No one comes out of the Rio-Chinalco experiment looking good. The Australian press fell hook line and sinker for the feed of Australian vested interests in the play. Unfortunately there’s little ballast in the way of Chinese expertise in the fifth estate. Australian policymakers directly responsible for the deal looked like a bunch of stumblebums and will have to work hard to restore confidence in the Australian investment environment. Chinalco made some seriously bad calls while Rio was a house divided against itself. Opposition political leaders (Turnbull, Costello and Hockey) performed like a bunch of clowns (on a par with the self-confessed ignorance of Joyce and Xenophon) who couldn’t be trusted with managing the national estate. Australia’s political leadership was missing in action. And the analysts, like me, assumed too readily that lessons learned in the past are lessons learned permanently.
Unless there is a massive effort to get things sorted out quickly, don’t think that there will be no fall-out from this episode for Australia. The fallout has nothing to do with iron price negotiations or peripheral noise in the commercial relationship with China. It has to do with the damage to Australia’s standing as an investment destination, especially in China but also among other global investors, and with our position in this business in the world.
Still far too few in Australia comprehend the scale and importance of what is going on in China, be it in the economy or politically, let alone the importance of China in terms of its palpable impact on our region and on the structure of world economic and political power. Fortunately we have a Prime Minister who knows more than most, but that is not enough. His understanding needs confirmation and articulation in a national statement that serves to put the madder ideas out there (not only in the community but also deep in the policy process), about what we have to deal with and what the opportunities and risks are in how we deal with it, under forensic scrutiny and rigorous assessment.
If you’d just had a round of intensive interaction with top players in the Chinese policy world, as I have over the past several days, the one thing you’d take away about Australia’s position in China is what a good run we still get there. There is generosity, to a fault, about what failings we might have in the Chinese scheme of things. There is generosity when we don’t run the same line on whatever issue. Above all, there is a genuine warmness towards Australia in the press and in the vast community that is China today. Senior officials puzzle over why it is that Australia is so liked in China – pretty well from the top to the bottom of Chinese society. This is a huge and precious asset. But in these affairs, it is an asset that can be easily wasted.
There’s not an issue of international importance on which Australia can afford now not to take into account the China dimension. This is true for many countries, even great powers like America. But it is acutely the case for Australia, given where we sit in the world.
We need to get our act together on and with China, and quickly.
On the proximate issue, Australia needs closer engagement with Chinese authorities and policy and commercial circles on China’s ‘going abroad strategy’, to enhance understanding of how the market works in China and what dynamics now drive it in terms of competition, corporate governance, financial transparency and going out into the international market.
But much more than that, Australia needs, as a matter of top policy priority, a well worked over and publicly debated national strategy paper, with intelligent input welcomed from both sides of the relationship, as a reference point to keep the relationship on a positive track and to realise the huge potential there is in it for both countries.
For further reading see “Chinese Foreign Direct Investment in Australia: Policy Issues for the Resource Sector”
Peter Drysdale’s article is encouraging in the wake of the fell-over of the Chinalco – Rio deal. Drysdale is one of a small number of Australians who have much better understanding of Japan, China and East Asia and their real significance for Australia and has both the experience, first hand knowledge and the analytical capacity to analyse such issues. Unfortunately, knowledge and rationality do not necessarily always prevail in a society, whether it is a democratic one or not.
The failure of that deal was hailed by many in Australia, as Drysdale implied. That is unfortunate, for both China and Australia. China may feel having been fool-played by the Australian government due to its prolonging its review process of the deal and being stabbed at the back, by some elements in Australia, including the Rio Board.
As a Chinese Australian, I hope China can view this incident as merely a blip in the expanding and beneficial bilateral relationship between the two countries. Leaving any disappointment and upset aside, neither China nor Chinese firms should retaliate against this incident, by countering with strategic playing, even though the Chinese may have greater leverage due to larger size. It will harm rather than benefit the interests of both sides, including China. Greater leadership and statesmanship need to be shown and displayed.
While there are lessons for Australia, China and Chinese companies should learn something from this incident and be more subtle in their approaches to investing in Australia. They need to take into account the political reality in Australia and the knowledge and understandings of Australia to adopt the most appropriate strategies and tactics in doing business with Australia and Australian companies.
