BHP's hardball tactics could rebound

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31 Jan 2010

WHEN BHP Billiton chief executive Marius Kloppers flew to China last week he was expected to try to placate officials who are overseeing iron ore negotiations and administering the country's new anti-monopoly laws. Commentators expected he would see Shang Ming, director-general of China's Anti-Monopoly Bureau at the Ministry of Commerce, who has spent much of the past eight months working out whether he can and will upset BHP's iron ore joint-venture plans with Rio Tinto.
“Everyone knows that the Chinese Government, including the Ministry of Commerce, are extremely unhappy about the proposed joint venture,” says Allan Fels, the former Australian Competition and Consumer Commission chief, who has advised Mr Shang on his new anti-monopoly powers. “And the Chinese law appears to have full extra-territorial force, which seemingly fully covers the transaction.”
Some thought Kloppers might also try to see Li Yizhong, the former oil company chief who now runs a “super ministry” of industry and information technology. The ministry is overseeing this year's price negotiations and is drawing up measures to track and potentially control iron ore imports, at a time when BHP is leading the charge to tear the old benchmark pricing system down.
"The international iron ore market is monopolised by the three leading miners,” said a spokesman for the Ministry of Industry and Information Technology on Thursday.
"We hope that they will bear in mind long-term interests of the industry and friendly long-term co-operation with China. We're expecting a fair price."
But Kloppers didn't see Shang Ming, Li Yizhong or, it seems, any other senior Government official. He didn't make it to Beijing, where the company no longer has an office.
Instead, sources say, Kloppers mostly let his key customers come to him at BHP's Shanghai headquarters, which is reeling from the exodus of three of the company's most experienced and respected executives.
China president Clinton Dines left the company in June, after two decades. Frank Xu, who close observers say “owned” government relations for the company, left in July. And now Robin Bordie, the company's key China economist, has told the company she's leaving.
BHP is well aware that it is one of the few companies in the world with the power to set terms with China. “If you're going to play in this game, then you have got to play with the big boys, and they know that,” chairman Don Argus said in October, brushing off problems that might arise if the joint venture with Rio Tinto caused hostility in China.
BHP's clear and uncompromising China strategy has plenty of admirers. But those same people warn that success depends entirely on execution.
"It's not against the rules to start a war when dealing with China," says the long-time China head of another big resources company (which does not sell Australian iron ore). "But you cannot back down, and you absolutely cannot lose."
Jim McGregor, author and former chairman of the America China Chamber of Commerce, warned last week in Time magazine that China is becoming an increasingly unpredictable and hostile environment for foreign companies.
He says it makes sense for some companies to draw a strategic line in the sand, provided they are well prepared and know that what goes around may come around.
"When you're in a business and you have a lot of leverage over China, you'd better be careful how you use it, because they have very long memories," says McGregor.
In the past two years, Chinese companies and officials have demonstrated that gaining better terms for iron ore trade is a national priority. They have thrown their weight around but have so far had mixed success.
Chinalco rudely interrupted BHP's original takeover bid for Rio Tinto, which was later aborted. China's top intelligence agency tapped the phone and email traffic of Rio Tinto and then detained Stern Hu and three other members of Rio's sales team, initially treating the case as a threat to national security.
The China Iron & Steel Association and some Government officials managed to temporarily block spot-market shipments from both companies. And Chinese steel mills walked away from contracts without apology when prices plunged during the financial crisis.
But, so far, the laws of supply and demand have been too strong for even the champions of "China Inc" to break.
China's iron ore imports rose an astonishing 42 per cent last year, to 630 million tonnes, while the rest of the world collapsed. It accounted for as much as 70 per cent of global seaborne trade. Australian miners secured the lion's share of those extra shipments.
Australia's global iron ore exports rose 17 per cent to 383 million tonnes, even as they fell to other major destinations. Exports to China rose by 46 per cent, to 282 million tonnes — nearly three-quarters of Australia's total.
It seems both BHP and Rio Tinto can virtually do what they like for as long as China is desperate for their ore. It may be a different story when the market turns. Chinese companies, with Government support, are bringing forward that turning point by furiously commissioning start-up mines around the world.
"It's pretty obvious that BHP have decided that playing hardball with China is OK," says Arthur Kroeber, principal at Beijing consultancy Dragonomics.
But he says the strategy "makes sense" now, but might not look so good when the supply curve catches up with demand. "If you go out of your way to play very aggressively when conditions favour you, there is a likelihood that there will be reprisals of one kind or another when conditions go the other way.”
