Font Size: Decrease Increase Print Page: Print Jennifer Hewett,...

Font Size: Decrease Increase Print Page: Print Jennifer Hewett, National affairs correspondent | April 19, 2008
SAM Walsh sounds remarkably sanguine for a man in the heat of intense negotiations with the Chinese over one of Australia's most crucial exports, iron ore.

"Sooner or later, you get convergence," he tells The Weekend Australian.

"Sooner or later, you do want to resolve the negotiation and reach agreement."

But as chief executive of Rio Tinto Iron Ore, Walsh also knows just how much is riding on the outcome of those price negotiations this year. Sooner rather than later.

Not only will the result affect Rio Tinto's ability to continue resisting BHP Billiton's takeover offer and the creation of a new super resources giant.

It will also have a huge impact on Australia's terms of trade and on the future development of the whole iron ore industry, second only to coal as Australia's most valuable export commodity.

And it comes at a time of great sensitivity in both Canberra and Beijing about Chinese intentions to invest much more in Australia's iron ore industry by taking stakes in a range of companies and projects.

That includes February's swoop by Chinalco on 9 per cent of Rio Tinto itself with the new Chinese shareholder saying it might well go higher.

As Walsh says, it's an extraordinary time to be in iron ore. Not too many companies of any other export would be arguing that an annual increase of about 70 per cent is still inadequate, for example. But Walsh has good reason to qualify as the most bullish man in Australia.

As he sits in his St George's Terrace office in Perth, he insists that the huge jump in price and the Australian demand for even more has to be seen in context.

"To an extent, the current prices we're seeing are as a function of the very low prices over an extended period," he says. "If you exclude the last five years, prices over a 20-year period reduced in real terms 1 1/2 per cent per annum every year."

But that, of course, was before the surge of Chinese growth turned the whole world on its head. Growth requires steel, which requires iron ore.

Walsh is understandably confident that the growth will only continue.

"What I can see from sitting here is very robust demand going forward," he says. "Certainly, in terms of China, despite what is happening in the US.

"Yes, there may be a slight slowdown but we're not seeing China being impacted in any significant way.

"Then there's India. The Middle East is booming. Russia, Brazil and if I'm really game, I would add Africa into the equation. So there's a whole host of developing countries that are really starting to flourish."

But the key clearly remains China, now responsible for more than 90 per cent of all global growth in the iron ore market and more than half the world's iron ore imports.

"The substance behind that growth is very fundamental," Walsh says. "It's the urbanisation of 15 to 20 million people a year who are moving to the cities and the infrastructure required for this.

"That's really the basis for saying a US recession won't really have a big impact on this Chinese miracle."

Miracles still involve a lot of hard knuckle brawling, however, particularly given the determination of the Chinese to try to contain their own accelerating inflation.

China is the country that now takes the lead in global price negotiations, replacing the once dominant Japanese.

The current argument is about the benchmark price for contract iron ore this year, as opposed to the spot market where prices are more than double -- at about $US200 a tonne.

The contract prices are backdated to April 1 each year.

The Brazilian giant, Vale, has now settled for a 65 to 71 per cent increase for this year in their contract negotiations with China's Baosteel.

The Australians say even that is not enough. Rio Tinto is leading a push this year in demanding a freight premium or surcharge as compensation for the cheaper cost of shipping from Australia.

Ironically, this was something proposed by BHP a few years ago and not backed by Rio at the time -- to BHP's great irritation.

Right now, of course, such a freight premium would only be used to bolster Rio's argument that its greater strength in iron ore deserves to be accorded increased value in BHP's takeover offer.

"That proves the iron ore companies have their own independent views of the market and independent view of how negotiations should resolve themselves," Sam Walsh says of the shift in Rio's position. "What struck us this year was just how great the difference had grown. It wasn't something any more that one could regard as an anomaly or an offset for varying grades or something like that. It was out and out people taking advantage of the Australians."

But he rejects any notion that companies such as Rio and BHP Billiton are being greedily short-sighted in using their market power to try to so aggressively raise the prices for iron ore.

The potential for even greater consolidation of the producers' market power is another reason the Chinese steel mills are so unhappy about the prospect of a BHP Billiton merger with Rio Tinto.

"I see extraordinary comments by some people about how we are being tough and asking for very large increases," Mr Walsh says.

"We're asking for people to recognise the difference between the benchmark and the spot prices. We should be moving to bridge that, not keep the two apart.

"Market power? Where are the real iron ore prices being set? They are being set by the Indians and the Chinese -- the spot price. It has nothing to do with Rio or Vale or BHP Billiton. The prices are being set in a free market by willing buyers and willing sellers at prices that are way above the benchmark. So it is a bit of a furphy to say consolidated iron ore producers are using their market power to set unrealistic prices."

The Chinese don't see it that way, of course. They have even attempted to increase the pressure on Rio and BHP Billiton by informally refusing to accept or slow down some spot deliveries from Australian producers.

That follows Rio Tinto's insistence it would be increasingly active in the spot market while the gap is so large and plans to sell up to 15 million tonnes that way.

Mr Walsh describes this strategic blockage or slowdown in accepting spot sales is "just part of the normal argy bargy" of negotiations. He says it's a tactic that the Chinese used once before in the lead up to a settlement.

"Each year is intense in its own way," he says. "I can remember when we used to argue about half a per cent either way and that, at the time, seemed earth shattering.

"But now the numbers and players are all growing ever so much larger."

Mr Walsh says the consolidation is occurring across the entire industry, including the steel makers.

"If you meet people in China, they all talk about how there will be a continuing consolidation of mills and we could end up with three groups of steel producers," he says.

But wouldn't that make the synergies of a BHP Billiton Rio merger seem even more logical?

"The issue in relation to the pre-conditional takeover by BHP Billiton relates to value," Mr Walsh says, firmly. "It doesn't relate to philosophy or culture or any other issue.

It relates to whether our shareholders believe BHP Billiton is offering value for the package."

And that makes this year's arguments over iron ore pricing and production even more commercially crucial.

Rio Tinto will produce 220 million tonnes of iron ore next year, moving to 320 million tonnes by 2012.

Some analysts have suggested that by that stage there will be a surplus of supply. It's not a view shared by Mr Walsh, who says he can see the reverse scenario.

Certainly, he believes that the 90 iron ore companies that have now set up in Western Australia courtesy of the rising prices won't fundamentally alter the equation of demand outstripping supply.

"Despite the fact prices have increased, these projects are tough, they are difficult," he says. "That's why I can say there won't be 90 producers in Australia. Whether it is trying to finance them, whether it is the very lengthy approval processes, or the escalating capital costs, or labour and skills shortages, you can pick half a dozen good reasons why these projects are much tougher than they were previously."

But it's clear that the Chinese are extremely interested in investing more directly in some of these companies, including the prospect of taking an even larger stake in Rio.

Mr Walsh says that Chinese investment in Australia's iron ore industry is a growing trend and an inevitable one.

"It's exactly what the Japanese and Korean steel mills have done over time," he says. "The Chinese had a 'going out' strategy that was under way well before any takeover offer from BHP Billiton. They have done a lot of work in Africa and other places looking to see if there are opportunities for them.

"From where they sit, they can see the growth, they can see the need to bring on projects, they can see what Japan and Korea did over time. And they would like a piece of that."

As to whether the federal Government should allow massively increased Chinese investment or control of iron ore projects, Mr Walsh smiles.

"That's too hard for me," he says. "Some very wise folk in Canberra I am sure will make the calls on that." Instead, he's just concentrating on getting the price he wants.