Big 3 Game Plan

This was posted on the AGO thread earlier today....Interesting read.

Taken from Alan Kohlers email on the weekend.

The key to BHP’s decision is the iron ore market, and specifically what’s going on in China. The iron ore spot price is languishing at around $US91 a tonne, having fallen from $US150 in early 2013. The reason the price has fallen is not a lack of demand: that is still up 5% year-on-year, which is slower growth than last year, but still positive.

In essence, BHP, Rio Tinto and Vale are in a struggle to the death with China’s high cost iron ore miners. The weapon in this battle is production – the two Australians and the Brazilian have been producing flat out and so have the Chinese, with each side trying to bury the other in iron.

Previously whenever the price went below $US100, Chinese producers – and many small high cost miners in the west – would shut down uneconomic production, and that would allow the price to recover. In 2014 that’s not happening: this time the Chinese miners seem to know this is their last stand. They are trying to keep producing at full tilt for as long as possible and outlast BHP, Rio and Vale.

They won’t. Instead of blinking, the big three have increased production this year. It’s war: they have decided to drive the Chinese iron ore miners out of business, and it seems likely they will succeed. This is an important part of the reason BHP is getting rid its “non-core” nuisances – Andrew Mackenzie needs to concentrate and marshall his resources. It is BHP’s (and Rio’s and Vale’s) greatest fight, and the rewards of victory will be immense.

At the moment the Chinese miners have about 30% share of domestic demand from steel mills; imports make up about 70%. The local Chinese producers are mostly running at a loss now and simply don’t have access to the capital needed to modernize their operations and reduce costs. They are desperately pleading for tax concessions from local governments to help them keep going and the governments are mostly happy to oblige in order to keep employment in their areas up. But that can’t go on forever. The local governments themselves are running out of money.

I believe the big Australian and Brazilian miners will win this war of attrition, and over the next few years most of the Chinese iron ore mines will close, with the result that the iron ore price goes back to $US120 or more and stays there.

So in the short term, as Andrew Mackenzie at BHP and Sam Walsh at Rio attempt bury the Chinese producers in iron and drive them out of business, their share prices will probably languish around where they are, and the share price of BHP’s NewCo will probably do well because base metal prices are likely to recover more quickly than iron ore.

But in the longer term, BHP's and Rio’s iron ore supremacy should make them and their shareholders the winners

patience is needed until these winners emerge in 2015 as china miners are buried the losers .