VZCZCXRO8346
PP RUEHCHI RUEHFK RUEHHM RUEHKSO RUEHPB
DE RUEHBY #0537/01 1570319
ZNY CCCCC ZZH
P 060319Z JUN 09 ZDK MULT SVC
FM AMEMBASSY CANBERRA
TO RUEHC/SECSTATE WASHDC PRIORITY 1591
INFO RUEHZU/ASIAN PACIFIC ECONOMIC COOPERATION
RUEHBN/AMCONSUL MELBOURNE 6408
RUEHPT/AMCONSUL PERTH 4672
RUEHDN/AMCONSUL SYDNEY 4634
RUEAWJA/DEPT OF JUSTICE WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 02 CANBERRA 000537 
 
NOFORN 
SIPDIS 
 
STATE FOR EAP/ANP AND EEB; STATE PLEASE PASS USTR - WEISEL, 
BISBEE 
 
E.O. 12958: DECL: 06/05/2019 
TAGS: EINV EIND ECON AS CH
SUBJECT: RIO SPURNS CHINALCO, EMBRACES BHP 
 
REF: A. CANBERRA 143 
     ¶B. CANBERRA 330 
     ¶C. PERTH 19 
     ¶D. MELBOURNE 42 
 
CANBERRA 00000537  001.4 OF 002 
 
 
Classified By: Economic Counselor Edgard Kagan, reasons 1.4 b, d 
 
¶1. (C/NF) SUMMARY: Anglo-Australian mining giant Rio Tinto 
today rejected a $19.2 billion deal with state-owned Chinese 
company Chinalco. Instead, Rio immediately announced a $5.8 
billion joint venture with fellow resource giant BHP Billiton 
to combine their existing iron ore operations in the Pilbara 
region of Western Australia.  The Chinalco proposal was 
subject to increasingly strong opposition from Australian 
politicians and Rio shareholders; the collapse of the deal 
spares the Rudd Government from having to make a difficult 
decision on whether to approve the deal.  Having worked hard 
to torpedo the Rio/Chinalco deal, BHP believes that it has 
scored a major victory by preventing a state-owned Chinese 
firm from influencing iron ore pricing negotiations from the 
producer side.  Eager to mend fences with a major customer, 
BHP has reached agreement with four major Chinese steel 
producers on iron-ore pricing that will be "noticeably" lower 
than that reached with Japanese customers.  Though 
disappointed that it was not possible to salvage part of the 
Chinalco deal, Rio believes that the agreement with BHP will 
assure its survival as an independent entity and will be 
lucrative for both firms.  Australia must now deal with the 
Chinese backlash, as Chinalco has made clear that it 
considers the Rudd Government's reluctance to approve the 
deal one of the major reasons for its collapse.  END SUMMARY. 
 
RIO/CHINALCO DEAL FOUNDERS 
-------------------------- 
 
¶2. (C/NF) Anglo-Australian mining giant Rio Tinto, the 
world's second largest iron ore producer announced June 5 
that it was pulling out of its proposed $19.2 billion deal 
with Chinese state-owned aluminum producer Chinalco.  The 
controversial deal would have seen Chinalco double its 
existing 9% stake in Rio by purchasing a convertible bond 
issue as well a purchase minority stakes in a number of Rio 
assets, including a 15% stake in Rio's Pilbara iron ore 
operations valued at $5.1 billion.  The deal was driven by 
Rio's need to pay down $38.7 billion in debt resulting from 
its 2007 acquisition of Canadian aluminum producer ALCAN, of 
which over $18 billion is due in 2009 and 2010. However, many 
Rio shareholders criticized Chinalco,s preferential 
ownership of proposed bonds, and proposed joint ownership of 
major assets.  Newly appointed Rio Chairman Jan du Plessis, a 
South African, tried to renegotiate of the terms of the 
February 2009 agreement to address Australian Government and 
shareholder concerns.  Rio Tinto's Australian Government 
Relations Manager Mark O'Neill told us June 5 that 
"Chinalco-lite" collapsed because the Chinese company 
insisted on board representation.  Rio will pay Chinalco $195 
million as a breakup fee. 
 
