How China's Resource Reach Spread Abroad

飞雪寒冰

A source told Caijing that Minmetals was also following the directions of the State-owned Assets Supervision and Administration Commission (SASAC), whose Director Li Rong demanded in 2003 that state enterprises become “bigger and stronger.” Li’s goal was industry leadership within three years. That put enormous pressure on state companies.



Minmetals, through an open tender, bought 100 percent in Noranda for US$ 4.2 billion, beating competitors including Brazil’s Vale and South Africa’s Anglo American. But the transaction met resistance in Canada as well as within certain Chinese government departments. Amid the dickering, non-ferrous metals prices skyrocketed, taking Noranda’s share price with them. Soon, the US$ 4.2 billion offer looked pretty small.



A participant in the transaction told Caijing that Minmetals’ biggest obstacle was the National Development and Reform Commission (NDRC), which frowned on Minmetals’ prospects.



“NDRC officials thought the Minmetals platform was too small, that it was just a trading company and did not have managers with experience in mining industry production and operations,” the source said. “So they dragged their feet on the approvals.”



Caijing learned that NDRC insisted Minmetals ally itself with several domestic steel companies if it wanted to complete the acquisition. As the exclusive negotiation period with Noranda was about to expire, NDRC even asked CITIC to step in and take Minmetals’ place in the deal – an idea rejected by the Canadian company. Another analysis, however, said Minmetals failed because it was relying on bank loans to finance the acquisition

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Insatiable Appetite



Minmetals’ failure marked the true start of China’s overseas mining ambitions. It was also a new beginning in China for awareness of overseas acquisitions. In subsequent years, as mineral prices skyrocketed, Chinese companies saw the importance of upstream participation.



An official once in charge of overseas investment for a Chinese steel company told Caijing that, in the 1990s, the Ministry of Metallurgy had organized Baosteel, Wuhan Iron and Steel, Maanshan Iron and Steel, and other steel companies to discuss cooperative projects in Australia and Brazil. But the companies showed little interest.



“Those companies at the time weren’t optimistic about the iron ore market and feared that, after developing a mine, they wouldn’t be able to sell their ore,” the official said.



On the other hand, even though China made “going out” a national policy in 2000, officials in charge of overseas investment approvals still controlled the fate of such acquisitions. That opened a door to rampant power abuse.



A typical example was He Lianzhong, director of the State Planning Commission’s Overseas Investment Foreign Investment Department. After structural reform in 2003, He took a position as assistant inspector at NDRC, until he was investigated in 2005 by party discipline authorities. During that time, several missed acquisition opportunities appeared to have been connected to He. In 2007, he was sentenced to 12 years for taking bribes.



As recently as 2004, the Australian resource company Fortescue’s CEO Andrew Forrest was repeatedly rebuffed while visiting China in search of investment opportunities. An unyielding NDRC director at the time not only required that the China Metallurgical Science and Industry Corp. represent Chinese steel companies in any investment negotiations, but also required that the Chinese side to obtain a controlling interest. In the end, the two sides parted on bad terms.

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Despite this obstacle, Fengli Group – founded by Wu Yueming in Jiangsu Province -- bought 5 million shares of Fortescue for AU$ 1 per share. At the time, NDRC said the move was unapproved and against regulations. But after a number of twists and setbacks, Fengli’s deal finally won approval. Since then, Fortescue has grown to become Australia’s third-largest iron ore producer.



Since the current phase of worldwide energy and mining company consolidations began in the 1990s, single-metal mining companies have expanded to become multiple-resource miners, and domestic mining companies have embraced a global focus. These circumstances have led to a greater concentration of mineral resource control.



Rio Tinto was formed in December 1995 through the combination of mining companies RTZ and CRA. Vale privatized and began consolidating the iron ore industry two years later. In June 2001, Australia-registered BHP Ltd. combined with Britain’s Billiton Plc to create BHP Billiton. Today, these three companies control more than 70 percent of the world’s iron ore trade.



In the aluminum market, Australia’s Alcan in 2000 acquired the Swiss company Alusuisse. In early 2004, it bought France’s Pechiney Aluminum. And in September 2007, Rio Tinto acquired Alcan for US$ 38 billion.



