Australia-based BHP Billiton’s US$150 billion takeover bid for rival Rio Tinto Group on November 12 sent shockwaves through the steel industry. Gao Jianfeng argues in the China Securities Journal's News in Focus section that Chinese steelmakers should launch a counter-bid for the iron ore miner

This year’s international iron ore talks are set to start soon in Berlin against the backdrop of BHP Billiton’s bid to acquire Rio Tinto. These two closely linked events have important repercussions for China’s steel mills. They need to move beyond “vertical integration” as merely a slogan and become proactive agents seeking to effect the events as they unfold.

Early this month, Australia’s BHP Billiton, the world’s second largest iron ore miner, made a bid to takeover Rio Tinto, the world’s third largest iron ore miner, in a share swap equivalent to US$125 billion in cash. The board of Rio Tinto firmly declined the bid and said it was considering a counter-offer to purchase BHP Billiton.

International players and experts have all expressed opinions on the acquisition and counter-acquisition war. Brazilian CVRD, the world’s largest iron ore miner, said that even if the two companies successfully merged, it would not influence next year’s global price for iron ore because the price should be determined by the “supply-demand curve”. According to Glyn Lawcock, general manager of Resource Research at UBS Warburg, the combined output of BHP Billiton and Rio Tinto will still lag CVRD, so the merger would not have a great impact on the global iron ore price.

By contrast, steel makers worldwide have called for strong opposition to the potential merger. The International Iron and Steel Institute argued that the merger would create an iron ore monopoly and suggested that the EU’s anti-trust institute should block it. Japan’s steel association made a clear-cut announcement that it was against the merger, which it said could cripple the market’s pricing mechanism. The China Iron and Steel Association also voiced its anxiety and said it would not want to see a monopoly.

The major steel players are concerned that, once merged, BHP Billiton and Rio Tinto would control 36% of the world’s iron ore output and have a profound influence on prices.

For instance, China’s iron ore imports from Australia accounted for 38.24% of its total imports, and most of that from BHP Billiton and Rio Tinto. If they merged, the new company would monopolize more than one-third of China’s iron ore imports. China is better off importing iron ore from Australia than Brazil’s CVRD because imports from the latter come with a longer shipping period and higher transportation costs.

China’s steel industry would not only lose favorable effects from the competition between BHP Billiton and Rio Tinto but would have to accept the Australian miner’s higher asking prices and shipping costs.

The Chinese steel makers should spare no effort to hamper the acquisition deal. First, China’s major steel makers could ally with domestic energy companies to offer a competitive price for Rio Tinto to “intimidate” BHP Billiton. Although BHP Billiton’s market capitalization measures up to US$145 billion, much larger than that of China’s number one Baoshan Steel, it is not necessary for the Chinese companies to acquire Rio Tinto – holding a stake should be the goal. Roughly calculating, US$100 billion would be enough to acquire a 50% stake in Rio Tinto, which would be affordable to a fund conglomerate of China’s energy giants, such as Bao Steel, Wuhan Steel, Gangshan Steel, Chalc, and China Shenhua. If not, the remainder could be financed by loans or share offerings.

If it succeeds, Beijing will be being influential in Rio Tinto’s resource exploration and production as a stakeholder. If a bid from the Chinese side is not successful, it could at least push up BHP Billiton’s takeover cost, making it pay for its future monopoly. China should also team up with the EU and Japan to campaign against that monopoly, and possibly dismantle the potential new company.

The average FOB price for iron ore imported to China was US$79.72 per ton in the first nine months, up US$16.98, or 27.06% on the same period of last year. According to the China Iron and Steel Association, China is able to supply 45% to 50% of its demand for iron ore. Macquarie Group has predicted 90% of the world’s demand for iron ore would come from China in 2011.

This article first appeared in Chinese in the China Securities Journal on November 21, 2007. The China Perspective takes no responsibility for the accuracy of the original article.