Over the past three months, the relationship between Rio Tinto and China has lurched from one crisis to the next.
From the disintegration of a proposed investment in Rio by state-owned miner Chinalco, through painful negotiations over iron ore prices, to the eventual arrest of four Rio employees on charges of bribery, the relationship has been stretched to its limits.
But Rio’s first-half results on Thursday revealed just how important the parties are to each other, and how much both need a return to normality.
Rio confirmed that its Australian iron ore mines were producing at a maximum capacity of 200m tonnes a year. Most of that ore is bound for Chinese steelmakers, Rio’s biggest customers.
Driven by the Chinese government’s infrastructure-centred stimulus spending, the steelmakers have been restocking. To do so, they need the high-quality Pilbara iron ore whose supply is dominated by Rio, the world’s second-biggest iron ore producer, and BHP Billiton, the third-biggest.
Thanks to China’s appetite, Rio’s iron ore division accounted for more than 50 per cent of underlying first- half profits of $6.1bn (£3.7bn).
Both sides know that the relationship needs to return to normality, probably through delicate, mutually face-saving solutions to two related problems.
The first is the price that the steelmakers pay Rio for their iron ore. This is still nominally agreed through a annual price negotiation, but that system is changing.
This year’s negotiations have seen Rio pushing for a 33 per cent discount to last year’s benchmark price, the same as agreed with Japan. The China Iron & Steel Association has been pushing for a discount closer to 45 per cent.
Recently, there has been some movement with Rio’s agreement on “provisional” contract prices with its Chinese customers. Rio is selling iron ore at a 33 per cent discount to the 2008 price.
Two months ago that was unacceptable to China, because the spot price was lower than the implied discount. But now the discount equates to $60 a tonne, while the spot is about $90 a tonne.
“Provisional pricing is good for our business,” said Tom Albanese, Rio chief executive. Although it loses Rio money, the provisional agreement gives both sides the breathing room to make changes to the system. Now might not be the time to fight another battle over a fair iron ore price, especially when employees are still under arrest and the 40-year-old tradition of agreeing an annual price for iron ore is disintegrating.
The system has shown itself incapable of dealing with periods of extreme volatility, as the difficulty of estimating a fair commodity price over 12 months leads to frustration and even diplomatic incidents.
Mr Albanese on Thursday acknowledged that “the system has to bend, or else it will break.”
It had already bent: Rio, like BHP, confirmed 50 per cent of its iron ore had been sold on the spot market in the first half. In future, the spot market is likely to play a bigger role.
The other issue that awaits resolution is the fate of the four Rio employees who were arrested in July. They were involved in the iron ore pricing negotiations and were detained on allegations of obtaining state secrets, suggesting that they knew information about Chinese steel mills that not only gave them an edge in negotiating prices but also was illegal for any non-state entity to possess.
Rio’s deal with Chinalco collapsed one month before the employees were arrested. Some people close to Australian iron ore mining and Chinalco say the collapse of the deal caused the arrests, not the iron ore disputes.
One sign of recent easing in the dispute is the employees’ formal arrest this month on charges of bribery and obtaining trade secrets, lesser crimes. Mr Albanese now does not have to worry about his employees being executed.
Rio on Thursday continued its policy of offering no comments on the arrests beyond saying that it respects Chinese law, is supporting the men and their families and is not aware of evidence to support allegations of bribery. “In general events have moved on favourably,” Mr Albanese said.
With the Chinese demand for iron ore proving to be such an important contributor to Rio’s first-half results, Mr Albanese will be hoping that the favourable direction continues to hold sway.
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