LONDON Glencore (GLEN.L) and Xstrata XTA.L, set to create a $90 billion mining powerhouse, have put iron ore at the top of their post-merger to-do list, building up the one key commodity where they are all but absent.
Yet industry sources caution that without a major deal, any hopes the two will swiftly repeat their coal success in iron ore -- a lucrative markets which is mostly concentrated in a few companies' hands -- may be disappointed.
Iron ore has become a major contributor to diversified miners' profits, making up between 40 and 70 percent of earnings at Anglo American (AAL.L), Rio Tinto (RIO.L) and BHP Billiton (BLT.L).
Traders and banks are piling in too, attracted by large physical trading volumes, a pricing mechanism that is becoming far shorter and more volatile, and China's appetite for steel as it expands cities, power lines and rail links.
In a sign of its own intentions, Glencore in January hived off iron ore into a separate business arm, headed by Christian Wolfensberger, previously head of ferroalloys, nickel and cobalt. Traders say those working in the fledgling division have been given a clear indication of the aim: build coal, mark two.
"When I was in the coal business, people told me it was too late to develop the coal business because it was already owned by the majors and there wasn't a way in," Glencore Chief Executive Ivan Glasenberg told Reuters on Monday.
"There is always a way in, there will be opportunities, you just have to find them. Today with the amount of iron ore opportunity in Africa, and development in Africa, it is definitely not too late."
Coal has been a success story for both Glencore and Xstrata, both of which are led by men who built their careers in the commodity. The two will control virtually a third of the world's seaborne thermal coal trade and will become the top exporter.
Few would bet against Glasenberg, but with Glencore's share of the seaborne iron ore market less than 1 percent, some industry experts say it will be tough to crack a market dominated by Vale (VALE5.SA), Rio and BHP, which hold a joint share of some 60 percent.
"Xstrata is very much only a fledgling (player) when it comes to iron ore. Glencore will have aspirations of a 15 to 20 percent (trading) market share -- like it tries to aim for in other commodities," analyst Ash Lazenby at Liberum said. "The challenge, though, is what you can buy."
Iron ore valuations are high, with tough competition for assets that include infrastructure and are either producing or close to first production -- the sort of project Glencore and Xstrata would like to immediately boost to volumes and profit.
Industry sources say both Glencore and Xstrata have already considered a string of projects and companies -- buoyed by iron ore prices still robust at three or four times the cost of mining -- but no major deal has yet made the grade.
Xstrata last year exercised an option to buy a majority stake in the Zanaga project in the Republic of Congo and bought junior miner Sphere Minerals in Mauritania.
Few, though, expect Glencore to just wait for Xstrata's early stage iron ore projects to produce.
The prize for Glencore, indeed, is not production but the trading potential. And it will be impossible for Glencore to become an iron ore heavyweight without a boosting volumes.
Glencore has traded iron ore since 2008, when the trading of iron ore swaps began, but in 2011 it traded just 10.3 million tonnes -- a fraction of what is a 1.1 billion tonne market.
One senior executive at a rival miner said Glencore or the combined Glenstrata could get as much as 15 million tonnes a year from smaller producers -- a 50 percent increase -- but would need a deal to "leap" above 50 to 100 million tonnes.
The bulk of what the big three miners produce is sold through long-term contracts, making it imperative for Glencore to secure its own contract with them or its own source of production if it is to avoid relying on sales at the margins.
"They really need to buy a big enough iron ore producer ... the obvious one is Fortescue, if they are serious about getting a foothold in the iron ore market," one executive at a rival diversified miner said.
Analysts and bankers agree Fortescue Metal Group (FMG.AX), Australia's third-largest iron ore producer, is among the potential targets for Glencore -- securing some 55 million tonnes of annual output in a stroke and the potential to triple that. Alternatives include its smaller rival Atlas Iron (AGO.AX), or even Brazil's unlisted Ferrous Resources.
But, with many buyers sniffing around, even if Glencore is interested in these assets, it will face competition.
A mystery buyer last month snapped up 2.9 percent of Fortescue, which has a market value of almost $19 billion.
"The situation is totally different to their entry into coal years ago -- you have to pay top dollar for iron ore mines now, whereas years ago, coal mines were cheap," the executive said.
The solution for Glencore, Glasenberg himself hints, is likely to be to copy not coal, but the copper blueprint.
That is likely to mean swooping in to rescue smaller, cash-strapped, iron ore miners in West Africa, repeating the offtake and financing deals that gave Glencore a toe-hold in African mining assets and eventually, via debt-for-equity swaps, its current portfolio of high-grade Congolese copper assets.
(Editing by David Holmes)