A Spy in the House of Iron?

By Julian Murdoch

With all of the news, gossip and rumor coming out of China about commodities (are they secretly stockpiling copper more than they admit? How many full ships are actually sitting in Shanghai?) it can be difficult to separate fact from fiction with regard to the long-drawn-out iron negotiations.

Here's one fact: The deadline for the benchmark price agreement between China and the big iron ore miners (Rio Tinto, BHP and Vale) has long since passed - June 30 is but a memory.

The sticking point? Not whether prices should come down - both sides agree they should - but just how much. China is interested in reductions in the neighborhood of 40-45%, while the iron ore companies are thinking more along the lines of the 33% price reduction Japanese steel maker Nippon and South Korean steel mills have already agreed to.

Beyond that fact, what is happening with negotiations gets a bit fuzzy.

Done, Active Or Stalled?

Last Wednesday, the Chinese Business News reported that unnamed sources said negotiations between Rio Tinto and China had concluded and that China had accepted the same benchmark prices that Japanese steelmakers had agreed to for a period of six months. There were no other confirmed sources, and no names were released, so the market took the news with a grain of salt. The market's skepticism was wise in this case, because by July 9, the denials started rolling in.

The big iron ore companies negotiate with the China Iron and Steel Association [CISA], whose members produce the majority of the steel in China. As Tian Zhiping, vice president of China's second-largest steelmaker, Hebei Iron and Steel, put it, "China Iron and Steel Association would inform us immediately if it's going to sign the agreement, but so far we haven't heard anything."

So we think it most likely that deals are still on the table. But of course, there's the James Bond problem. How much negotiation is occurring when one of the main participants in those negotiations is being held on charges of bribery and stealing of economic secrets?

Muddy Waters

On July 5, Stern Hu, general manager of Rio Tinto's iron ore operations in China, was arrested in China. The news hit the media on July 8 in Australia - plenty of time for the markets to react to the news. And react, it did. Rio Tinto's share price on the NYSE Arca dropped from a close of 147.29 on July 7 to close at 125.68 the following day - a one-day drop of 16.73%.

In the intervening few days, there has been much speculation about the possibility of political motivation behind the arrest. With all due respect to our friends across the Pacific, getting arrested in China is no picnic. Mr. Hu (and three associates) has apparently not technically been charged, but has been accused of rather vaguely "stealing state secrets."

But what that means is up for discussion. The Australian in calling shenanigans on the whole thing:

"It is now clear that the allegations against Mr Hu and his colleagues are directly related to prolonged and unresolved negotiations over benchmark prices for iron ore being sold by Australian miners to Chinese steel mills," they said, specifically citing Rio's belief that they're out over $5 billion due to Chinese steel mills cancelling, and delaying shipments during negotiations.

Iron is incredibly important to China's economy and its economic recovery plan - the media can be little forgiven for making the connection. But until more information is released - something China is never anxious to do - speculation is all we've got. And it's going to take time - it's not looking like the Australian consulate will even be allowed to see Hu again for another month.

Iron Movement

As always though, we bring things back to investors, and in this case, the commodity is iron. Someone is buying ore in China - even if there hasn't been a benchmark agreed upon.

Bloomberg CNIVIORE:IND

Bloomberg data shows iron ore imports to China [CNIVIORE:IND] were up 3.4% to 55.29 metric tons in June - only 3% down from the record 57 million tons that were shipped in April.

Gervase Greene, iron ore spokesman for Rio Tinto, told Reuters on July 6:

"We're selling everything we make, we've never been as busy. Instead of buying under contract, they just choose to buy at whatever the prevailing rate is on the day. At the moment, that's about $82, so we're selling it at a higher price than if they had agreed, so that's where it's at."

Bloomberg reports that iron ore shipping into China from countries other than Australia is also seeing a price jump. Ore from India is up 4.7% and ore from Brazil is up 5% on the week. Since there is no publically traded spot market for iron ore, all of the information comes from participants in the trades. Metal Bulletin began publishing a daily iron ore index a few months ago for subscribers based on such information.

Just think - if we could establish a viable futures market for iron ore, complete with transparent and predictable settlement, we might even be able to keep Rio's employees out of jail. That strikes me as "aggressive negotiations."