The unfortunate delay of the Australian government review process and some media displays may be interpreted by some as Australia played a strategic game against Chinese firms and China. Some may think that the delay by the Australian government may have resulted in a few factors that caused the deal to fail.
First, it extended the timeframe for the equity market to bottom out and to recover, so the deal may be seen less or un-attractive to Rio. The market did just that. The risk for Rio’s survival has greatly reduced and it is breathing much easily now.
Second, the Australian government may have influenced Rio Board to ditch the deal with Chinalco and to join hands with BHP, as the event finally played out. Rio’s Chairman’s remarks, that they received feedback from investors AND regulators about the deal, may be perceived as an implicit admission, though he may have been innocent in saying that and did not mean to sell the government out.
Third, the facts of the changes to the criteria regarding foreign investment in Australia by the Australian government immediately following the announcement of the Chinalco – Rio deal and the conditions imposed to earlier approvals of other deals with Chinese firms may have strengthened the impression that the Australian government has not been fair to Chinese investments in Australia.
Australian Prime Minister, Kevin Rudd should have more expertise on China. It, however, can be a double edged sword. Already, as some Australian media reports suggested, some Chinese analysts and commentators already voiced that Chinese may feel it is more difficult to deal with Rudd as compared to Howard, ironically. The underlying message may be that Rudd has more difficulty dealing with China because he knows how to play China’s vulnerabilities to Australia’s advantage. Whether it is misunderstanding or something else remains to be seen.
Yes. Mining is an industry that, for whatever historical and cultural reasons, seems more prone to arousing nationalistic passions than other industries. This seems to be the case in most countries, including China.
I fear that in this case supporters of the proposed deal have been very weak in their efforts to overcome this sentiment. The alarmists made big gains out of uncertainties about the priorities of state-owned Chinese enterprises. While they might be guilty of no small amount of hyperbole, there is a real lack of transparency in Chinese state enterprise which makes this a very easy card to play. Given such a situation, people who like deals like this one will have to be much louder cheerleaders, and give a clearer demonstration of why this is not just a good deal for a company deeply in debt, but a good deal in itself, before Australians will “get their act together.”
Peter,
This analysis seems to miss some basic things. This outcome was not politics but basic economics. Australia has some monopoly power in resource markets and China has some monopsony power. China buys more than half our iron ore exports and wool. Why should we transfer the market power we have to a major purchaser?
Opposition to Chinalco’s moves is not opposition to China. It would be the opposition we should maintain to any resource-hungry customer of Australian resources seeking to buy a significant stake in the enterprises that supply them.
Chinese interests as a large scale (indeed monopsonist) purchaser are not coincident with Australian interests as a supplier with monopoly power.
I am no fan of the Rudd Government but on this occasion they seem to have moved behind the scenes to limit a move that would have been advantageous to Rio but disasterous for Australia. Rio could have extracted more from Chinalco than BHP because Chinalco’s moves would have thwarted BHP’s market power as well.
Your claim that we should set things straight with the Chinese is accepted. We should make it absolutely clear to the Chinese that our foreign investment policies will not allow investments contrary to the national interest – we won’t allow major Australian resource suppliers to be owned by major consumers of these resources.
John Garnaut has an excellent article in The Sydney Morning Herald on this issue here:
http://business.brisbanetimes.com.au/business/future-deals-with-china-may-be-a-long-time-coming-20090607-bzs5.html?page=2
The money quote (or maybe the ‘no money’ quote) is this:
“Since China’s first choice, Australia, has troubled us with obstacles and bias, Chinese companies will re-evaluate,” a Mysteel analyst, Xu Xiangchun, said.
Emeritus professor Drysdale has gleaned insight into the Chinese policy world from intensive interaction with their top players, and offers his conclusion that the Chinalco deal was thwarted by a combination of Australian stumblebums, clowns and ignoramus’s.
He acknowledges neither the influence of the 76% shareholders in London who railed against their exclusion from the converting notes that became commercially unsuportable as the Rio share price rose, nor the objections of the Australian shareholders to the sale of our mineral assets.
Malcolm Turnbull’s contribution to the national press club contained the following point:
…..”China knows that as its economy continues to grow it will need to import more and more of the world’s natural resources.
