The high price of metals, a consequence of speculation in some funds on the London market, and the abrupt rise in demand from emerging nations have combined to provide the huge mining multinationals with great liquidity. At the same time, their need for exploring new deposits and the entrance of new players from Russia and China have spurred these firms to launch a historically unprecedented restructuring process involving mergers and acquisitions in order to avoid losing their positions in markets where the leading player in the rankings can change in a matter of minutes. Gold, nickel, copper, zinc and aluminum play the leading role in this mining revolution. In the largest acquisition in the sector, Falconbridge, the Canadian firm, has been purchased by Xstrata of Switzerland. The biggest news, however, has been the creation of an aluminum giant in Russia, with the merger of Rusal and Sual, which will take over the leading position in the rankings from U.S.-based Alcoa.
RussiaPlays a Leading Role
The merger of Rusal and Sual, the two largest producers of aluminum in Russia, will create a platform with sufficient scale to become one of the world’s main mining companies within a few years, reaching the scale of Australia’s BHP Billiton and Britain’s Rio Tinto, say analysts. To create this new company, Rusal will have to spend about 23.4 billion euros ($30 billion), which it will also use to purchase the aluminum assets of Switzerland’s Glencore group. This deal is not only viewed favorably in the Kremlin, it is personally favored by Russian president Vladimir Putin, who has made the exploitation of hydrocarbons and raw materials the engine of his country’s economic development.
Russia is the world’s largest producer of gas, producing 25% of European consumption, and it has just taken over the leading position in petroleum operations. Until recently, Russia was in second place, hard on the heels of Saudi Arabia. In addition, Norilsk, the world’s largest producer of nickel, is a Russian company, and its price on the London market is breaking historic records. Apart from nickel, Russia is also a leader when it comes to the production of gold and iron. Robert Tornabell, former dean of the ESADE business school in Madrid, says that Russia’s goal is to dominate this sector, “and they are achieving that.” When it comes to raw materials, Russia will be able to boast that it holds the key. In contrast, Africa has some of the world’s greatest deposits. “Putin maintains strong control over primary materials,” notes Tornabell, who also warns that Russia “is not a reliable partner.” He recalls that there were cuts in gas supplies [from Russia] last winter at a time when Algeria and Libya were fulfilling their commitments. Those [North African] countries guaranteed that Spain had a regular supply of gas at a time when other European countries were suffering the consequences of a cut in the supply of this fuel.
Why does Russia have such a strong interest in controlling the raw materials sector? According to Tornabell, the answer is rooted in the fact that although Russia “has a surplus of foreign exchange, it is a member of neither the European Union nor NATO, and it is buying portions of companies that fit well with Europe.” The danger of this approach [for Europe] is that when it comes to energy sources, Europe depends on the Middle East, “which is a powder keg, and on Russia, and you don’t know if Russia will fulfill its commitments.” Between February and May, the price of nickel tripled. With prices so high for metals and such fossil fuels as petroleum, Russia’s trade surplus “is extraordinary.”
You also have to take into account that the average salary in Russia is about 200 euros a month. As a result, “the big state-owned companies are making a fortune with their fabulous revenues,” notes Tornabell. Through mergers, such as the one that brings Sual and Rusal together, the government maintains much more state control over many of these energy giants. The Kremlin directly controls the economic expansion of the country and its effort to become an important player on the international economic scene. “Getting control of any raw material is a key to power,” notes Lina María López Sánchez, professor at the Madrid Polytechnical University’s school of mining. In this case, she adds, “Russia has the big aluminum mines that enable it to control this market.”
When it comes to aluminum, Joaquín Garralda, professor of strategy at the Instituto de Empresa (IE) business school, explains that metal is a commodity whose quality depends on what part of the world it is produced in. Price is another critical factor, and that depends on who manages to achieve the lowest costs. At a technical level, this metal exhibits the unique quality of having great economies of scale. That is to say, it needs to be produced at very high levels in order to be profitable. It also requires a process of continuous production, which cannot be stopped. As a result, fixed costs are very high and energy consumption is a key factor in reducing production costs. For Garralda, Russia’s big advantage is that energy is cheaper there. Russia also has a national company that has cut its fixed costs because it has increased its production capacity and become a “very significant competitor” on the international level. In addition, Russia has easy access to such minerals as bauxite (from which it makes aluminum). Nevertheless, Russia is not the only country that is rich in raw materials.
