the mine and a deepwater port. It clearly hopes that Rio and Chinalco will share the burden. This coincides with a geopolitical spat between China and Australia that has put Rio in an uncomfortable position. Though it still has power in the iron-ore market, its tune is changing. It now says that if Simandou is going ahead anyway, it may as well join in. But that is oversimplifying what should be a very careful calculation.
Start with the economics. Rio once estimated that the cost of developing Simandou, including building the railway and port, could be more than $20bn. That could now be partially split with SMB-Winning. However, if that were the case, Rio would lack full control of its freight costs, a critical factor in the iron-ore business. Erik Hedborg of CRU, a commodity consultancy, says that bringing both northern and southern blocks into production would add about 150m tonnes a year to the 2bn-tonne seaborne iron-ore market, which could push prices down by up to $10 a tonne. That would hurt Rio. If, however, only the smaller northern block were developed, the price impact would be far shallower.
As it is, many analysts expect prices to fall with or without Simandou. They have been artificially inflated in the past two years as a result of disaster-related outages in Brazil. China’s demand for iron ore is also considered close to peaking, especially given the mounting pile of scrap steel the country can recycle. The world hardly needs a new gusher of supply.
Then there are the environmental and social complexities. The deposit sits among rainforests rich in tropical species. The railway would traverse unforgiving hills and valleys, could require the relocation of local communities, and will raise the prospect of heightened scrutiny from investors already alarmed by Rio’s governance failures during the Aboriginal-site debacle. Not to mention the risks of dicey politics, corruption probes and social unrest that have hitherto plagued Simandou.
But what if SMB-Winning decides to forge ahead regardless? Rio has no easy options. Throwing all its weight behind the consortium would be reckless, especially if it would clobber prices that are already likely to fall. There are far safer ways to allocate capital. They include further iron-ore development in the Pilbara in Western Australia, which is so cheap and well served by infrastructure that Paul Gray of Wood Mackenzie, a consultancy, says producers could make money even if iron-ore prices fall as low as $40 a tonne. It could also try to develop copper, lithium, nickel and other minerals vital for clean-energy infrastructure, for instance.
Nerves of steel needed
Alternatively, it could try to sell its stake in the southern block. But after failing to do so to Chinalco, it is not clear who else would be a willing buyer. The best way for it to preserve its interests may be to sit tight on the southern block, advising everyone else how to make progress, but avoiding sinking lots of capital into producing its own ore. Whether the other firms want to proceed will be up to them. For all Rio’s ups and downs at Simandou, the policy of strategic inaction has worked so far. Whoever becomes Rio’s next boss would be unwise to abandon it. ■
This article appeared in the Business section of the print edition under the headline "Battle for the iron throne"
Author: | Post link: https://www.economist.com/business/2020/10/10/why-rio-tinto-and-china-are-at-loggerheads
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