Monday, July 20, 2009

Behind Chinese walls

THE detention of four executives of Rio Tinto, an Anglo-Australian mining giant, has transformed an industrial spat to a big test of how China intends to pursue its economic objectives. It has also sent a shudder through Chinese employees of Western companies in any area that is deemed important to the country’s welfare.
News only began to emerge on Tuesday July 7th though the government picked up Rio’s employees two days beforehand. After nearly a week details still remain sketchy. Despite the government’s being barraged by inquiries, there has yet to be any official comment. The scant information that has emerged has appeared in local publications believed to have access to government sources, and to announcements by Rio Tinto and the Australian government. The latter pair say they are mystified by what has unfolded. A worker at a large steel company, Shougang Group, has also been detained. Many others may have been questioned.
The detentions come during acrimonious negotiations between the Chinese steel companies and Rio over benchmark iron ore prices, which are set annually. Last year’s contract expired on April 1st, and a supposed final deadline for settling prices passed on June 30th . Last year’s negotiations took place when ore prices were soaring and the final, hard-fought agreement led an 85% price increase. This year, the China Iron and Steel Association was outspoken in its desire to see prices fall sharply, which throughout the spring seemed likely as demand wavered and spot prices sank. But the hard-line approach now seems to have backfired.
In late May, Japanese and South Korean steelmakers agreed price cuts with the three mining companies that dominate the trade in iron ore—Rio, BHP Billiton and Vale. Chinese negotiators continued to push for more but Rio remained firm, as have the other producers. Typically, mining companies like to work under annual contracts, since it enables them to assemble the massive supply chain needed to move vast amounts of ore from remote locations around the world.
This year, the failure to reach agreement has not been without benefits for the miners. Spot prices, which guide the annual benchmark, have risen steadily. And Chinese steel mills have been forced to make purchases on the spot market. Here prices are currently not only significantly above what they had hoped to pay, but approximately 7% more than what the Japanese and South Korean mills have agreed to under their annual contracts. This has put the Chinese producers at a disadvantage at a time when they felt their heft should give them a preferred rate in the annual negotiations.
That, say many in the industry, has resulted in the disastrous Chinese negotiating strategy—playing tough while prices were rising. There is widespread speculation that this has been enough to prompt embarrassed officials to attack Rio by alleging that Rio’s employees engaged in the theft of “state secrets”, presumably meaning the production targets of state-run Chinese steel mills. In a further twist, as part of the investigation into Rio, Chinese authorities are said to have seized information which may provide insight into the mining firm’s production costs and capacity.
Whether any of this is useful to China is questionable, but without a doubt the recent events could carry a high cost. The mysterious nature of the arrests has raised widespread concerns within foreign companies attempting to operate in China. If state espionage charges are used in a case stemming from a commercial contract negotiation, the worst fears of foreign companies and countries about the Chinese companies will be justified. In June, Rio rejected an offer by Chinalco, a state-controlled aluminium company, to raise its stake in the mining company to 18%, preferring a joint venture with BHP Billiton encompassing the iron ore assets of both comanies in Australia. The Chinese government was irate. But the detention of the Rio employees would seem to justify some of those concerns. Jul 17th 2009 | SHANGHAI

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