What does BHP Billiton chasing Rio Tinto mean for the future of iron ore pricing?

BHP Billiton Ltd., the world’s biggest mining company, plans to pursue a takeover of Rio Tinto Group after an earlier approach was rejected, in what would be the largest acquisition in history.

A purchase of Rio, which has a market value of $159 billion, would create a company that controls more than a third of the iron-ore market, supplies the most energy coal and copper, and owns mines and oilfields in six continents. Rio, the third-largest miner behind Anglo American Plc, surged 21 percent in London trading.

“If the name of the game at the moment is resources in the ground, then why pussyfoot with junior or medium-size miners when you can go to the top?” said Stephen Pope, chief global market strategist at Cantor Fitzgerald Europe in London. “This deal will happen, it’s just a question of time.”

The combination would raise antitrust issues, particularly in the iron-ore market, said Charles Bailey, an analyst at Brewin Dolphin Securities in London. BHP, Rio and Brazil’s Cia. Vale do Rio Doce control about 80 percent of seaborne trade in the ore.

Rio, the world’s second-largest iron-ore exporter after Vale, may now decide to combine with its Brazilian rival, according to Ian Henderson at JPMorgan Asset Management in London.

I’m curious about what this means for the future of the bench-mark pricing of iron ore. BHP (if you recall ), the smaller of the Big Three (relative to Rio and CVRD) want a spot-price/futures market; the bigger two do not. If BHP secures Rio Tinto, I would expect that process to accelerate (China, are you paying attention?). If, on the other hand, Rio Tinto were to merge with CVRD, I would expect the bench-mark approach to remain.

Given a merger of Rio Tinto and CVRD, one also wonders what would become of the standardisation of the bench-mark. Australian ore is closer to Asia, and deserves a premium for that expediency; Brazilian ore is of a higher quality, and deserves a premium for that. If one firm was extracting ore of both types, would we be more likely to see two prices emerge, or still just the one? It seems to me that a merged Rio Tinto/CVRD would see an advantage in price differentiation – even if they retained an annualised bench-mark pricing mechanism. The monopsony power would also be likely to put a stop to China’s pressure for discount-pricing.

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