Glasenberg’s madcap manoeuvre

Glasenberg’s madcap manoeuvre

PUBLISHED: 8 hours 12 MINUTES AGO | UPDATE: 0 hour 0 MINUTES AGO

Ivan Glasenberg’s audacious bid to merge with Rio Tinto is almost as crazy as the moves by Rio and BHP Billiton to destroy billions of dollars of Australia’s mineral wealth by flooding the world market with iron ore.......

As arguably the world’s most successful commodities traders, Glasenberg understands the wisdom of the principles of supply and demand.

He does not understand what Rio and BHP hope to gain from racing to produce as much iron ore as possible.
Is it a last ditch effort to remove the high cost iron ore producers in China? Or is it a deliberate attempt to wipe out all of the producers in Australia with higher costs than themselves including Fortescue Metals?

If it is aimed at the Chinese it could well be doomed to fail. Take for example, the Chinese alumina industry. It has operated at a loss for many years but that has not resulted in reductions in production.
China’s metals and mining markets are not necessarily responsive to the market forces that usually prevail in Western countries.
Fortescue won’t be defeated

If the strategy of RIO and BHP is to wipe out Fortescue Metals that too could fail.

Fortescue has an iron ore cash cost of production and sustaining capital investment equal to about double the level of Rio and BHP so it is vulnerable to a continued surge in supply by two of the world’s biggest producers.

But Xstrata’s experience in relation to Minara Resources, which was formerly Andrew Forrest’s Anaconda Nickel, holds some valuable lessons for Rio. Minara was bought by Xstrata in 2006 after the majority of its debts had been written off by creditors and its equity almost wiped out.

The end result of squeezing Fortescue into severe financial difficulties might actually result in the company being even more competitive than before.

It is a worst case scenario, but if Fortescue could not pay the interest on its estimated $7 billion ($8 billion) in net debt that would lead to a catastrophic situation.

But the Fortescue iron ore mine would remain. The equity would be wiped out and the company’s debt holders could emerge with control of the company. Rio and BHP might end up facing a reinvigorated competitor with zero debt and a significantly lower cost of production.
Change of tune

Glasenberg has for several years railed against the widespread irrational behaviour by mining companies. He said the world’s biggest miners had “screwed up” by continuing to build and invest in new mines without getting returns for their shareholders.

He could not understand why Rio and BHP dramatically expanded their capital investment programs at the height of the so-called commodities super cycle.

They competed with each other for scarce development resources, talked up the costs of mine building and lost touch with their obligations to shareholders..........

On reflection, the race between Rio and BHP to sell as much iron ore is hugely damaging to Australia’s national interest.
It can be justified on a pure analysis of the lowering of the cost of production by spreading more tonnes across a fixed cost base.

That lower cost of production means Rio and BHP preserve their profit margins.

But it is completely irrational when considered against the principles of supply and demand. It is hugely damaging to Australia’s finite reserves of iron ore resources.

The strategy of cranking out iron ore at maximum levels not only threatens to destroy the capital of higher cost producers it simply transfers money into the pockets of the Chinese steel mills.

The obvious alternative to flooding the market with iron ore is to withhold supply, allow prices to rise and leave as much iron ore in the ground as possible. It is not as if any other producer can replicate the 62 per cent iron ore intensity mined by Rio and BHP in the Pilbara.....

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