it can be a dirty business, page-4

Signals from China shake confidence.

Matthew Stevens | August 11, 2009
Article from: The Australian.

THE juxtaposition of the latest news flows from China yesterday was as excruciatingly instructive as it was politically fraught.

On the one hand we have China Inc reported to be closing on its biggest single plunge into the Australian resources sector.

On the other, we have the latest outburst of angry intimidation of the seaborne iron ore industry by (almost official) China, as the rhetorical sweep of the allegations against the Rio Tinto four is amplified to 11 on the Cold War dial.

The local investment in question is a potential bid for Felix Resources. It is one of that class of pocket battleships in the Australian coal industry, boasting control of some of the better mines in the Hunter and Bowen basins and a share of Newcastle's second coal terminal operator, the BHP Billiton-led NCIG consortium.

Felix sought suspension from trading on ASX yesterday in the wake of apparently informed speculation that Yanzhou Coal Mining Company was close to delivering a bid around the $3 billion mark for the Australian.

The talk is Yanzhou, an associate of China's fourth-biggest coal producer, could offer up to $20 a share for Felix, which looks pretty good given the share price was resting at $16.90 a pop when Felix called a halt yesterday.

The other thing to note here is that, given Felix's managing director, chairman and one other director collectively own nigh on 50 per cent of the business, you'd reckon if Yanzhou's bid lobs, then it is going to, at very least, deliver control of the business to China Inc.

Given, of course, Yanzhou is granted the indulgence of the federal Treasurer who, courtesy the foreign investment rules, has the final call on China Inc's latest pitch for a slice of Australia's resources action.

Yanzhou is one of the more interesting of China's operators. It was an early mover into international equity markets, listing in Hong Kong, New York and Shanghai, in that order, over 1998. Its controlling shareholder is Yankuang Group Corporation and it, in turn, is controlled by the People's Republic of China. It is, in short, an SOE (state-owned enterprise).

Which means there will be, inevitably and quite understandably, opinion aplenty that would encourage the Treasurer to block this deal. At the very least, you would expect pressure for the Treasurer to use any approval process for Chinese investment as some sort of leverage in the dark and apparently vengeful Stern Hu affair.

These are temptations the Treasurer should, on balance, try mightily to avoid. To do anything but contemplate the anticipated offer from Yanzhou on anything but the expressed FIRB national interest guidelines would be to reject the Treasurer's case-by-case commitment and be a step away from transparent, dispassionate process.

Mind you, these are strange days indeed for those of us who advocate Australia's ready and open embrace of Chinese investment flows as being a natural extension of our expanding trade relationship, a sound pathway to future national prosperity and, potentially, a means of fertilising the seeds of open economy in China.

But the miserable progress of the Hu affair, as highlighted again by the most recent unfathomable commentary emerging from China over the weekend, has strained the confidence of even the most ardent of the PRC supporters.

Stern Hu, an Australian citizen employed by Rio Tinto, has been in jail since early July, apparently accused (although not yet officially charged) with bribery, corruption and being in possession of state secrets. Three other Rio Tinto employees have also been detained and not yet charged. They are Chinese nationals.

The risible allegations published on a reasonably official Chinese website over the weekend doubtless reflect ingrained antagonism towards Western capitalism and its corporations. That the baseless, headline grabbing commentary was removed from Biaomi.com on Monday and its content dismissed by two more mainstream official news organs suggests higher officialdom regards the views as a step too far.

Nonethless, the content is worth reviewing for both its factual inaccuracies and distortions, and for the underlying fear and anger it reveals.

The author of the Biaomi.com commentary was Jiang Ruqin. According to Bloomberg, he is employed by the Jiangsu Province Administration for the Protection of State Secrets. According to Jiang, Rio Tinto has run a six-year-long campaign of "commercial espionage warfare", which has resulted in China paying $122bn more for iron ore imports that it needed to.

This is, needless to say, total nonsense, not least because the numbers are plainly massively inflated. By the end of this financial year, Australia will have sold $116bn worth of iron ore to the world over the past six years, according to the latest ABARE figures. That includes shipments to the other big three of north Asia, Japan (still BHP Billiton's biggest destination customer), Korea (where Posco is BHP Billiton's biggest individual customer) and Taiwan (a big customer for Rio Tinto).

So where does the $122bn figure come from? Likely it is a bizarre extrapolation of the impact of the surging price of iron ore on the gross bill for China's iron and steel industry over the six years in question.

The reason that is bizarre is because it is the cost of China's own iron ore (which makes up maybe half the total material used by its steel producers) which actually sets the market price for iron ore.

The logic here is that the seaborne price reflects the replacement cost of Chinese material. Put very simply, the idea is that China's iron ore market is essentially rational, which means it will not pay more for imported material than it does for the domestic production it replaces.

There are obvious complications within that simplicity. For example, China is simply unable to produce the quantity and quality of material to meet the demands of its steel industry, which means to sustain economic growth ambitions built on steel production, it must import raw materials.

Nonetheless, the framework of the argument holds. If imported iron ore is too expensive, it will be replaced by domestic output.

And here is where we arrive at the reason for everyone to keep their eyes on the prize in our quite necessary discussion about engagement with China in a post-Stern Hu era.

The fact is, China's steel mills continue to behave just as the market says they should, despite the disastrous intervention of the Cold War intellects who run the bogus China Iron and Steel Association.

The reason the spot iron ore price is again running at more than $US100 a tonne (a good 30 per cent more than the Japanese contract price settlement, which is the new benchmark) is that China's mills are buying all the material they can get their hands on. In the end, the market is working.

The problem is, in working it is embarrassing the bureaucratic bunglers at CISA who first turfed Baosteel out of the annual price negotiations and then, too publicly to enable a backdown, refused to accept the new benchmark. And, with Hu in jail and the spot contract gap growing, CISA finds itself in a terrible spot.

When talks started, the contract price was running well ahead of the spot market. Since then, though, the cycle has turned against CISA big time, and with the gap between spot and benchmark widening by the day, CISA is looking ever more foolish as it blames speculators for driving the spot market beyond any sensible foundation.

The thing is, the spot market is essentially a Chinese market. Without Chinese demand, it barely exists. Which means that speculative demand has to be Chinese. And it is in the form of minerals traders and the smaller Chinese mills who make money filling their import quotas and then flogging the product to bigger domestic producers.