BHP has work to do in China

BHP needs to watch itself. It's never healthy to have bad relations with your major customer because, in the long term, it will usually come back and bite you.

Two developments overnight underline this position. First, Rio Tinto has revealed that the problems with the European regulator might delay the implementation of the Rio Tinto and BHP joint iron ore production venture. Second, developments in the Stern Hu case indicate that it extends deep into China's web of power.

When BHP bid for Rio Tinto, the Chinese were enraged. Then in November 2008 when BHP withdrew its bid, Rio Tinto set up a panic-driven deal with the state owned group Chinalco. One of the aims of the deal was to skewer BHP.

So when Rio Tinto pulled back from Chinalco and agreed to the joint iron ore production deals with BHP, both Rio Tinto and BHP were in China's bad books.

But Rio Tinto has repaired the damage much faster than BHP. The Chinese government analysis of the deal largely exonerates both Chinalco and Rio Tinto, but it is not forgiving of BHP and its lobbying in Canberra. While that looks to be an unfair position to take, it is a sign of a deeper problem (Titans of the Chinalco affair, March 16).

Around mining circles it has been widely circulated that the Stern Hu case is much more complicated than a simple Chinese reaction to Rio Tinto's Chinalco withdrawal. The fact that Stern Hu pleaded guilty to some charges has given added momentum to those stories. Today, the China correspondent for Fairfax Media, John Garnaut, has revealed that one of the men charged, Wang Yong, did not actually report to Stern Hu but rather marketed Rio iron ore to companies linked to China billionaire Du Shuanghua. Du operated outside the China Iron and Steel Association and has an association with the family of President Hu Jintao. This may explain some of the factors causing the trial to be secret (Full coverage: Stern Hu).

In situations like this, both Rio Tinto and BHP need to tread very carefully.

But, Rio Tinto looks better placed because both Chinalco and Rio Tinto have saved face. Stern Hu has pleaded guilty to some charges, the Chinese government has exonerated the company and they have cemented a new relationship with a joint iron ore venture in Guinea.

And Rio Tinto is looking for other ways to restore and enhance relations with its biggest customer. Rio Tinto remains firmly committed to the BHP and Rio joint production agreement. However, long delays are never healthy for an arrangement like this and as Rio Tinto begins to work more closely with the Chinese, the China opposition to the deal may have an effect.

As long as iron ore is in short supply, then what the customers think of you is not that relevant. But some time in the future the Chinese will have the upper hand on the suppliers. In that situation Rio Tinto will be much better placed unless BHP can mend the fences (Rio keeps its comrades close, March 22).

BHP's chief executive Marius Kloppers will be working on this long-term problem. The Chinese objection to the BHP lobbying was directed at outgoing chairman Don Argus. When Argus steps down at the end of the month, and when Jac Nasser finds his feet as chairman, Nasser will have the chance to help Kloppers mend the fences.

Right now the market puts a higher rating on BHP earnings than Rio Tinto and the track record of the two groups justifies this market rating.

But step by step, Rio Tinto is working itself into a stronger position, particularly as its debt is falling.