One theory about the continuing wave of mining-sector mergers and acquisitions is that these deals reflect views in the mining companies that commodity prices may be at, or near, cyclical peaks.
According to this view, investment in large, long-term projects has become more risky and expansion through mergers offers better returns.
This theory is certainly not being supported by the recent rhetoric from BHP Billiton and Rio Tinto.
What it means
 Shift to resource-intensive growth
Prices could stay higher for longer
|
Since BHP Billiton confirmed its plan for a merger with Rio Tinto last month, both companies have displayed extreme bullishness about commodity markets. Both have also added more detail about ambitious expansion plans over the next five to 10 years. And neither has hinted at any reservations raised by the credit crisis or a potential economic downturn.
Other diversified miners such as Xstrata, Vale (previously called CVRD) and Anglo American all have a large pipeline of expansion projects. The same is true of Kumba Iron Ore, which could more than double its production of iron ore in the next 10 years.
BHP Billiton and Rio Tinto, the global leaders (with Vale) in the iron ore sector, seem particularly positive on this market's long-term prospects as well as the nearer-term outlook. A bullish view is reflected also in Kumba's share price, which has risen 144% this year. At the half-year results announcement in July, CE Ras Myburgh said Kumba was aiming for an annual iron ore production capacity of 70 Mt by 2015, though full use of the resources in the Northern Cape would depend on a cost-effective, reliable rail or export system.
On the BHP Billiton/Rio Tinto merger proposal, there is still no agreement between the companies. Rio Tinto CE Tom Albanese has described the proposed terms of three BHP Billiton shares for each Rio Tinto share as being "several ballparks" away from reflecting value and the company has described a deal on those terms as "dead in the water". Albanese has not rejected the idea in principle.
Both companies have claimed to have superior strengths or performance records. When Rio Tinto used its annual investment seminar to respond to the proposal, Albanese said the company had a better growth pipeline than its competitors, as well as an "unrivalled track record of delivery". He outlined five key "value drivers" for investors. It has plans to treble its annual production of iron ore to more than 600 Mt. In the aluminium and bauxite sector, where Rio Tinto is the world leader, expected after-tax synergies from its Alcan acquisition have risen by more than half, to US$940m/year. It sees new potential for expansion of copper production. After a strategic review, it has increased its divestment target of at least $10bn to at least $15bn.
It said its total 2007 dividend would be increased by 30%, with a further annual total increase of at least 20% in each of the following two years.
Last week, BHP Billiton CE Marius Kloppers reiterated the "compelling logic" of its merger proposal.
Since 2001, he said, BHP Billiton had created significantly greater shareholder value than Rio Tinto. It had delivered superior production growth, he said, and had invested more capital in development, delivering projects on time and on budget.
Kloppers added more detail on the company's expansion plans in some sectors. When discussing iron ore, he restated the merger rationale that it would enable delivery of more tons to customers faster than would be possible were the companies to remain separate.
Confidence in long-term demand for metals and minerals, as well as pricing levels, underpins all these growth plans.
Rio Tinto's view, spelt out in a paper by its chief economist, Vivek Tulpulé, is that firm global economic activity, led by China, will support strong increases in demand for most metals and minerals over 2008 and 2009.
With low stocks and a likely continuation of supply-side difficulties, it adds, most commodity prices are expected to remain well above their long-run trend over the short and medium term. It adds that it is too early to suggest that the present price cycle has peaked across the range of commodities.
Though there are short-term risks associated with the predicted slowdown in the US economy, it's important to recognise that the US is significantly less important in world commodity markets than it was just five years ago, it says.
From a longer-run perspective, says Rio Tinto, recent history and International Monetary Fund forecasts suggest the world is going through a period of growth not seen since the period of growth and reconstruction in OECD economies after World War 2.
This leads to "profound implications" for commodity markets. Forecasts for iron ore, aluminium and copper suggest demand could double and even triple over the next 25 years, says Rio Tinto.
It argues there has been a structural shift towards resource-intensive growth in developing economies with large populations. Though China and India provide the most recent examples of this growth, they are not alone. Many countries in the Middle East and Southeast Asia are also on fast growth paths.
The present rush to meet demand has led to rising construction costs and project delays; higher levels of disruption as production systems are stretched; higher average production costs due to labour and other input cost increases; and higher industry marginal costs as more expensive production is drawn in.
Rio Tinto concludes that most metal and mineral prices can be expected to assume significantly higher average levels over the very long run than has been the case historically, due to structural increases in industry costs.
If the mining companies are right, this is a reassuring scenario for investors and for producer economies such as SA. If it turns out to be wishful thinking, the next commodities downturn could be severe and protracted after the big investments in new capacity.
Ranking the Analysts 2009
