The BHP / Rio Merger

It’s interesting how times change. Talk of a merger between Rio Tinto was proposed by the BHP-Billiton was proposed in the late 1990s. The idea never really caught on beyond the board room. BHP needed a catalyst for change and growth, but Rio shareholder were never interested. In 2001, BHP merged with British resource giant Billiton, and the happy marriage has been thriving ever since. Fast forward 6 years, a new merger worth over $370 billion-plus dollars is being proposed, and this time looks like a strong possibility.

The argument goes, both Rio and BHP are 60% owned by various mutual funds. Why should these mutual funds have to pay for two structures? A huge efficiency gain could be made that would benefit both shareholders. Its a solid argument, but also an overused one. Every merger proposal uses the efficiency argument as their number one bullet point. Even the dot com’s tried to do it; sure we rolled our eyes, but hey, at least everyone’s taken an Econ 101 course at some stage in their lives, so the sell was easy. In this example, however, it could hold some weight. The growth potential of the Pilbara region of WA; an area both BHP and Rio’s hold mining interests, seems to be the key piece of the puzzle. 500,000 square kilometres of potential iron ore deposits, still with no accurate long term reserve appraisal, because its just that big. But there in lies the problem:

Rio Tinto and BHP control about 95 per cent of the state’s $15.8 billion iron ore output. Iron ore contributes 28 per cent of Western Australia’s exports, which have risen in value by 123 per cent in three years, and earned the state $851 million in royalties last financial year.

A merger would give a private company a virtual monopoly on the states most important net money earner. Disputes have existed in the past, with the government arguing that BHP and Rio should both be looking to opening up their railways to 3rd parties. BHP and Rio have both stonewalled this request. And its not like the WA state government hasn’t done its share; millions have been spent on roads and other infrastructure, as well as grants to aid exploration. Without doubt, this forward investment policy has led to a boom in the Western most state, with a flood of jobs, capital, and don’t forget what seems to inevitable in modern economies; a housing bubble. Its an up and down relationship, no doubt. “Anyone who is not scared is a fool,” says Larry Graham, the former state MP for the Kimberley. The prospect of a monopoly corporation in control of your source of prosperity is a scary thing for an isolated community such as WA. So what’s the answer?

At some stage, commodity prices are going to stabilise, and will probably retract from recent highs. With this, incentive to invest capital is reduced. I think its important that we keep mindful of possible future conditions, rather then sticking too the over used catch phrases from both sides; ‘monopolies destroy competition’, ‘mergers create efficiencies’. Its important that the infrastructure that would be controlled by a merged entity is not cut off from any new entrants or competitors. First of all, it begs the question of price manipulation; create an impenetrable barrier to entry, and you’re fit to do what you please. Second, although there would be efficiency gains from a merger, from an economic point of view, this is wiped out if companies become to complacent with existing arrangements. What incentive is there for BHP-Rio to upgrade tracks, therefore decreasing delivery time, when no one else is going to out sell them? Like the argument against Telstra, some sort of infrastructure arrangement needs to be made. If these issues can be resolved, and the shareholders are happy with the financial side, I see no reason for the government to be a barrier. It could signal the beginning of even more exploration and innovation in an already booming (and relied upon) sector.