Through it all China, as the largest consumer of mineral resources and energy, stood by and watched. It was clear, however, that a main target of these acquisitions was to build an operation that would appeal to China’s massive appetite.

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China relies on imports for more than half of its iron ore production. According to the China Steel Association, iron ore imports have grown about 20 percent per year since 2000. Last year, when China’s domestic production growth peaked, iron ore imports grew 15.8 percent over 2007.



To this day, China’s overseas iron ore interests amount to only 40 million tons, or less than 10 percent of import volume. Resource-starved steel giant Japan, on the other hand, holds overseas iron ore assets equal to more than 60 percent of imports.



In addition to iron ore, China imports many other kinds of non-ferrous minerals each year. Liu Boya, a metals analyst at Macquarie, said 75 percent of China’s copper needs and nearly 30 percent of its lead and zinc must be imported.



With three iron ore producers in the global driver’s seat, iron ore prices have inched steadily higher since 2004. Rio Tinto and BHP Billiton negotiated price increases of 96.5 percent in 2008. And for Vale’s Carajas mineral block, the contract price that was US$ 16.90 per dry metric ton in 2000 had quadrupled to US$ 81.36 by 2008.



“For bulk raw materials, this was enormous growth,” Xu Xiangchun, Beijing Steel Union chief information officer, told Caijing.



“Skyrocketing iron ore prices set ‘going out’ in motion,” said Xu. “Now that prices are high, companies are afraid they won’t be able to buy iron ore.”

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Signals from Chinalco



In the months leading to its latest Rio Tinto bid, Chinalco was preparing to launch an IPO. A three-executive team took the helm for the company’s overseas effort. Zhao left his CNMIEC job to work for Chinalco’s IPO office and later became the director of the company’s overseas development department. Wang had already joined Chinalco’s overseas holding company after jumping from the China Minmetals ship at the end of 2003. They were joined by Tai Yu, a former London trader who was one of the principal players behind Minmetal’s 2004 talks with Noranda.

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The brain behind it all was Xiao, who became Chinalco CEO and secretary of the company’s Communist Party branch. Xiao’s creativity and flair for risk opened a door of opportunity that Chinalco did not want to miss.



Chinalco is far from the largest biggest or strongest of China’s top 100 state-owned enterprises. But in January 2008, it won international fame overnight by partnering with Alcoa for a US$ 1.45 billion purchase of 12 percent of Rio Tinto. Chinalco thus became that company’s largest single shareholder.



The purchase of Rio Tinto shares not only surprised BHP Billiton, which itself was bidding for the Down Under miner, but also exceeded the expectations of Chinalco insiders. One Chinalco source involved in the transaction told Caijing, “We didn’t think we’d succeed at the beginning. It just seemed like a direction that we needed to start moving in.”



After the acquisition, Xiao told his group, “This is just the first step.” He knew Rio Tinto’s stock would tumble after the failed merger with BHP Billiton. So he began to prepare.



Across-the-board global mineral prices were dropping like rocks in late 2008 as the economic crisis spread. BHP Billiton dropped its bid for Rio Tinto, and in Rio’s stock value fell below 11 pounds, resulting in a startling loss on Chinalco’s balance sheet.



But Xiao said repeatedly that his goal was to stop a merger of the two mining giants -- and that he had succeeded.



It was then that Rio Tinto, itself mired in debt, gave China another opportunity. In December, the company said it would lay off 13 percent of its workers and cut 2009 capital expenses by US$ 5 billion. However, US$ 8.9 billion of their more than US$ 40 billion in debt was coming due in October 2009, meaning Rio needed a repayment strategy to present to stockholders before issuing 2008 results in February.

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Xiao took his second big step February 11 in the London law office of Clifford Chance, where he signed a contract that he said he “couldn’t even imagine.” In the agreement, Chinalco said it would inject US$ 19.5 billion in cash into Rio Tinto by purchasing assets and through other debt-reducing strategies.



“The amount of capital we’re using to cooperate with Rio Tinto is the largest of its kind in the world,” Xiao said later in Beijing. The foreign press called it a “pearl on the crown.”



