Bulk Buys: Does China’s iron ore standoff open the door to BHP-Rio merger?

• BHP has been mum on the outcome of iron ore price negotiations with CMRG
• RBC’s Kaan Peker thinks BHP-Rio merger or alliance could wrestle negotiating power back for miners
• The coal miners Morningstar views as undervalued

BHP (ASX:BHP) and Rio Tinto (ASX:RIO) famously attempted to tie the knot in 2008 before the GFC and a regulatory stranglehold quelled the then $140bn mega merger.

By late 2010 hold ups in approvals from five separate bodies including Australia’s Competition and Consumer Commission killed a proposal to JV the miners’ iron ore assets 50-50, a similar structure the world’s two largest gold companies Barrick and Newmont would implement at their Nevada Gold Mines operation a few years later.

Now, BHP has been caught in the cross-hairs of a game of brinkmanship between China and its top iron ore suppliers.

Having already seen calls from the China Mineral Resources Group to halt purchases of its Jimblebar fines blend, the State-owned iron ore buyer formed in 2022 to deliver pricing power back to the Middle Kingdom’s struggling steel mills issued a call to halt all BHP Pilbara purchases.

This continues to go unregarded in official communique by BHP, which says its all part of ‘normal negotiations’. A trade pub, Steel Orbis, this month said BHP cargos had been allowed to flow after the miner agreed to settle a portion of sales in China’s RMB currency, something which hasn’t drawn a peep from the mining giant.

Now, the reputed standoff has industry experts wondering if China’s power play could put a BHP-Rio merger back on the table.

As per RBC’s Kaan Peker:

“CMRG now coordinates procurement for >85% of Chinese steel capacity, effectively functioning as a state-backed buyer consortium. In our view, the CMRG consolidation has changed the competitive dynamic enough that a revived Pilbara alliance, if narrowly structured and compliance-driven, may no longer be implausible,” he said in a note on Monday.

“While a “full” RIO/BHP Pilbara merger remains out of reach, we think a ‘JV-light’ approach focused on logistics, blending, and decarbonisation alliances could dilute the CMRG’s influence, defend the Pilbara premium and maintain control over benchmark price formation, as well as capturing margin and capex benefits.

“In short, CMRG’s creation may have unintentionally reopened the strategic logic for limited Pilbara cooperation between Rio and BHP – once unthinkable, now potentially pragmatic.”

Pricing power

The big thing here is pricing power.

China’s formation of the CMRG institution came after a period where iron ore briefly topped US$230/t in 2021 as post-Covid stimulus sent steel demand in the industrial powerhouse sky-rocketing.

It was a source of embarrassment to Xi Jinping and the Communist Party, which became the losing side of a trade war against the previous Aussie Government of Scott Morrison, paying through the nose for WA’s iron ore, and later lithium, after trying to bully Australia with import bans ranging from rock lobster, to wine and coal.

Environmental controls and the collapse of a host of major property developers brought the commodity crashing back to Earth, but prices have remained stubbornly high thanks to rising marginal tonnes and persistently high steel production in China – around 1Bt each year since 2020.

At US$100/t (less after grade discounts are considered), Aussie miners continue to be highly profitable with C1 costs in the US$20/t range, while many Chinese steel factories are marginal to lossmaking.

As CMRG tries to flex its muscle for pricing discounts, a BHP-Rio chimera would collectively control ~40% of seaborne iron ore tonnes before the ramp up of Simandou (of which Rio is a partial shareholder) is taken into account.

That would dramatically shift the needle when it comes to negotiating leverage, Peker says.

“The 2010 BHP-RIO Pilbara JV failed under competition law; CMRG achieves the same objective under state policy, outside merger control frameworks,” Peker said.

“While this may not mark a turning point in price discovery, it does suggest the centre of gravity is shifting from miner-led index pricing to one that is more influenced by one large buyer.

“This re-opens the question of whether future supply coordination (e.g., Pilbara blending, marketing alliances) could re-emerge as a defensive response.”

What is Pilbara Alliance 2.0?

Peker’s interpretation of a new alliance would not be a complete JV, describing it as a ‘networked alliance model’ rather than a merger.

He suggested by pooling 20-30% or around 150-170Mt of the mining giants’ shipments into a single marketing desk, the companies could have a ‘counterweight’ to CMRG’s purchasing power.

“The rest of the ‘non-pooled cargoes’ would be marketed independently (as is done now). This could address anti-trust concerns as it would limit market concentration, without controlling the whole market, but create a counterweight to a large buyer,” Peker said.

“Such an alliance would effect <35% of global seaborne iron ore supply versus ~50% at the time of the 2010 proposal.”

If that fell foul of competition watchdogs, some other collaboration options could achieve similar outcomes, Peker said. They include a common logistics platform, which could allow for product blending at port in Australia, improved product consistency and a US$2-3/t chop off operating costs.

Other ideas include infrastructure sharing, shared decarbonisation spending and green iron ore branding to create a premium market for low carbon buyers in India, the EU and Japan.

Singapore iron ore prices were largely unchanged on Monday, rising 0.5% to US$104.40/t.

Rio Tinto (ASX:RIO) shares fell 0.75% to $129.89, while BHP dropped close to 1.5% to $42.96. The Pilbara’s last major Fortescue (ASX:FMG) was off marginally to $20.16, while Mineral Resources (ASX:MIN) dropped 0.6% to $41.52.

ASX iron ore stocks

Coal valuations attractive

With prices beating down on the sector, there are plenty of reasons to be bearish on the coal sector.

But there are bright spots, companies where costs have been kept under control and continue to be profitable in a down market, offering leverage to gains when prices do eventually move higher down the line.

Morningstar this month fingered two key choices in the ASX market, with analyst Jon Mills saying both Whitehaven Coal (ASX:WHC) and New Hope Corp (ASX:NHC) are undervalued.

Morningstar has lifted its 2025-2027 met coal forecast frim US$195/t to US$210/t, with its thermal coal prediction down from US$120/t to US$115/t, and has maintained mid-cycle post-2029 prices of US$160/t and US$107/t respectively.

With that in mind, Morningstar has a $9 fair value estimate on WHC and $5.50 on New Hope, compared to current prices of $7.03 and $3.97.

“The energy transition is likely to occur more slowly than the market assumes. Attempts to reduce harmful emissions are likely to first reduce demand for lower-quality coals than the high-energy, low-ash coal produced by Whitehaven, New Hope, and, to a lesser extent, Glencore,” Mills said earlier this month.

Met coal futures are currently US$187.46/t for top grade product, with thermal at US$103.45/t, prices that have led to planned mine shuts at higher cost operations.

Shares in Coronado Global Resources (ASX:CRN), meanwhile, fell close to 15% on Monday, when The Australian’s Dataroom section reported a coal seam collapse at its Buchanan mine in the US had added to complications amid a prolonged sale process for the company and/or a share of its assets.

Coronado was yet to comment on the report as of market close.

ASX coal stocks