Sunday, January 31, 2010

Staring down the dragon

Mr. Don Argus,
Chairman - BHP
businessconduct@bhpbilliton.com

Dear Mr. Argus,

We refer to the report below for your information.

Would you like to comment, please?

We look forward to hearing from you in due course.

Yours sincerely,

Eddie Hwang
President
Unity Party WA
UnityPartyWA@westnet.com.au
http://twitter.com/unitywa
http://unitypartywa.blogspot.com/
www.unitywa.org
Ph/Fax: 61 893681884
Date: 30-Jan-2010.
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Staring down the dragon: BHP's battles in China
January 30, 2010 - smh
BHP has stood up to China like no other corporation, but the world's biggest miner is playing a dangerous game, John Garnaut reports from Shanghai.

When BHP Billiton's chief executive, Marius Kloppers, flew to China last week, he was expected to reach out and try to placate officials who are overseeing iron ore negotiations and administering the country's new anti-monopoly laws.

Commentators expected he would see Shang Ming, the director-general of China's Anti-Monopoly Bureau at the Ministry of Commerce, who has spent much of the past eight months working out whether he can and will upset BHP's iron ore joint venture plans with Rio Tinto.

''Everyone knows that the Chinese Government, including the Ministry of Commerce, are extremely unhappy about the proposed joint venture,'' says Allan Fels, the former Australian competition boss, who has advised Shang on administering his new anti-monopoly powers. ''And the Chinese law appears to have full extra-territorial force, which seemingly fully covers the transaction.''

Some thought Kloppers might also try to see Li Yizhong, the former oil company chief who now runs a ''super ministry'' of industry and information technology. The ministry is overseeing this year's price negotiations and is drawing up new measures to track and potentially control iron ore imports, at a time when BHP is leading the charge to tear the old benchmark pricing system down.

''The international iron ore market is monopolised by the three leading miners,'' said a spokesman for the Ministry of Industry and

Information Technology on Thursday. ''We hope that they will bear in mind the long-term interests of the industry and friendly long-term co-operation with China. We're expecting a fair price.''

But Kloppers didn't see Shang Ming, Li Yizhong or, it seems, any other senior Government official. He didn't make it to Beijing, where the company no longer has an office.

Instead, sources say, Kloppers mostly let his key customers come to him at BHP's Shanghai headquarters, which is reeling from the exodus of three of the company's most experienced and respected executives.

The China branch's president, Clinton Dines, left the company in June, after two decades. Frank Xu, who close observers say ''owned'' government relations for the company, left in July. And now Robin Bordie, the company's key China economist, has told the company she's walking out as well.

BHP is well aware that it is one of the few companies in the world with the power to set terms with China. ''If you're going to play in this game, then you have got to play with the big boys, and they know that,'' the chairman, Don Argus, told reporters in October, brushing off problems that might arise if the joint venture with Rio Tinto caused hostility in China.

BHP's clear and uncompromising China strategy has plenty of admirers. But those same people warn that success depends entirely on execution. ''It's not against the rules to start a war when dealing with China,'' says the long-time China head of another major resources company (which does not sell Australian iron ore). ''But you cannot back down, and you absolutely cannot lose.''

Jim McGregor, the former chairman of the American Chamber of Commerce in China, warned in Time magazine last week that China is becoming an increasingly unpredictable and hostile environment for foreign companies. He says it makes sense for some companies to draw a strategic line in the sand, provided they are well prepared and know that what goes around may come around.

In the past two years Chinese companies and officials have demonstrated that gaining better terms on the iron ore trade is a national priority. They have thrown their weight around, but have so far had mixed success.

Chinalco rudely interrupted BHP's original takeover bid for Rio Tinto, which was later aborted. China's top intelligence agency tapped the phone and email traffic of Rio Tinto, then detained Stern Hu and three other members of Rio's sales team, initially treating the case as a threat to China's national security.

The China Iron and Steel Association and some government officials managed to temporarily block spot market shipments from both companies. Chinese steel mills walked away from contracts without apology when prices plunged during the financial crisis.

But, so far, the laws of supply and demand have proved too much for even the champions of ''China Inc'' to overcome.

China's iron ore imports rose an astonishing 42 per cent last year, to 630 million tonnes, while the rest of the world collapsed. It accounted for as much as 70 per cent of global seaborne trade.

Australian miners secured the lion's share of those extra shipments. Australia's global iron ore exports rose 17 per cent to 383 million tonnes, even as they fell to other major destination. Exports to China rose by 46 per cent, to 282 million tonnes - nearly three-quarters of Australia's total.

It seems both BHP and Rio Tinto can virtually do what they like for as long as China desperately needs their ore. It may be a different story when the market turns. Chinese companies with Government support are bringing forward that turning point by madly planting start-up mines around the world.

''It's pretty obvious that BHP have decided that playing hard ball with China is OK," says Arthur Kroeber, the principal at Beijing consultancy Dragonomics.

''The structure of the market here clearly favours them, because ore producers are highly consolidated and the domestic consumer base is highly fragmented, with no reasonable prospect of being tightly controlled. In that sense, it is a strategy that makes sense.''

However, he says the strategy makes sense now but might not look so good from the moment when the supply curve catches up with demand.

''Business and politics in China are even more closely intertwined here than in most other markets,'' he says.

''If you go out of your way to play very aggressively when conditions favour you, there is a likelihood that there will be reprisals of one kind or another when conditions go the other way.''

BHP headquarters is confident that the work of reading, engaging and anticipating China has not missed a beat.

''Our China office is as important to us today as it always was, given the significance of the China market,'' says a BHP spokeswoman, Samantha Evans.

But it will not be easy to make up for the loss of Clinton Dines, Frank Xu and Robin Bordie, and the closure of BHP Billiton's office in Beijing.