Comments

[traderross:]

"Rio Tinto's share price on the NYSE Arca dropped from a close of 147.29 on July 7 to close at 125.68 the following day - a one-day drop of 16.73%."

The ex-dividend date was the following day, July 8. Holders are to receive $22.80 per share. This perhaps explains the "one-day drop" mentioned.

Jul 13 06:16 PM

[jstratt:]

You have to admit, the Chinese know how to negotiate hard. I wonder if Tinto's leaders still want the Chinese to hold a controlling stock position in the company.

Also I am guessing the CEO wont be going to China to wrap up negotiations.

Jul 13 07:54 PM

[Ryu Mei Co:]

IMO, China had overdone this "spy" thing, and it is going to cost them in the future. I mean, come on, you think it is such a cosmic coincidence that this GM Hu of Rio Tinto just happened to be caught "spying" after less than 10 days away from the broken deal with Chinalco.

Yeah sure, if Mr Hu is stealing and spying state secrets, wouldn't the Chinese "secret police" authorities would have discovered that already before authorizing Chinalco - Rin Tinto deal? Like all mega multi national deal, I would assume everything has to be investigated thoroughly before the states authorized any go-ahead meager deal. Now, if Mr Hu is actually a spy, then imo, the Chinese would have already found out. There is more towards this than meets the eye, and I think China is really angry because of losing "face"....... yikes, you can never make China lose "face"

Jul 13 08:23 PM

[Rays-a-laugh:]

What about other companies that export over 50% of aaa grade ore & of that over 33% exported to China. The company Ferexpo (FXPO.L) & It's shares are over 45% down from 1st June and has traded sideway's from 1st Jully! Just watch this GO over the next 30 day's if this article is true?

Jul 13 08:45 PM

[Alan Young:]

Boys, boys... this can be resolved peacefully. Agree on a price RANGE and tie the monthly or quarterly point within that range to some objective index that neither side can manipulate-- the same way floating rate loans are tied to LIBOR.

Strangely (or not), Rio's competitors seem more amused than threatened by the situation, and their shares are mostly up.

Jul 14 01:53 AM

[Moon Kil Woong:]

China will inevitably pay higher prices in the future as they are in the present merely because of even more dire forms of counter party risk in dealing with them. This is not only shameful, but is a very bad business practice.

Jul 14 06:26 AM

[Spook:]

With all the bits and pieces information coming out, Reuter reported that the department head of Shougang Iron Ore was also detained.

In light of all these information, the case is probably not spying, but unethical business practice, it looks like Stern bribe the iron ore department head of Shougang, to know whats the bottom line that the Chinese can take, instead of the steep cut (discount) that the Chinese want, the department head may had divulge the information, but not sure about the bribery.

This information was probably used by Rio to walk away from the price negotiation (40% cut asked by the Chinese) and stick with 33% only. It may have caught the Chinese negotiator by surprise, but if the charges above were true, I will bet that the department head will either go to prison or execute for treason.

If this is not about loosing face, I don't know what it is then.


> IMO, China had overdone this "spy" thing, and it is going to cost
> them in the future. I mean, come on, you think it is such a cosmic
> coincidence that this GM Hu of Rio Tinto just happened to be caught
> "spying" after less than 10 days away from the broken deal with Chinalco.
>
>
> Yeah sure, if Mr Hu is stealing and spying state secrets, wouldn't
> the Chinese "secret police" authorities would have discovered that
> already before authorizing Chinalco - Rin Tinto deal? Like all mega
> multi national deal, I would assume everything has to be investigated
> thoroughly before the states authorized any go-ahead meager deal.
> Now, if Mr Hu is actually a spy, then imo, the Chinese would have
> already found out. There is more towards this than meets the eye,
> and I think China is really angry because of losing "face".......
> yikes, you can never make China lose "face"

Jul 14 09:09 AM

[coreopsis:]

Do you know what counterparty risk is? Why do you use hijack terminology which you don't understand? Your posts are increasingly erratic. Please consult your physician.


On Jul 14 06:26 AM Moon Kil Woong wrote:

> China will inevitably pay higher prices in the future as they are
> in the present merely because of even more dire forms of counter
> party risk in dealing with them. This is not only shameful, but is
> a very bad business practice.

Jul 14 11:22 PM