BHP BILLITON-RIO TINTO JOINT VENTURE AGREEMENT 
--------------------------------------------- - 
 
¶3. (U) Immediately after revealing the end of the Chinalco 
bid, BHP and Rio, the world's second and third largest iron 
ore miners, announced their agreement to combine their 
Pilbara iron ore operations in a 50-50 joint venture; Rio 
will receive almost US$5.8 billion from BHP. Rio said the 
Qwill receive almost US$5.8 billion from BHP. Rio said the 
joint venture with BHP (which itself attempted a takeover of 
Rio in 2007-08) would unlock significant value, with net 
present value of the savings to be more than US$10 billion by 
combining nearby mines into single operations, including 
greater efficiency in their rail operations. 
 
BHP WINS BIG 
------------ 
 
¶4. (C/NF) BHP has been lobbying extensively to block the deal 
(reftels), highlighting concerns about Chinese investment and 
the possibility that seats on the Rio board would give 
Chinese representatives important insights into the producer 
side of the annual iron ore price negotiations.  The collapse 
of the Chinalco deal forced Rio to agree to merge its Pilbara 
iron ore operations with BHP's, a longstanding goal that 
 
CANBERRA 00000537  002.2 OF 002 
 
 
should allow both companies to reduce operating costs. 
Despite the 50/50 participation in the joint venture that 
will produce the iron ore, BHP will appoint the CEO, giving 
it effective control.  Treasurer Wayne Swan's Chief of Staff 
has told us on several occasions that BHP has played its 
cards with consummate skill, in part due to the increasing 
marginalization of BHP CEO Marius Kloppers as BHP Chairman 
Don Argus has taken the lead in lobbying the GOA with the 
able assistance of BHP's well-connected VP for Government 
relations, Bernie Delaney. 
 
¶5. (C/NF) BHP has suffered some fallout in its relations with 
the Chinese government and some key steel producers, Delaney 
told us on June 5.  Recognizing the need to "do some damage 
control," BHP has recently reached agreement with four PRC 
steelmakers on iron ore prices that are "noticeably" lower 
than the 37% reduction that Japanese and Korean customers 
agreed to in the May. Delaney said that the catch is that 
contract is quarterly and not yearly, which brings BHP closer 
to its longstanding goal of "index pricing."  He noted that 
this agreement has yet to be announced because BHP is still 
negotiating with most of its Chinese customers.  The other 
major challenge will be regulatory approval by Brussels, 
according the Delaney, who said "we would not have gone ahead 
without a clear signal that the EU is willing to sign off 
once we do a few things to address their major concerns." 
 
GOA Avoids Tough Decision While Rio Survives 
-------------------------------------------- 
 
¶6. (C/NF) The deal,s sudden collapse spares the GOA from 
making a difficult decision, caught between significant 
opposition to allowing a Chinese SOE a key stake in Rio, and 
worried about the loss of jobs Rio threatened would happen 
should the GOA have rejected the proposal.  It leaves PM Rudd 
to deal with an unhappy China -- we noticed a very glum 
Chinese Ambassador Zhang Junsai waiting outside Rudd's office 
with Chinalco CEO Xiong Weiping on the afternoon of June 5. 
BHP's Bernie Delaney and Rio Tinto Government Relations 
Manager Mark O'Neill separately told us June 5 that the 
Government had made clear that it would not approve the 
Rio/Chinalco deal without some significant changes.  This, 
combined with growing opposition from Rio shareholders, led 
to the deal's collapse, according to O'Neill.  He expressed 
disappointment with the collapse of the Chinalco deal and BHP 
winning control of the JV that will operate the joint assets. 
 However, Rio will still control the marketing of its 50% 
share of the production and will share more or less equally 
in the cost savings from rationalizing the two companies' 
operations.  More importantly, BHP's $5.8 billion, combined 
with a successful rights issue, will allow Rio to address its 
debt repayment challenge in the coming two years, allowing 
its survival as an independent company and avoiding fire 
sales of assets that would have hurt longer term shareholder 
interests. 
 
COMMENT 
------- 
 
¶7. (C/NF) Today,s events bring to a sudden end what would 
have been the largest ever Chinese overseas investment. 
Despite Prime Minister Rudd,s protestations after the 
deal,s collapse that Australia was open to Chinese 
investment, this move ) and the speed with which Rio jumped 
Qinvestment, this move ) and the speed with which Rio jumped 
from the Chinalco,s arms to BHP,s bed ) may well raise 
suspicions in Beijing about Australia,s openness to Chinese 
investment.  The new BHP-Rio iron ore joint venture will 
greatly concern global steel producers who already believed 
those two companies had too much power to set iron ore 
prices. 
CLUNE