In two years BHP's China staff has been cut from about 100 to 70, including the dismantling of both its China exploration and Beijing Olympics sponsorship teams. Rio Tinto, in contrast, maintains about 130 staff in Beijing and Shanghai.

''BHP has now got no machinery at all for engaging with the Chinese Government, at a time when Australian corporate and political relations with China have never been shakier,'' says one source who has worked with BHP.

''Frank 'owned' all of the relationships with the Chinese government and media. Clinton was pretty well-known and liked by domestic and foreign media, and Robin was part of that cabinet.''

All three employees declined to talk about the reasons for their departure.

Dines, who has taken up consultancies and board directorships, hinted at differences with head office in a joint opinion article published this month in the Herald.

''One area where the big suppliers have some work to do is developing - or repairing - stable, long-term relationships," he wrote, together with an iron ore consultant, Philip Kirchlechner. ''It seems that many senior managers in the industry do not understand what a relationship is, in the East-Asian, Confucian context.''

Bordie, according to BHP's website, had brought the company ''invaluable ability to analyse the complex situation and rapid changes in China - our single-country market''. Her analysis of China's economic recovery last year is thought to have been more optimistic and therefore more right than public comments given throughout the year by Kloppers and Argus. She is joining the Noble commodities group in Hong Kong.

Xu has left BHP for the Barclays investment bank, in part because his family could not easily make the transition to Shanghai.

But maintaining his unrivalled relationships throughout the Chinese resources industry and bureaucracy was always going to be more difficult from Shanghai.

''If you call up someone like Xiong Bilin [in charge of industry and consolidation at the National Development and Reform Commission] he'll say, 'OK, I'm free, let's have dinner tonight,' " says a government relations veteran. ''You simply can't arrange things far enough in advance to get through the traffic and catch a plane from Shanghai.''

Rio Tinto's travails in China are well known and it has the bigger hole to clamber out of.

But Rio is now sharing the bad press with BHP. Reports of BHP lobbying against ''China Inc'' in Canberra have been embellished in the Chinese media, producing front-page headlines like ''BAD BOY BHP''.

This week that story mutated and again sprang back to life.

BHP's government and community relationships may not be what they were two years ago, but its commercial operations remain strong. Its steady march towards clear corporate strategic goals stands in contrast to Rio Tinto's three-year vacillations.

Rio Tinto's China operations are going through a rebuilding phase. The company's chief iron ore salesman, Stern Hu, is in jail, along with three members of Hu's sales team, while Hu's former right-hand man has retreated to the company's Singapore sales platform. Rio's China president, Tony Loo, has quit the company and headed for Las Vegas, and is yet to be replaced.

BHP's production report last week shows it continues to ruthlessly and persistently execute its five-year-long strategy to dismantle the benchmark contract pricing system. The existing system penalises Australia compared with other benchmark suppliers who carry higher freight costs, such as Brazil, and also privileges Indian and domestic Chinese suppliers, who get much higher prices on China's spot market.

In the second half of last year, BHP sold 46 per cent of shipments on ''short-term referencing pricing'', with the remainder sold on annual contract prices. The statement implies that a large majority of shipments to China were made at quarterly negotiated prices, index-based pricing or the spot market.

The significance of this lies well beyond the tens of millions of dollars BHP implicitly earned from its shipments last year that its competitors did not.

It appears to mean that by the end of March, a large number of BHP's customers will have accepted that they have rescinded on their long-term contracts - perhaps in exchange for BHP forgiving contractual non-performance during the financial crisis. At the same time, local analysts say, the company has been rapidly gaining new customers on non-benchmark terms.

BHP has gone halfway towards smashing the benchmark pricing system in its most important market, while its competitors have not. At the same time, some observers suggest BHP has quietly taken the lead on negotiating with Baosteel and the China Iron and Steel Association on this year's prices for remaining Chinese benchmark contracts.

Clearly, BHP's smart and well-regarded iron ore sales chief, Ben Williams, has been on top of his marketing job.

Williams, who has spent 20 years of the past 30 in China and speaks the local language fluently, has been elevated to China president. He has back-up from Lu Jianzhong, a sharp and affable technology and uranium expert who was formerly a diplomat at the United Nations. Lu has taken control of Chinese media relations.

But they have a power of work ahead.

Whatever the market mood - and in recent weeks it has sagged - China's efforts to get a better deal in iron ore are not about to stop.

''Iron ore is a core national interest for China,'' a senior official says.

Nobody knows how the next round of iron ore wars will be played out. Shang Ming at the Ministry of Commerce might rule that the BHP-Rio joint venture is anti-competitive. But it's not obvious that he has legal sanctions in his armoury that would hurt the miners more than Chinese mills.

''Because BHP Billiton has almost no assets in China and there appears to be very little grip that the Chinese Government can have on this offshore transaction,'' says Fels, the former chairman of the Australian Competition and Consumer Commission.

In June, shortly after announcing the Rio Tinto joint venture, Kloppers dismissed the risk of Chinese or Japanese regulators intervening with the deal.

He said his company was ''just largely a seller of product into those markets, so we don't have any local businesses in China or Japan that would be affected by this''.

An adviser attached to China's Ministry of Commerce immediately begged to differ.

''According to China's anti-trust law, we can veto such a merger agreement if the concentration of overseas business operators will affect domestic market competition,'' said Ma Yu, a director of the Foreign Investment Department at the ministry's Academy of International Trade and Economic Co-operation. ''If the joint venture is set up regardless of China's opposition, the Government can also resort to trade sanctions against the two entities on future business transactions with China.''

Business and government veterans of the Australia-China relationship and iron ore trade are impressed at the strategic vision of Kloppers and his chairman, Don Argus. But they worry that the pair have underestimated China before and may be doing so again.

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