Sent: 17-02-2009 10:19:01
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The Rio Assets: Let the Chinese Take Them
The Chinese are just the latest to fall into the trap of buying Australian mining assets to consolidate their grip on global supplies. We should take advantage of their mistake.
Aside from issues of shareholder value, the Rio Tinto/Chinalco transaction unveiled in the past week raises some questions of national sovereignty which will tax the minds of Treasurer Wayne Swan and members of the Rudd government.
Some people are concerned that Chinalco, a Chinese government owned entity, will exert influence on Rio Tinto's development priorities which could compromise the living standards of Australians.
The debate on this question is only just beginning and will reach a climax when the Treasurer announces whether he will block the sale after getting advice from the Foreign Investment Review Board.
The starting point for any consideration of this issue should be Australia's ongoing need for foreign capital to help develop its natural resource base. Australia has a natural endowment which is well beyond its capacity to fund from domestic sources. Australia's propensity to consume is simply too high and its population base too small. Savings are, consequently, inadequate to domestically fund mining projects at a pace which keeps up with global demand.
Under virtually any foreseeable circumstances, there will be a need for foreign capital. We have to decide whether Chinese sourced capital is more or less acceptable (and more or less forthcoming) than US, UK, Japanese or Korean funds.
Over the decades, our offshore capital sources have varied. Earlier in Australia's history, the UK and Europe dominated flows. Then the US loomed larger. Japanese capital subsequently became more important. Now, China and the Middle East are more likely sources.
There is also a long history of foreigners bailing out floundering Australian mining companies. In the 1930s, the then American Smelting and Refining Company saved a failing Mount Isa Mines. The company which became ASARCO was a global mining colossus with a reputation for ruthless exploitation of business opportunities. It remained a shareholder in Mount Isa for several decades until it was barely a shadow of its former greatness on its way to bankruptcy protection in its homeland, never having received any significant return on its Australian investment.
More recently, in the 1980s, when Australia's Bowen Basin coal mines were being brought into production, Japanese interests took equity stakes ahead of development and in anticipation of locking in sales contracts. The rationale for these investments rested on the possibility of good investment returns but also on the belief that a strategic investment would better ensure access to raw materials then in apparently short supply.
The Japanese strategy did not go according to plan.
- Adequate investment returns proved disappointingly elusive as coal prices fell, mining costs rose and a declining Australian dollar impaired the value of the assets they had purchased.
- There was no scarcity. An abundant supply of coal meant that equity positions were ultimately unnecessary to ensure supplies. Whether they were shareholders or not, the Japanese investors would have got all of what they wanted.
- Corporate governance practices in Australia were different than in Japan. Larger shareholders could not bypass those responsible for conducting sales negotiations to do more favourable deals in the boardroom.
One by one the Japanese left disillusioned but wiser. Whether Japanese, American or the British from earlier years, the results have been pretty much the same.
The leaders of Chinese industry and the Chinese political elite have been shocked by the difficulty over the past 10 years in sourcing raw materials for the country's burgeoning industrial output. Prices were driven higher and costs were aggravated by a speculative fervour on commodity markets stoked by U.S. monetary policies. The inevitable lag between a cyclical rise in demand and investment in new mine developments also meant that there were temporary supply shortages with which to contend.
Just as others before had concluded that these problems could be solved by directly owning mining assets, Chinese interests have begun to take matters into their own hands.
The Chinese will realize over the coming several years that supplies will be more than adequate to meet their needs. They will also realize that any deals done will be scrutinized by auditors, shareholders, governance consultants and taxation authorities to ensure that there is no commercial skulduggery.
Of course, this scenario could be wrong but only if the economic conditions in China are far more buoyant than currently appears likely, in which case Australia will be even more hungry for capital to compensate for its desire to consume more than it produces.
In either case, we should let the Chinese pump as much into the Australian industry as we can get our hands on, committing them to large-scale infrastructure spending whenever possible, before they get a chance to realize the mistake they are making.
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