Its growth, and demand for those resources, in recent years surprised everyone and this surge in demand resulted in a spike in prices before the recent downturn.
So it is in China’s interest to be able to secure as much of these natural resources and do so in a way that ensures it will have enough supply in the future when growth returns to keep prices low.”
The statement is logical and valid; not the view of a clown. It is, however an aim, that if achieved, would not be in Australia’s interest.
Turnbull concluded:
…..”So in a nutshell what is China’s national interest? It is to use the opportunity of the global financial crisis to acquire as many premium resource assets around the world so that it emerges with a global portfolio of sufficient scale and diversity to enable it to secure long term and low cost access to the natural resources it needs.
Now, what then is our national interest?
Australia’s national interest is to ensure wherever possible that the control of its major natural resource assets remains in the hands of companies that will pursue the development of those assets in a way that will maximise the economic returns for Australia.
We should be very wary of acquisitions where the commercial interests of the would-be purchaser may be at odds with the Australian national interest.”
Another reasoned cautious response to the Chinalco proposal.
I do not doubt the warmth towards Australia that professor Drysdale feels from his interaction with the Chinese policy world. But the commercial world is an entirely different place and must be evaluated to ensure he get sthe balance right.
I think HC’s comments reflect the thinking of the vast majority of Australia. I suspect a lot of the argument about Chinese “state ownership” was misdirection, and the real problem was simply “foreigners owning our stuff” combined with HC’s position of “why sell market power?”.
However I think it’s very wrong and dangerous thinking. We will have to live with the consequences of this decision for a very long time to come and the gain in market power will look very insignificant next to the costs to our relationship with China, the way the world perceives Australia, and the cost of perceived barriers to investing in Australia.
Market power is the smallest part of this whole equation.
Dominic, HC has summed it rather well, whereas you’ve just made some vague comments that seem to suggest we should all just bow down to the Chinese and their wants and demands?
“Market power is the smallest part of this whole equation”???? Which?
The arguments presented by Dominic (and in separate communications with Peter) do not convince me. I set out my responses here.
Harry
What’s your evidence of the outcome having been a consequence of the
consideration of monopoly power issues?
In any case that issue was dealt with
analytically by ours and other competition authorities. Anyone who has
studied this industry over the years knows that what
monopoly-monopsony power issues there are, are confined to the rents
on transport cost differentials (see Smith ER). I
don’t know what dream world market you assume exists for these
commodities but all of them are subject (over a remarkably period of short time)
to contestability on a large scale. This is applied international resource
economics 101.
On the FIRB policy question, if you’ve read anything of what I’ve had
to say,you’d know that I’ve never contested the national interest
test; quite the reverse. I helped set the
thing up as a political buffer. But with sloppy Joe Gullett type
arguments still around, I’m beginning to think that perhaps we need to
define it more
rigorously
And if you don’t think that this episode hasn’t messed in the Australian
investment environment, get out and take a careful look.
Best
Peter
Peter, The comments got out of sequence Peter. My response to your points is in the comment before yours.
I’m afraid the quote from Turnbull is rather simplistic in the extreme. The supposition is firstly that that once China in the form of Chinalco has “secured” said resources, the market pricing mechanism would automatically be discarded and “China” can then dictate the price at which it buys supplies. And secondly that China’s demand for resources will never cease. Turnbull’s logic is tantamount to cutting off one’s nose to spite oneself and it is highly doubtful that even the Chinese government is that shortsighted, considering how far down the capitalist route they’ve travelled.
I’m afraid that China and Chinese investors will see it in no other way but that potential profit can flow any which way except theirs.
As a small shareholder in RIO I am disappointed that the role of shareholders has been completely overlooked in the analysis of this transaction. The main reason the deal fell over was because it was uncommercial even when it was first promulgated. It is clear from press reports that despite strident canvassing by the board and executives of RIO the majority of shareholders were strongly against the deal. The disadvantage of selling assets at the bottom of the cycle were to be offset by some nebulous advantages sometime in the future. China Inc has every reason to be disappointed having missed out on the deal of the century.