BHP headquarters is confident that the work of reading, engaging and anticipating China has not missed a beat.
"Our China office is as important to us today as it always was, given the significance of the China market," says BHP spokeswoman Samantha Evans.
But it will not be easy to make up for the loss of Dines, Xu and Bordie, and the closure of BHP's office in Beijing.
In two years, BHP's China staff has been cut from about 100 to 70. Rio Tinto, in contrast, maintains about 130 staff in Beijing and Shanghai.
"BHP has now got no machinery at all for engaging with the Chinese Government, at a time when Australian corporate and political relations with China have never been shakier," says one source who has worked with BHP.
All three employees declined to talk about the reasons for their departure.
“One area where the big suppliers have some work to do is developing — or repairing — stable, long-term relationships,” Dines and iron ore consultant Philip Kirchlechner wrote in an opinion piece published in BusinessDay (January 20).
“It seems that many senior managers in the industry do not understand what a relationship is, in the East-Asian, Confucian context.”
Rio Tinto's travails in China are well known and it has the bigger hole to clamber out of.
But Rio is now sharing the bad press with BHP. Reports of BHP lobbying against “China Inc” in Canberra have been embellished in the Chinese media, with headlines like “Bad Boy BHP”.
BHP's government and community relationships may not be what they were two years ago but its commercial operations remain strong. Its steady march towards clear corporate strategic goals stands in contrast to Rio Tinto's three-year vacillations.
Rio Tinto's China operations are going through a "rebuilding" phase. The company's chief iron ore salesman, Stern Hu, is in jail, along with three members of his sales team, while Hu's former right-hand man has retreated to the Singapore office. Rio's China president, Tony Loo, has quit and headed for Las Vegas, and is yet to be replaced.
BHP's latest production report shows it continues to execute ruthlessly and persistently its five-year long strategy to dismantle the benchmark contract pricing system. The system penalises Australia compared with other benchmark suppliers which carry higher freight costs, like Brazil, and also helps Indian and domestic Chinese suppliers which get much higher prices on China's spot market.
In the second half of last year, BHP sold 46 per cent of shipments on "short-term referencing pricing", with the remainder sold on annual contract prices. The statement implies that most shipments to China were made at quarterly negotiated prices, index-based pricing or on the spot market.
The significance of this lies well beyond the tens of millions of dollars BHP implicitly earned from its shipments last year that its competitors did not.
It appears to mean that, by the end of March, many BHP customers will have accepted that they have reneged on their long-term contracts — perhaps in exchange for BHP forgiving contractual non-performance during the financial crisis.
At the same time, local analysts say, the company has been rapidly gaining new customers on non-benchmark terms.
BHP has gone halfway towards smashing the benchmark pricing system in its most important market while its competitors have not.
At the same time, some observers suggest BHP has quietly taken the lead in negotiating with Baosteel and the China Iron & Steel Association on this year's prices for the remaining Chinese benchmark contracts.
Clearly, BHP's smart and well-regarded iron ore sales chief, Ben Williams, has been on top of his marketing job.
Williams, who has spent 20 of the past 30 years in China and speaks the language fluently, has been elevated to China president. He has back-up from Lu Jianzhong, a sharp and affable technology and uranium expert who was formerly a United Nations diplomat. Lu has taken control of Chinese media relations.
But they have a power of work ahead.
China's efforts to get a better deal in iron ore are not about to stop.
"Iron ore is a core national interest for China,” says a senior official.
Nobody knows how the next round of iron ore wars will be played out.
Shang Ming at the Ministry of Commerce might rule that the BHP-Rio joint venture is anti-competitive. But it's not obvious that he has legal sanctions in his armoury that would hurt the miners more than Chinese mills.
"Because BHP Billiton has almost no assets in China, there appears to be very little grip that the Chinese Government can have on this offshore transaction,” says Fels.
In June, shortly after announcing the Rio Tinto joint venture, Kloppers dismissed the risk of Chinese or Japanese regulators intervening with the deal. He said his company was "just largely a seller of product into those markets, so we don't have any local businesses in China or Japan that would be affected by this".
An adviser attached to China's Ministry of Commerce immediately begged to differ.
"According to China's antitrust law, we can veto such a merger agreement if the concentration of overseas business operators will affect domestic market competition," said Ma Yu, director of the Foreign Investment Department at the ministry's Academy of International Trade and Economic Co-operation.
"If the joint venture is set up regardless of China's opposition, the Government can also resort to trade sanctions against the two entities on future business transactions with China.”
Veterans of the Australia-China relationship and iron ore trade are impressed at the clean strategic vision of Kloppers and his chairman, Don Argus. But they worry that the pair have underestimated China before and may be doing so again.

Source: The Age