By John Kemp
LONDON Feb 26 "What we've got to do, when the markets do get stronger, no need to keep building a new asset and let's keep the market tight for a while," Glencore Chief Executive Ivan Glasenberg said in remarks about overinvestment in the mining industry.
Glasenberg's comments underlined the case for vigilant antitrust enforcement in the mining sector.
"Not that we're here to create an anti-competitive nature, but we've got to get returns. You the investors want to get returns on our assets and it's easily done if we just use our brains," the Glencore chief told investors at the BMO Capital Markets conference in Florida, reported by Bloomberg.
"We've always been wanting to keep building and keep putting the cash which we generate into new assets. That's what we've got to stop doing as a mining industry. We've got to learn about demand and supply," he said.
Glasenberg was criticising departing chief executives at BHP Billiton, Rio Tinto and Anglo American for reacting to higher prices by investing in too much new capacity ("Glencore's CEO says rival mining chiefs really screwed up" Feb 26).
But his frank observations about the nature of mining profitability confirm the need for heightened scrutiny of asset purchases and mergers and acquisitions activity in the industry.
Given entry barriers, the incentives facing mining bosses and their intentions are crucial.
As the Glencore chief's comments show, there may be incentives to enjoy the benefit of limited supplies and strong demand in the form of higher prices, rather than respond by rushing to order new capacity.
Regulators should be on guard. The sector is already very concentrated. Further increases in concentration should be resisted and the industry's conduct should be subject to the strictest form of scrutiny to ensure it continues to operate competitively in the interests of customers as well as shareholders.
Regulators have not always appeared to take potential problems as seriously as they should. In 2008, the Australian Competition and Consumer Commission (ACCC) decided not to object to BHP Billiton's proposed acquisition of Rio Tinto because "the acquisition would not be likely to substantially lessen competition in any relevant market."
"The proposed acquisition would combine two of the three major global seaborne suppliers of iron ore lump and iron ore fines," ACCC observed.
Yet "while barriers to market entry are high, involving significant sunk costs, market inquiries indicated there has recently been significant new entry and expansion in response to high demand for iron ore."
"The ACCC's inquiries indicated that the merged firm would be unlikely to limit its supply of iron ore given the uncertainty it would face in relation to the profitability of this strategy and the risk that limiting supply would encourage expansions by existing and new suppliers."
In the end BHP's attempt to acquire Rio fell apart because the EU insisted on asset disposals, and the likely prices realised for them were impaired by the escalating global banking crisis at the end of 2008.
But the ease with which the ACCC and the EU set aside their concerns about the market power of the major miners raised troubling questions about the thoroughness of their review processes and ability to safeguard competition.
NONE SO BLIND
Long lead times, significant investments in exploration, mine development and the establishment of associated power, rail and port infrastructure, all make pricing unstable and render the industry vulnerable to competition concerns, as ACCC explained in its preliminary statement of issues on the BHP/Rio tie-up.
"Given the merged firm's significant portfolio of low-cost iron ore projects and relatively high barriers to entry and expansion, the merged firm may have the ability and incentive to influence global supply and global prices for iron ore."
"To the extent that the merged firm could profitably time future production and infrastructure capacity expansions so as to maintain a global shortfall of supply," steelmakers could face higher prices, ACCC warned.
Somehow ACCC and other regulators, including the EU, still managed to get comfortable with the tie up, in the latter case insisting only on limited disposals, according to sources familiar with the review at the time.
In 2010, the question of competition cropped up again, this time in the context of the proposed joint venture between BHP and Rio to develop their iron ore mining interests in the Pilbara region of Western Australia.
Somewhat sheepishly, given its earlier insouciance, the ACCC took a tougher line. Capacity expansions it had previously counted on had not happened. Rio and Brazil's Vale had cut production.
"While production cuts might reflect the large drop in demand (owing to the global financial crisis), they might also reflect strategic behaviour with the purpose of limiting the decline in prices," ACCC observed. If so, it might indicate "there are opportunities for large, low cost iron ore producers to withhold supply."
Ultimately the proposed joint venture was abandoned and ACCC ceased its review, but the tougher scrutiny indicated greater unease among regulators.
Concerns about BHP and Rio centred on iron ore. But the same issues arise in all areas of bulk mining, including thermal and coking coal, as well as some higher-value production like copper and are not restricted to the two big Australian miners. Long lead times, capital intensity and the small number of firms involved all heighten risks to competition.
Competition lawyers and consultants acting for BHP and Rio pointed to restraining effects from potential new entrants as well as existing competitors. In practice, barriers to entry have remained insurmountable. Most competition has come from within the major mining houses, in the form of capacity expansions.
It is the effects of that competition and capacity expansion which have now been criticised by investors and Glasenberg for cutting prices and lowering returns.
"Now we have a new generation of CEOs; I hope CEOs have learned their lesson. They built, they didn't get the returns for their shareholders. It's time to stop building," Glasenberg told the conference.
The Glencore head's diagnosis is not entirely fair. Much of the value-destruction within the industry came from ill-judged financial acquisitions rather than capacity expansions, for example Rio's disastrous overpayment for Alcan's aluminium assets.
Glencore-Xstrata will be more cautious. "We will get better returns on our investments, we will be able to kick out more cash to our shareholders," Glasenberg promised. "We will be late to invest."
Glasenberg's comments underscore the need for continued vigilance.
If necessary, regulators must be ready to take both structural and behaviour measures to ensure the industry remains competitive and executives have incentives to invest appropriately and raise output, not just pocket price increases.