This cooperation between Chinalco and Rio Tinto would include almost all Rio’s best holdings in copper, iron ore and other minerals. The transaction would assure a steady supply of iron ore and bauxite for Chinalco. Under the contract, their venture would include a hefty percentage of the Weipa mine bauxite sold outside Australia, in addition to 30 percent of Hamersly mine’s iron ore sales to China. Chinalco would also receive a secure, 25-year supply of Weipa bauxite.



Xiao said ties with Rio Tinto would raise the level of Chinalco’s international management. “Through this cooperation, we gained completely new knowledge in the fields of international capital operations, mergers and acquisitions, and corporate management.” he said. “We also saw the enormous differences between Chinese state-owned enterprises and international corporations.



“If the deal goes through, we’ll send several of our managers to work at Rio Tinto,” Xiao said. “This will be a very valuable asset.”



As Xiao closed the deal, another Chinalco team led by Deputy CEO Lv Youqing and overseas executive Tai arrived in Australia. Soon they submitted a request to Australia’s Foreign Investment Review Board (FIRB), which is now deciding whether to give the transaction a green light.

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Seeking Common Benefits



Perhaps not coincidentally, Australian Finance Minster Wayne Swan on February 11 announced that his government would start viewing convertible bonds as shares when considering overseas investments. Some observers think this adjustment stemmed from the Chinalco-Rio Tinto deal, which includes US$ 7.2 billion in convertible bonds.



But Chinalco insiders say there were communications with Australian regulators before the deal was announced, and that the company was not surprised by Swan’s statement. What appeared to be a sudden policy change was actually designed to convince Australians that the government was simply doing its job.



Indeed, Chinalco’s 2008 deal for Rio Tinto shares on the British market did not involve talks with the Australian government; the application for Australian regulatory approval came after the deal was inked.



Nevertheless, Australian regulators have come under pressure and the Chinalco deal faces many obstacles, including opposition from some Rio shareholders, unions and human rights groups

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Australian citizens and labor unions are worried about the possible effects of Chinese purchases of Australian resources. Some concern stems from Chinalco’s investment in Rio Tinto, but there is also broader anxiety over Chinese investments in general. Some critics frowned on Minmetals’ investment in the mining company OZ and Hualing’s bid for Fortescue shares.



Rio Tinto’s second-largest shareholder, Legal and General Investment Industries (L&G), has asked the board of directors to consider other solutions to the company’s financial predicament, such as selling new shares to existing shareholders. “The priority of shareholders is important,” said L&G, which now hopes all Rio Tinto shareholders will find a mutually acceptable solution.



The Australian government’s regulators, on the other hand, have neither a board of directors nor Rio Tinto shareholders to satisfy. Instead, they analyze deals according to perceived national benefits. And Swan has had a circumspect attitude toward the US$ 19.5 billion deal.



“Our government will consider the particulars of this deal on the basis of national interest,” Swan said. “Since Chinalco is Rio Tinto’s customer, this deal will receive a great deal of scrutiny.”



Australian Senator Barnaby Joyce is among those protesting. “When they come here to buy Australia’s resources, it’s very hard to turn them away once they’ve arrived at your doorstep,” Joyce said. “It’d be best if there remained a distinction between client and owner.”

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Relatively speaking, local governments in mining areas affected by a Chinalco-Rio deal have been welcoming. Colin Barnett, premier of Western Australia, supports Chinalco’s plan to boost its stake in Rio to 18 percent -- but he also hopes that’s where it stops. Western Australia is the country’s primary producer of iron ore.



Anna Bligh, premier of Queensland, voiced support for the deal soon after the London announcement. Queensland is currently working with Chinalco to develop bauxite production. Bligh said, “The contract between Chinalco and Rio will be extremely beneficial to the local economy. I hope the federal government will allow the deal to go through.”



As this edition of Caijing went to press, Australia’s Chinese-speaking Prime Minister Kevin Rudd had yet to comment on the deal.



But a leading figure in the Australian mining industry told Caijing the extent to which his country allows Chinese participation in the resources industry will be determined by the amount China privatizes.