A revolution in the Mining Sector
Although Africa and Latin America have some of the richest mining deposits in the world, Canada is the world’s largest producer of nickel, zinc and potash. This fact, along with the upward trend in metals prices on the London market, has awakened the interest of mining multinationals in acquiring Canadian companies. Switzerland’s Xstrata, which owns Spain’s Asturiana de Zinc, has played the major role in the largest deal in history by acquiring Canada’s Falconbridge for a price of 13.25 billion euros ($17 billion). Xstrata had to increase its offer price twice because it was competing with Phelps Dodge of the U.S., which wanted to merge with Falconbridge. It was also competing with Canada’s Inco. A merger with Inco would have created the world’s largest producer of both nickel and zinc.
Xstrata, along with Britain’s Rio Tinto, has been the subject of rumors about a possible takeover offer for Anglo American, the world’s third-largest mining firm measured by market capitalization. Xstrata has dismissed all talk of a deal, and other possible buyers have decided not to comment on the subject. On the other hand, two Canadian companies, EuroZinc Mining and Lundin Mining, announced a few days ago, that they will merge in a deal that values Lundin at $1.64 billion. This is the latest deal in a complicated process of acquisitions. Things have become more and more complicated ever since Xstrata destroyed the plans of Phelps Dodge, the world’s third-largest producer of copper, and Teck Cominco of Canada launched a takeover offer for Inco, the world’s second largest producer of nickel. To make the deal work, Xstrata would have had to end all plans to become the world’s largest zinc producer. Nevertheless, Brazils Companhia Vale do Rio Doce (CVRD), the world’s largest producer of iron, has also wanted to participate in this unprecedented wave that is carrying prices for some metals, including nickel, to historic heights.
A few weeks ago, in fact, the London metals market was forced to impose contractual restrictions to stop the upward rise of that metal [iron]. So far this year, the price of iron has increased by 19%, following the 71% rise of last year. For its part, zinc shot up 160% between the second quarter of 2005 and the equivalent period this year. Nickel prices have risen by 36%, reaching historic highs. A labor strike in Chile’s La Escondida mine, the world’s largest deposits of copper, contributed to the upward move. The mine is owned by Australia’s BHP Billiton. Production was shut down there for almost a month after the company refused to improve labor conditions and salaries of the miners, despite the fact that it had announced earnings that were a record high for an Australian company and for any multinational mining company. During the second half of the fiscal year, BHP Billiton’s revenues increased by 77%, while its net profits practically doubled, reaching $6.1 billion.
Currently, the international situation is dominated by this Australian company, which resulted from a merger of BHP and Billiton. When it comes to market capitalization, the top ten mining multinationals after BHP Billiton are Britain’s Rio Tinto and Anglo American; Canada’s Teck Cominco; Switzerland’s Xstrata; Russia’s Norilsk Nickel; Canada’s Falconbridge; Phelps Dodge of the U.S.; Canada’s Inco and Southern Copper, based in Peru. However, these rankings will change in a few months after the completion of the deal that will bring Falconbridge and Xstrata together. The resulting company will be ranked the fourth largest in the world. If the offer by CVRD is accepted by shareholders of Inco, CVRD will become one of the world’s 10 biggest companies in a single move. The new company would also become the leading position in nickel production from Russia’s Norilsk, and the sector would become even more concentrated. According to experts, steel is one of the industries most affected by the restructuring of the mining sector in which Canadian companies are playing the lead role.
Steel manufacturers Arcelor, Mittal Steel and Acerinox have all suffered declines in their earnings largely because of the rising price of iron, the basic material for steel, and for nickel, which is essential for manufacturing stainless steel. The other problem for steelmakers is the lack of concentration in the sector, compared with concentration of the mining sector. This means that negotiating power is in the hands of the producers of raw materials [rather than the manufacturers]. Greater concentration in this sector, says López Sánchez, “would lead to a reduction of mining costs from the viewpoint of the companies; increased investment capacity; and greater profitability. From the viewpoint of the market, it can mean a greater concentration of power, and can lead to greater control of raw material prices in the marketplace.”
The big mergers “are created in order to adjust supply with demand,” says Garralda. An expert in strategy, Garralda believes that the arrival of new competitors on the international scene, such as those in Russia and China, can lead to increased supply. However, there is no reason for the same thing to happen on the demand side. Some countries, such as China, have the capacity to generate sufficient internal consumption to absorb greater production levels. However, this doesn’t work out in other locations. For example, the aluminum sector is a cyclical market that has some very good periods, such as the current period, but also some periods that are very bad, says Garralda.
