BHP and Rio's Pilbara placation

BHP Billiton and Rio Tinto have been quite pragmatic in deciding to drop their plan to jointly market 15 per cent of the production of their proposed $US58 billion-plus Pilbara iron ore joint venture. Whether they came to that decision of their own volition or as a result of some signals from the European Commission isn't clear, and may never be.

The companies have been steadily working their way through the details of the proposed joint venture with the aim of completing definitive and binding agreements by the end of the year. However, the proposal has already produced strident, albeit predictable, opposition from Chinese and European steelmakers, who have been publicly urging the EC to block the deal.

What BHP and Rio are proposing is a straightforward production joint venture rather than the corporate merger that BHP pursued and ultimately abandoned last year. The only piece of it that wasn't straightforward was the concept that 15 per cent of the joint venture's output would be jointly marketed.

That original element of the plan was apparently designed to give the prospective partners some flexibility in marketing more difficult to sell ore, as well as to allow them to market to new customers in emerging markets with shorter term contracts than is the norm or to sell into the spot market.

However, it was destined to breed confusion and scepticism within the steel industry, and complicate and perhaps undermine the prospect of getting an EC clearance of an obviously delicate transaction which would bring closer together two of the world's three big iron ore producers and about 35 per cent of the world's seaborne trade in iron ore.

Opponents of the joint venture fear the companies will collude to manipulate iron ore prices and the notion of joint marketing of a meaningful proportion of the production provided fuel for those fears.

By removing the joint marketing element of the original proposal, BHP and Rio can present to the EC a cleaner and more conventional production joint venture, with each party separately marketing its share of the output in competition with the other.

The joint venture proffers at least $US10 billion of synergies. It will significantly lower the cost base of the Pilbara producers and should enable the joint venture to bring more ore to market more quickly than if their operations remained separate. If more and lower-cost ore displaces higher cost production, that's actually a positive for the steel mills.

The companies are only at the most preliminary stage of engaging with the EC and at this stage there haven't been any signals of the commission's initial attitude towards the deal.

BHP would have a fairly clear idea of the likely sensitive issues because it had almost gone through the EC process last year before it abandoned its bid for Rio as the financial crisis intensified, and this time it will have a supportive Rio onside and the capacity to offer joint concessions if necessary.

The rough timeline for completion of the proposal – and a payment of about $US5.8 billion from BHP to Rio to equalise their shares in the joint venture – is that they are targeting completion by the middle of next year. That would suggest the discussions/negotiations with the EC will get serious in the first few months of next year.

It is improbable that the excision of the joint marketing feature of the original proposal will placate the steel mills. However, it should make the EC's evaluation of the proposal, if not its decision, rather more straightforward.