Stephen Bartholomeusz
EU's new horizon for BHP
Tomorrow the European Commission is almost inevitably going to push its consideration of BHP Billiton’s bid for Rio Tinto into phase two of its processes, giving it at least another 90 days to consider the competition policy implications. Reports out of Europe suggest it has adopted an unusual approach to the bid, one that may be helpful to BHP’s cause.
A Reuters report overnight says that the commission, which normally considers the impact of a proposed merger over a two or three-year time horizon, has been asking competitors and customers about the effect of a merger between BHP and Rio on their business out to 2015.
While at face value, that appears a negative signal for BHP – it would tend to signal the extent of the commission’s concerns that it is worried about the long-term implications for competition – the longer the time frame within which the merger is considered the more likely it is that whatever increased market power BHP might gain would be diluted.
The most sensitive period, in terms of the anti-competitive effects of the merger would be in its early years, when BHP would control the combined output of the groups within market settings not-too different from today's.
Longer term, the combination would facilitate a very substantial acceleration of Pilbara production, as BHP would be able to use Rio’s infrastructure to fast-track its own expansion plans at a lower cost. The merger would lead to more iron ore coming into the market earlier, helping to redress a significant imbalance in supply and demand.
More particularly, over time production from new producers will become a material part of the market and help provide a counter to the dominance of BHP, Rio and Brazil’s Vale.
Fortescue Metals, for instance, plans to be producing 55 million tonnes a year by next year and 200 million tonnes in the not-too-distant future. The Midwest region of Western Australia, where Chinese state-owned enterprises have made a series of corporate plays, should also be a significant producing region by 2015. Rio’s giant Simandou prospect in Guinea, which Rio is more enamoured with than BHP, could be in production before then and possibly in different hands.
At the sort of price levels for iron ore that have been set in the most recent round of contract negotiations – Rio received an average increase of 85 per cent – a lot of what would otherwise have been marginal or uneconomic resources and production would now be highly profitable and will be brought into the market.
In the longer term, therefore, even if BHP were able to hold or increase the combined market share of the seaborne trade in iron ore there would be a number of significant new players and production to provide a competitive counter.
With China buying a substantial proportion of its requirements from high cost producers and in the spot market, an accelerated increase in BHP/Rio production would probably give it access to more higher quality ore at lower prices than it now pays.
Even if BHP were successful in convincing the market to move towards index-related pricing, iron ore prices will continue to be set or substantially influenced by the marginal producers.
The 2015 timeframe apparently set by the commission is interesting. It may or may not be a coincidence but that is the earliest date at which both BHP and Rio believe the market could be in balance, although Rio believes demand will remain very strong out to at least 2022.
It won’t damage BHP’s position that the most recent contract negotiations have demonstrated that Rio and BHP don’t actually have absolute market power, or at least don’t have the courage/conviction to deploy it. Rio settled for less than it might have had it been prepared to take from the steel mills and BHP, having remained in the shadow while Rio negotiated, appears to be about to fall in behind it, accepting the Rio-set benchmark prices and continuing to argue for a more market-oriented pricing regime in the longer term.
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