Perhaps Professor Drysdale is correct in saying our broader national interest has been damaged by this proposal. Let us hope that future arrangements are more soundly based and for the benefit of both countries.
I have some sympathy to Ross Daniel’s point, although I don’t think the deal was uncommercial even when it was first promulgated and the Rio board then acted against the shareholders’ interest. Although the value of a company is hard to measure because ever changing environment and internal situations, one could get a clue from its share prices. At the time the deal was conceived, what was the total market capitalisation of Rio and what value was the deal value Rio at? I did not calculate that but that should be an easy matter to do. I suspect that that deal valued Rio much higher than the market capitalisation.
One got to remember is the fact that Rio was having very high debt to equity ratio and the market situation during late last year and early this year was so dangerous that some companies were fighting for their own survival. The deal and the Rio board had to take that into account. Yes, it turned out that the world banking and finance crisis almost subsided now, but back then, the whole system was in danger of collapse and many companies, especially those with high debt would have gone under if the banking crisis was not averted by the unprecedented and concerted efforts by the governments of major large countries/economies.
Individual shareholders may or may not have got the whole and true picture as the board in most of time, unless the board is acting strangely but that is relatively rare. On the other hand, shareholders have every right to be concerned and often get emotional.
Even now it is unclear whether the deal with BHP will bring benefit to Rio or not, given that many major countries are voicing their concerns about the monopolistic nature of the deal. They may devise some scheme to counter any savings and pricing monopoly behaviour that would potentially benefit Rio. Don’t worry about WTO rule, if there are many countries that think it is unfair, they will act and design new rules. The matter of fact is that WTO rules are made by its member countries. They can make them and they can change them.
China did not see this as an issue of offsetting monopoly power? I don’t believe it?
Peter Matters
Peter
I’ve been on the road and just caught up with your comment. It is thoughtful and deserves a response.
My piece presumed nothing about whether the deal was in the end commercially acceptable to the parties principal. It clearly wasn’t, for a variety of reasons that are now becoming clear. My point does not rest on whether it was or not. What is important is that the way in which the commerce, the policy and the politics were managed has left us with a set of problems that we have to deal with.
On Peter Costello and Mr Turnbull, you know I am sure as well as I do that they (and Joe Hockey) said other things that were a sad joke (see an earlier post of mine). Moreover, Mr Turnbull used the argument you cite to declare the deal not in Australia’s national interest. That, too, is a joke to anyone who knows the nature and structure of these trades and investment links which, for good commercial reasons, commonly involve just such buyer-customer associations. National leaders are irresponsible if they mess with the national interest in this way.
Harry Clarke
Harry
Likewise.
It might have helped your readers to judge the issue if you had included what I actually said somewhere in your post.
Where do I argue that ‘the main issue is politics not economics’?
You contend:
Really, and where are prices now? Prices rose in the face of a huge adjustment in the industry in China (and to a lesser extent India). Such price surges provide no evidence of sustainable monopoly power. By-the-by Australian suppliers have been delivering into the Chinese market at a margin significantly below the average cif price until recently. The lift in supplies to Chinese mills was significantly domestic, from India and Africa. Australia has been ‘undersold’ into China by up to 20 percentage points on its market share in the rest of Asia. Explain that with your model?
The lift in BHPB and Rio shares is again no evidence of sustainable monopoly power.
Some knowledge of the economics of these industries is essential to presuming to weigh in on these issues, Harry.
To date, there is not a shred of evidence to support the assertion that ‘China’ is a monopsony buyer (the spelling of which, incidenatally, is a cheap issue on which to score a point).
Almost all the buying is done by totally fragmented Chinese users. Chinese metals industries are by far the most fragmented in the world. Some Chinese industry leaders may wish it were otherwise, and there is a risk that the Chinalco set back will strengthen their position.
To date, there’s not a shred of evidence that China’s offshore resource investors have subsidised onshore consumers by supplying ore cheaply.
But, there is a huge perception problem for China because the process of separating government ownership from management control, even if the two are separate in practice, is a gigantic work still in progress (and there are plenty of exceptions to this, where SOE’s at the margin are still required support government social and otherpolicies).
And on your glee about the threat of anti-trust action in China on BHPB-Rio, what does BHPB think about that?
Best
Peter
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