BHP Billiton (ASX: BHP) may already be taking advantage of that massive 240% price increase in coking coal it scored last week. Turning coal into cash, that gives BHP anywhere from US$5.5 to US$7 billion in 2008 revenues it didn’t have before.
By contrast, Rio Tinto’s (ASX: RIO) exposure to rising iron ore prices may “only” deliver an extra US$1.5 billion to 2008 earnings. BHP could use the coal cash to sweeten its share offer for Rio. The current ratio between the shares is 3.32, slightly below the 3.4 share offer that BHP put on the table.
Our technician Gabriel Andre has been tracking the ratio recently to see if there is a premium or discount in either company. The red line on the chart marks the 3.4 level of the formal offer. You can see that since the offer was made in November of last year, the ratio hasn’t deviated much. This current dip doesn’t put any pressure on Rio’s management to accept the offer. But more weakness-where it takes fewer BHP shares to buy one Rio share-could.
The BHP Billiton/ Rio Tinto Share Ratio
There was a small story in the Australian last Friday that the China Development Bank floated a proposal that China and Australia develop a long-term plan for, “Chinese investment in Australian mineral resources?” There wasn’t a lot of detail about the plan, like how it would work and whether it would replace the current system.
The current system, of course, is the share market, where if you want mineral resources you pay the market price for them. The market price for coal, iron ore, and copper is going up, of course. It would be much nicer, if you’re a customer of those things, to NOT pay the market price and pay, say, a contract price, or have some other kind of joint venture deal.
Australia and China are already joint venture partners in the commodity boom. But if China is suggesting a government-to-government relationship over resources and not a market-to-market relationship, well that’s different kettle of fish altogether isn’t it? Is it a proposal? A suggestion? Or an indication of how China would like things to be in the future, in order to remain a reliable customer for Aussie resources?
The Australian article says China would like to reach a “consensus” over Chinese investment in Australia for the next five to ten years. Finance Minister Lindsay Tanner did not agree saying, “We are committed to the long-established foreign investment review framework, which operates on a case-by-case basis governed by national interest considerations… The proposal floated by the China Development Bank would involve a dramatic deviation from those principles.”
Just something to think about. In an integrated global market for commodities where there are plenty of buyers and sellers, the market price prevails. But with the bear market in credit and the “Triple F” crises we mentioned yesterday, there may be fewer cashed up buyers of key global commodities.
Sellers in possession of key strategic tangible resources will have an interesting option to consider. With scarcity, the market price of most resources will go up. But if you want price certainty (or to use your resources to your national advantage), you might choose to sell only to certain clients and not others. If that were the case, you might move to contract pricing and not market pricing.
Take oil. The crude futures contract began trading in 1983. In early trading the futures price was lower that the price OPEC had set with its pricing mechanism. As the world’s largest supplier of oil at the time (it sill is, but less so as a percentage of total crude production thanks to the North Sea, the North Slope, and Russia), OPEC had all the pricing power in the oil market.
The futures contract changed the pricing mechanism for oil because it established a market price. And as it turns out, that pricing mechanism has worked better for OPEC in the last five years than any arbitrary ability to fix prices could. You get a bidding war for what you produce.
The only risk to the market price today is that bidding wars precede shooting wars. There is, after all, already a war in the Middle East that began in 2003. At what point does possession of a valuable strategic go resource change from having a prime position in the marketplace to having a big fat target on your back from larger, resource hungry neighbours?
One day your neighbours ask for more formal arrangements in your amicable trading relationship. The next day they stop asking. And the day after that?
Markets and Money