Beijing's metal move is bad timing for Rio

CHINA'S embrace of profound re-engineering of its sprawling metals processing industry by 2011 could yet create complications for its current international champion Chinalco, as its $US19.5 billion Rio Tinto deal winds slowly through Australia's Foreign Investment Review Board. On Monday, China's ruling State Council endorsed a plan to manufacture between three and five mega-metals corporations and to deliver overwhelming market power to the country's top 10 producers of copper, aluminium, nickel, lead and zinc. Needless to say, the ambition is grand and commercially very sensible. But the timing of the annunciation of the policy could hardly have been worse if you are Chinalco and Rio Tinto, and the masters of your immediate shared fate are FIRB and a politically vulnerable Treasurer. The object here is to create no more than five super customers which will be able to, at worst, match it with the world's major resources houses and, at best, engineer similar strategic alliances as that being planned by Chinalco and Rio. Body: As bold and logical as that outcome might be, there is no question the policy announced on Monday will re-ignite debate over the strategy underlying China's investment in the Australian resources sector. Given everything that is afoot, Chinalco is very likely to be one of China's biggest five. After all, it cannot be any sort of coincidence that the push for reform comes only months after Chinalco's former chairman Xiao Yaqing joined the ruling council. Under Xiao's direction, Chinalco was a first mover in consolidation in China's aluminium sector and the engineer of its boldest move on the international stage: the plunge into Rio. Chinalco will almost certainly become an even bigger customer for Australian miners across a far wider range of raw materials. It is unarguable that the planners of China's still boisterous economy have properly decided the global financial crisis has delivered it with motivation and opportunity enough to force further reform on the inefficiency within its manufacturing base. China's metals processors account for about one-third of global production but that doesn't mean they are anything like as efficient, either financially or environmentally, as their Western counterparts. The State Council has endorsed a plan to change that situation, calling out improved economics and reduced environmental footprints as major targets of the planned reforms. Absolutely explicit in the State Council directive is that these new majors are to be platforms for investment in international mining, either directly of through partnerships with existing operators. The Government will "encourage" foreign investment by providing access to new equity and foreign exchange. It is expected the consolidation push will focus initially on the smelting side of the metals industry. In some sectors, such as the already quite concentrated nickel business, the task will be relatively painless, but in others, where there is still distracting geographic and technological diversity, it might be quite fraught. It is estimated there are only about 40 copper smelters across China with average capacity of 80,000 tonnes a year and 97 aluminium smelters with capacity averaging 150,000 tonnes (30 per cent of which is accounted for by Chalco, a child of Chinalco). Lead and zinc is probably the most diverse consolidation challenge given there are maybe 200 smelters dotted around the country, with capacity of about 30,000 tonnes a year. By the end of this process, the the 10 domestic copper producers would control 90 per cent of China's output, 70 per cent of aluminium output and 60 per cent of lead and zinc production. So, will this really have an unsettling effect on FIRB's continuing assessment of the Chinalco investment in Rio? You better bet it will, according to one operative in a recent FIRB negotiation. Our source insists the issue of consolidation will go to the heart of FIRB and Treasury concerns over the underlying motive for China Inc's push into raw materials. "What are the Chinese looking for here? Are they looking at a routine commercial relationship or an opportunity to use market power derived from PRC Government edict to assert their national interest," a source commented. Put yourself in the shoes of an FIRB official for a moment, if you dare. So there you are, trying to control an outcome on this negotiation, to effectively put stakes in the ground on issues you want resolved. And then China Inc announces it is changing the game and you are suddenly facing a whole lot of new questions. The prospect of government-initiated consolidation will only feed the legend of China Inc and fan fears we are not dealing with benign investors driven by reasonable commercial imperatives but by the commercial constructs of a command economy run by the State Council of the People's Republic of China. That this reform comes with not a hint of greater transparency nor a gesture to improved governance regimes nor with any sort of commitment to investment reciprocity, will further intimidate the fearful. As we have said before, Chinalco's Rio dreaming has only reinforced a collection of prejudices on the often dicey issue of foreign investment. On one side of the argument, there are those fearful about a loss of sovereignty over our resources to a collection of corporations owned exclusively by the Chinese state. Then, over here with me, are those who believe we owe our lifestyle to foreign investment and that the arrival of Chinese investment should be welcomed but carefully scrutinised and managed. So far, never the twain have shown no inclination to meet. But FIRB, like King Canute, cannot turn back the tide. But it can, like a good modern engineer, control the tidal shifts to serve our needs. We can debate China's desire to invest in Australia as long as we want, but the fact is our nation is fuelled by foreign investment and few nations have as big an interest in feeding that need than China. That, mind you, does not mean we think the Chinalco deal should be done and dusted. Far from it. The Chinalco proposal might not be a foreign-investment issue, but it is, and always has been, a value issue. Right now some markets agree with that view, with Rio Tinto Limited shares trading at an uncomfortable premium to the first tranche of the four-tiered convertible notes Chinalco is acquiring. At the same time, the green shoots of recovery have begun showing through in some metals markets. As reported yesterday, China's demand for coking and thermal coal has recovered strongly over the past quarter and the word from the miners is that that incipient strength has continued beyond April. Given we really do have some sort of spring thaw in demand, then Rio is going to come under ever-stronger pressure to re-price its deal, but that can only happen once we have FIRB's verdict. source：www.theaustralian.news.com.au