SA loses amid iron ore brinkmanship

[] — I’M STRUGGLING to recall a dispute in mining sector in the last few years so public and as acrimonious as the one between Kumba Iron Ore and ArcelorMittal SA (Amsa). Perhaps Harmony Gold’s failed attempt to take over Gold Fields?

As the situation currently stands, it’s employees of ArcelorMittal SA – up to 4,000 of them – that stand to suffer most in a dispute that is essentially between two sets of foreign shareholders.

First, however, a summary of events since the iron ore supply agreement between Kumba’s operating subsidiary, Sishen Iron Ore Company (SIOC) and Amsa lapsed on March 1.

Following the lapse, Kumba agreed to continue the supply of iron ore to Amsa on a cost-plus 3% basis – an agreement that dated back to the days when the iron ore assets in SIOC were part of Amsa’s predecessor, Iscor Mining – with the difference between the cost-plus price and the market related price payable into an escrow account.

But Amsa contested this and only paid cost +3%.

Kumba, therefore, proposed a further two new supply agreements to Amsa which were also rejected.

This then forced Kumba into the action announced on Friday which was to demand Amsa pay for any deliveries of iron ore 48 hours in advance at a cost of $50/tonne for deliveries to Amsa’s Saldanha Bay plant, and $80/tonne for delivery to Amsa’s inland plants.

Kumba is now also demanding all outstanding payments from the beginning of March to the end of July which, assuming a market related iron ore price of $110/tonne over the five month period is an outstanding amount of about R1.5bn. Analysts reckon this is, in turn, equal to R9.30/share.

Amsa responded by saying it would prepare to shut its Saldanha Bay plant – a move of quite remarkable brinkmanship.

Announcements from both sides have tended to talk about Kumba and Amsa but let’s personalise it because, after all, there are individuals making decisions behind the scenes here.

On the one side, Kumba’s CEO, Chris Griffith who answers to Cynthia Carroll, whose company Anglo American owns about 66% of Kumba.
On the other side, there’s Nonkululeko Nyembezi-Heita, Amsa CEO who reports to Lakshmi Mittal whose family trust owns 52% of the Mittal Group, and which indirectly owns 21% of Amsa.

It’s obvious for all to see that Nyembezi-Heita’s move is somewhat desperately intended to draw the South African government into the dispute and cast Kumba in a bad light. She knows that steel is the all-important ingredient in automotive part manufacturing and other downstream industries, the growth of which are crucial to trade and industry minister Rob Davies.

And it seems to have worked.

Davies has called a meeting tomorrow (Monday) to plan a settlement, or at least get the sides to step back from Kumba’s price ultimatum on one side, and Amsa’s job loss ultimatum on the other.

The question is who will win the battle?

You’ve got to think Kumba has the upper hand. I wonder if Davies will be cognisant of how BHP Billiton was forced to re-negotiate a binding electricity contract with Eskom in the national interest?

In that sense, historically cheap access to iron ore a bit like historically cheap access to electricity?

As it turned out BHP Billiton knew that to continue operating its aluminium smelters in sub-Saharan Africa, it had to agree a new contract that dealt with a fundamentally important input on market terms.

The days of taking advantage of government-backed subsidisation – Amsa as Iscor was once government-owned – are over.

I also find sympathy difficult for the Mittal Group which, by evidence of the anti-competitive litigation it has been fighting in South Africa over the last four or five years, views local industry here as an opportunity to make hay.

There’s also some interesting commentary attributed to analysts in Business Times on Sunday which claim that contrary to its objections, Amsa can well afford to pay market related prices for its iron ore. Amsa already pays a company called Cleveland-Cliffs a figure some 15% below market related prices for supply of iron ore which is pretty similar to the amount Kumba wants to charge.

Macquarie Securities also noted that in not opting for Kumba’s interim or compromise price offer, Amsa is ultimately giving signal that it’s not too confident of its position in arbitration.

One isn’t sure just how much sway government will have – afterall, these are privately held, listed companies duking it out – but Davies will nonetheless be mindful Kumba is about to produce another set of stellar results. It recently indicated on July 9 that headline share earnings would be between 1,900 to 2,055 cents, an increase of up to 90% year-on-year.

“The increase in earnings is largely attributable to an increase in export iron ore prices and a 10% increase in export sales volumes in the period,’ Kumba said in a statement.

Certainly, there’s no way government can sit by while a dispute between foreign shareholders sees local employees take the consequences

As mentioned before, Anglo’s Carroll has many other political considerations with which to reckon including sealing new order mining rights for Anglo Platinum. I’m not suggesting Anglo Platinum will be held to ransom, but Carroll does have a relationship with the South African government to maintain. If Davies asks Kumba and Amsa to take a seat at the negotiating table, how will Carroll direct Kumba?

At this stage, Amsa may be asked by government to agree to take iron ore at the $50 and $80/t levels (for Saldanha and inland plants respectively), certainly as an interim arrangement, and discover from Kumba whether it will accept these prices as a long-term arrangement. These are not unreasonable levels and are still well below what the market is actually paying for iron ore.

If that’s the case, you have to wonder how wise it was for Nyembezi-Heita to call Kumba’s bluff. Certainly, there’s no way government can sit by while a dispute between foreign shareholders sees local employees take the consequences.

Government saw nearly a million jobs lost last year. We’re supposed to be in the throes of an economic recovery.

Or will this dispute drag interminably on. Well it can’t, can it? Having said that, Credit Suisse has made the interesting point in a note to clients last week that previous disputes between Kumba and Amsa have never been settled quickly. “The arbitration process between the two companies over Sishen South (where Kumba was eventually successful) went on for three years,’ said the broker’s Michael Shillaker.