Last week’s Zinifex-Oxiana merger grabbed the headlines in the resources sector, but unnoticed on Friday’s re-alignment of the BHP offer for Rio Tinto.
Rio’s shares fell to $13.12, a drop of $4.80 while BHP’s fell 92c to $38.88 and the value of the offer fell to $132.19.
But the real story is the earnings urge, probably just for the next year, that will flow to coal Australian coal companies, even after the cutbacks to export caused by port constraints and the central Queensland flooding.
Some estimates are for price rises from 134% to 150% for the year starting April 1, which will produce a surge in earnings at a time when iron ore earnings also surge from an expected 65% price rise.
The upshot is that hard coking coal contract prices could rise by 150% and thermal coal (for power stations and cement companies) could rise by 134%. Even with the port constraints in NSW and Queensland, there will be a surge in earnings for the industry because all are on one year contracts with foreign buyers with prices reset in annual negotiations.
The longer Rio hangs on, the closer it gets to an earnings surge that could re-price the bid: and BHP with its earnings surge could be under pressure to offer more.
The BHP-Rio re-pricing is probably a function of the fluctuations in Friday’s nasty market fall, but it should give investors pause for reflection. Around 12% of Rio’s outstanding Australian shares (around 240 million in total) are on the official ASX’s ‘short list’, so there are a few punters who believe the price will go lower.
That will only happen if BHP withdraws: at the moment the BHP share price is underwriting the Rio price.
The expected easiness today could see Rio’s share price remain within the range of the BHP offer, which will get tongues a clucking in investment markets.
In view of the uneasy state of confidence in all financial markets a sudden emergence of a possible successful BHP bid for Rio would trigger some awfully big alarms in some investment banks and broking houses.
If the BHP share price starts driving the Rio share price, then the game is over: unless there’s a big problem in the markets. That can’t be ruled out given the current unease about a big failure, as evidenced by the continued rise in credit spreads on corporate debt.
That rise in spreads makes it much, much harder for BHP to entertain any idea of raising $US70 billion, even in a year’s time, at spreads which are economic.
The Zinifex-Oxiana deal and the BHP-Rio price changes have tended to push the booming coal story to the sidelines
BHP is playing a part in that, as is Xstrata and the likes of Wesfarmers with its Curragh mine. Rio Tinto is also impacted.
But the impact for Rio and BHP is on the negative side because of shipment delays caused by flooding and other constraints.
Their role is somewhat unwilling and linked to the flooding in and around the Bowen Basin in central Queensland, and the severe storms in China in January through February which has taken China out of the export coking coal market as it struggles to rebuild its coal stocks for its power stations
According to two leading investment broker research teams, Merrill Lynch and Goldman Sachs JBWere, the flooding in Queensland’s has helped pushed hard coking coal prices to levels never seen before.
Two weeks ago Japanese steel mills bought around a million tonnes of coal from the US for the first time in 18 months: the price was a huge $US350 a tonne, such was the desperation of the mills.
Now prices have hit $US400 a tonne for spot deals from the US and Australia.
Merrill Lynch estimates that flooding in the Bowen Basin has taken about 15 million tonnes of coking coal out of the market, as infrastructure limitations restrict the ability of producers to make up the lost output.
"There is now an obvious scramble for supply with industry sources confirming that Asian steel mills are begging for tonnes at close to any cost," Merrill Lynch said in its research note to clients on Friday.
"Under current market conditions, spot prices reflect the ‘hysteria’ of the supply shortage and therefore spot appears a reasonable guide for contract settlement."
Merrill Lynch expects "peak coking coal prices" for the 2008 Japanese financial year, starting April 1, with a forecast premium hard coking coal price of $US300 per tonne.
The consensus for 2008 contract prices had been $US197 per tonne, almost $US100 higher than the 2007 contract price of $US98 per tonne.
Goldman Sachs estimated a price of $US250 a tonne in a client note last Thursday: it significantly upgraded earnings outlook for Wesfarmers for its Curragh mine in central Queensland.
The Bowen Basin is the world’s single largest resource of export quality hard coking coal: the flooding has hit a number of mines, with the BMA group, the world’s biggest exporter, especially hit.
BMA is the BHP Billion Mitsubishi Alliance, the old CQCA, which owns most of the major hard coking coal mines in the Bowen Basin.
A number of companies are declaring force majeure on coal deliveries. These have included Xstrata, Rio Tinto Ltd subsidiary Coal & Allied Ltd, Ensham, Macarthur Coal, Wesfarmers and BMA.
Macarthur Coal has lost about six weeks production, which will put further stress on the company as it struggles with low shipment levels because of port constraints.
Goldman Sachs says one Asian steel mill paid $US300 per tonne for hard coking coal.
"Feedback from our Goldman Sachs colleagues in Asia suggests a large Asian mill has contracted to buy spot coking coal at just over US$400/tonne," Goldman Sachs said in the client note on Thursday.
UBS estimated in a client note earlier last week that prices for coking coal and thermal coal, used as fuel for power stations, may rise by 30%