When the cycle is at low ebb, companies have no reason to lower their prices because consumption depends on the needs of other sectors, such as construction and auto manufacturing, not on the cost of the raw materials. At such times, moreover, aluminum companies are not interested in starting a price war that does even more damage to their earnings. Although their costs go up, they cannot stop production, and they incur higher inventory costs. The mega-mergers enable the big companies to become more competitive, and reduce the number of competitors. Garralda believes that multinationals “do not want to begin a price war, and it is much easier to have just a few companies that get along well with each other.” When big companies let midsize firms get into the game, they run the risk that that the midsize firms will want to win market share by lowering their prices.
Conquering the Market
The unstoppable advances made by India and China have led to a major rise in the consumption of such metals as steel, aluminum and copper. Inventories of such minerals have been drastically reduced in recent years, to the point where the ability to extract some raw materials is lower than the demand for those materials. In the case of copper, for example, the sector is planning to develop new deposits in different continents. At the moment, copper production is concentrated in Chile, which has about 40% of global reserves. Not surprisingly, Codelco, a Chilean company, is the world’s largest copper company. It has about 20% of the world’s reserves.
When it comes to geography, deposits of other minerals are also very concentrated. The world’s largest coal and diamond mines are in Africa. Latin America has some of the other largest deposits in the world, beyond copper. These include nickel, zinc and many other minerals. López Sánchez says that Asia is one of the continents that has the greatest potential when it comes to mining. Nevertheless, current deposits are not sufficient to satisfy current demand, so prices have shot up. Another factor that has contributed to rising prices is speculation by hedge funds that invest in metals, explains Tornabell.
Until now, the philosophy has been to grow by buying companies that are in bad financial condition and rebuild them. However, at the current price of metals, “all of the companies in the sector are profitable,” says Tornabell. As a result, the big multinationals have had to change their strategy. They need to develop new deposits, and that requires a critical mass. “If they do not increase their scale [of operations], they cannot compete in markets” that require significant investments, Tornabell says. From the moment when they decide to develop a deposit until the time when it becomes productive, there are several years when they must invest large sums of money but there is no stream of revenues.
For example, a new petroleum production facility requires seven years; uranium takes five years; and iron takes three years. “If a company does not acquire a critical mass, it remains isolated from markets because it does not have [sufficient] resources.” In addition, those deposits that are beginning to be developed today — in order to satisfy the higher levels of demand — will not bear any fruit for several years. During this entire time frame, prices for metals will continue to grow, and multinationals see mergers and acquisitions as an opportunity to maintain their strong annual revenues.
According to López Sánchez, “the rising price of metals is a significant incentive because it enables companies to make more money, and it is a good time to invest and buy other, smaller companies and become bigger as a result. Mining operations require big investments. The bigger the companies are, the lower their risks when it is time for tem to explore new deposits that will require significant investment but which are not guaranteed to pay off.”
Gold Fever Returns
When it comes to gold, South Africa is the country that has the world’s most important deposits. However, Latin America also has big reserves. China trails behind in this area. But not only is China the largest consumer of every sort of metal in the world, it also has aspirations to become the largest producer of some minerals, such as gold. Zijin Mining, a Chinese firm, wants to increase its production capacity so that it can oust Newmont Mining, an American firm, from the leading position.
Gold is one of the industries that have experienced the most change in recent years. In 2001, the leading company in the sector was South Africa’s AngloGold. Three years later, AngloGold merged with another South African firm, Ashanti Goldfields. The newly strengthened company is known as AngloGold Ashanti. The company took over top spot in the rankings from Newmont Mining. However, those rankings could change in a few months if Canada’s Barrick manages to acquire Novagold, following on the heels of Barrick’s recent acquisition of Placer Domen, at a cost of 8.1 million euros. Another Canadian firm, Goldcorp, has just announced its intention to buy Gladis Gold, an American firm, for shares worth about 6.7 billion euros.
This battle for supremacy has awakened a second gold fever among mining multinationals. They have found an opportunity to further their investments and increase their production levels in the undeveloped regions of Central America. The governments of that region offer these big companies concessions that last up to 30 years, including incentives that can mean a maximum tax rate of only 2% of total production. Lax environmental regulations put the finishing touches on the attraction, leading largely U.S. and Canadian companies to more than 20 deposits identified in Central America.
Nickel, zinc, copper, aluminum and gold, among other minerals, have become the major players in a corporate concentration that is unprecedented in the history of mining. Although the short term result has been higher prices, experts are confident that this restructuring process will wind up stabilizing prices in the medium and long term.
