Burying the great joint venture that never was

The truth is that the biggest deal in Australian history, the hugely hyped $120 billion merger between BHP Billiton's and Rio Tinto's interests in the world's premier iron ore province, has been off the operating table for most of this year.

It was dealt a fatal blow by the sharemarket recovery of late last year, the resurgence of the Chinese economy and China's renewed demand for steel-making raw materials. It was kept on life support until about August, but even then, purely for the sake of appearances.

Way back in the early months of this year, senior BHP figures were quietly putting the chances of a successful joint venture of their West Australian iron operations in the Pilbara at "slightly less than 50:50".

In fact, some sceptics questioned the deal's rationale when it was announced midway through last year. If BHP's 2008 takeover bid was scuppered by European Union regulatory concerns about combining iron ore operations and marketing in the Pilbara, they asked, what chance was there of a merger of those same operations now, and why bother?

At the time, that may have been a rational line of thought. But it ignored a central reason for the merger which had less to do with synergies and cost savings than it did with escape clauses and face saving.

And that may go some way to explaining the reticence of both parties to formally walk away from the deal.

The fact is that the merger proposal was a fabulous success for both BHP and Rio Tinto, or rather Rio Tinto's board and management.

It achieved everything both companies desperately craved - in the short term at least - because it provided Rio Tinto with an iron-clad excuse to abandon its ill-considered and ludicrous attempt to relinquish control of the company to a Chinese government-owned entity.

Rio was facing an almighty backlash from its own investors at the time. The chairman-elect, Jim Leng, had quit in disgust after just one board meeting while London institutions were in uproar and baying for senior management and boardroom blood.

That the company could have put itself into so much debt and then ridden roughshod over its shareholders by trying to salvage a future through handing control to its biggest customer was beyond belief.

Rio shareholders weren't the only ones alarmed by the proposed Chinalco deal.

The prospect of a Rio tie-up with Chinalco had sent fear through BHP's upper echelons. The idea that a Chinese government-owned entity would have control over vast swathes of the world's premier iron ore territory right next to its own operations sent BHP into lobbying overdrive.

As part of Rio's proposed deal with Chinalco, struck when the sharemarket was at its lowest ebb early last year, it was allocating two board seats to the Chinese along with the right of veto over crucial decisions on the Pilbara iron ore operations.

The Chinese government, the world's biggest buyer of iron ore, would be making decisions over production and pricing of the commodity.

The then BHP chairman, Don Argus, and senior executives began working furiously behind the scenes to sink Rio's deal with Chinalco with a strong argument that clearly resonated in Canberra.

But, for the federal government to can the Chinalco deal on foreign investment grounds was a risky proposition with potential to create diplomatic havoc between Australia and its biggest trading partner.

And so the BHP, Rio Tinto iron ore merger was born. Far more attractive to Rio shareholders, the company then led by a new chairman, Jan du Plessis, announced on June 25 last year that it had no option other than to abandon Chinalco in favour of BHP.

Breathtaking in its ambition, it also saved BHP from having to compete against a much bigger rival that was controlled by the world's biggest iron ore customer. And it delivered Kevin Rudd and Wayne Swan from a political and diplomatic maelstrom.

But the longer term objectives of the merger were mostly BHP's. Had the deal proceeded, it would have ended up with the prize that had initially motivated it to launch its takeover bid for Rio Tinto 18 months earlier.

Rio Tinto's Pilbara iron ore operations are much bigger than those of BHP. To reflect that, BHP was to make a $5.8 billion "equalisation payment" to Rio Tinto.

But just as the market recovery and rebounding commodity prices killed Chinalco's chances of extracting its 10 pounds of flesh from Rio shareholders, the resources boom has similarly wiped any chance of BHP concluding a successful deal with its rival.

The value discrepancy between BHP's operations and Rio's has moved way beyond the "equalisation payment" of 15 months ago.

The sensitive nature of the relationship between the two companies was reflected in the confidential comments by du Plessis to his fellow directors on Monday where he warned them not to be critical of BHP or "denigrating them in any way".

The idea of a merger between the resource giants has had corporate advisers and investment bankers salivating for more than a decade and kept senior executives at both companies busy running the slide rule over each other's operations.

But the time has passed. Both companies are too big. And competition regulators will never allow it.