24/11/2014 - 13:56

Glencore strategy straddles the continent

24/11/2014 - 13:56

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The iron ore majors’ move to flood the market may see off their small rivals, but a bigger opponent looms large.

Glencore strategy straddles the continent
HALTED: Glencore stopped production at its east coast coalmines for three weeks.

Australia's all-important mining sector is being used in a far-reaching experiment of financial and leadership theory, which could determine the future control of a major portion of the Western Australian iron ore industry.

One side of the experiment involves Rio Tinto’s flooding of the iron ore market, a strategy designed to drive rivals out of the industry and, theoretically, lead to higher profits sometime in the future.

Glencore is the other side of the experiment, closing its Australian coalmines for three weeks to achieve higher coal prices now.

The connection is not widely understood, however, largely because one half of what’s happening is affecting coalmines on the east coast, and the other half iron ore mines on the west coast.

Linking everything is Glencore’s ambition to acquire Rio Tinto, with its first informal merger proposal delivered three months ago and the next move likely to be made early in 2015.

The audience watching what’s happening very closely largely resides in London and is comprised of the institutional fund managers who effectively control both companies.

Because British takeover laws prohibit a second approach by Glencore with six months of the previous move, not much is going to happen at a corporate level before Christmas – officially, anyway.

Behind the scenes it’s a different matter, because Glencore chief executive Ivan Glasenberg has made it very clear that he regards market flooding as a daft idea that hurts everyone.

Mr Glasenberg has criticised Rio Tinto at every speaking opportunity, and by inference its chief executive Sam Walsh, about how the big iron ore miners are damaging the market, and damaging themselves by over-producing and over-investing in new mines.

Until now his words have been largely ignored as those of a man who runs a company that does not, yet, produce iron ore and therefore can be discounted.

Coal is something that Glencore produces in abundance. Like iron ore, coal is currently oversupplied, with few producers of thermal coal (the material used to generate electricity) making profits.

Mr Glasenberg’s solution is exactly the opposite of that adopted by Rio Tinto, BHP Billiton, Vale and Fortescue Metals Group, the iron ore miners chasing productivity gains by ramping up production in the belief that they will be the last men standing.

By mothballing all of Glencore’s Australian coalmines, Mr Glasenberg has set about proving that the flooding of any market is a poor management decision; and that while it might wipe out a few high-cost rivals, it also hurts the shareholders of the companies doing the flooding.

The next few months will determine who’s the winner out of Mr Glasenberg and Mr Walsh, and whether flooding is better than mothballing.

Given that flooding will take time to work, and that it takes a long time for high-cost producers to exit any market (and time for stockpiles to shrink), it’s a fair bet that by early next year the iron ore market will still be awash in surplus material and the price will still be depressed.

Coal, however, is already showing the benefits of Glencore’s three-week holiday, edging up slightly on news that around 5 million tonnes has just disappeared from the market.

If that trend continues, and coal rises marginally while iron ore doesn’t, then Mr Glasenberg will enjoy one of those classic ‘I told you so’ moments, and be able to tell institutional investors that Rio Tinto is making a dog’s breakfast of the iron ore industry and it’s time for a new management.

There will be several ways to judge who’s right and who’s wrong: the price movement of the commodities involved in the experiments; the share prices of the major players; and the profit results scheduled for release early in 2015.

The jury weighing up the evidence will be the big shareholders of both companies with their position likely to be tested by a fresh, and more formal takeover proposal from Glencore for Rio Tinto.

Ho ho ho … hum

FALLING residential property prices are just one way of measuring the slowdown in Western Australia’s economy, as the mining boom becomes a fading memory.

Other important measures of economic activity can be found in consumer spending and vehicle sales.

According to the latest data covering new vehicle sales there has been a 5.9 per cent decline in WA so far this year compared with the first 10 months of last year, a much bigger fall than the 1 per cent decline in Victoria and a country mile behind the 2.6 per cent rise in NSW new vehicle sales.

But the numbers that may cause retailers to reconsider how much to spend restocking their shelves for Christmas can be found in the Westpac survey of consumer spending plans for the festive season.

While the Australia-wide trend is for reduced spending on gifts, the state where gift giving looks most exposed to a downturn is WA.

According to Westpac’s survey of consumer spending plans in the lead-up to Christmas, WA will suffer a net decline of 28.3 per cent, a number derived from subtracting the number of respondents likely to spend more on presents (6.9 per cent) from the number expected to spend less (35.2 per cent).

Other states have a different mix of spending less and spending more, but WA’s 6.9 per cent spending more is easily the lowest in Australia and compares with 15 per cent of respondents planning to spend more in Victoria and 12.3 per cent in South Australia – the two states generally seen as being Australia’s economic laggards.

Bitten by Leviathan

WOODSIDE Petroleum hasn’t had too many wins over the past few years, but it can chalk up what might be called a negative success with its decision to walk away from Israel.

Controversial at the time, because big gas discoveries in the eastern Mediterranean were seen as an opportunity for the Perth-based oil and gas company to expand its production footprint, it now seems that Woodside was correctly reading the policies of the Israeli government.

High taxes and strict domestic gas reservation policies imposed by the government have stopped all exploration off the coast of Israel and raised doubts about any future development.

Leviathan, the project in which Woodside planned to invest, is said to be creeping forward but a start on construction next year is not assured.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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