Shock and Ore
(SMH) -Secret agents are shadowing Australian executives as the Communist Party's hardliners gain the upper hand. Now Rio Tinto must play by China's rules, writes John Garnaut in Beijing.
When China tracks the conversations and email traffic of foreign executives, it normally does so covertly. These days, with Rio Tinto, surveillance can take the form of overt intimidation.
Three weeks ago, Rio's global strategy chief, Doug Ritchie, checked into Shanghai's downtown Four Seasons Hotel to find the entire floor had been cleared of other guests. His only companion was Ian Bauert, Rio's global head of iron ore marketing, who had arrived before him. Plain-clothed officers proceeded to shadow their every move across the town.
For Ritchie, the treatment might have smacked of revenge. He was the architect, negotiator and driver of Rio's $US19.5 billion ($24.3 billion) Chinalco investment deal which collapsed in June, staining the business reputations of Rio Tinto and Australia in China. China's Chinalco bid was a response to Australia's iron ore duopoly and an effort to ease China's resource constraints by playing by global rules. It didn't work, so now Rio would be asked to play by China's rules.
For Bauert, it was personal. Bauert is the low-profile, Chinese-speaking power behind Rio's iron ore sales and negotiating team. He opened Rio's China office in the 1970s. It is his men - Stern Hu, Liu Caikui, Wang Yong and Ge Minqiang - who are in a Shanghai jail. He caught a plane to China the moment he learnt his team had failed to turn up to work on Monday, July 6, and has been there ever since.
Efforts by Bauert and Ritchie to see their employees in Shanghai were obstructed at every turn. And if Hu, Liu, Wang and Ge were detained for alleged serious crimes on behalf of their company, then there was an outside chance that their bosses might be told to join them.
A statement on an official Government website said the Shanghai State Security Bureau had found Hu and his colleagues had stolen and obtained secrets by "bribing internal staff of Chinese steel companies". "This has caused huge loss to China's national economic security and interests,'' it said.
China's Ministry of State Security does not concern itself with ordinary crimes, such as bribery or theft. Its tens of thousands of analysts and intelligence operatives have the job of protecting the Communist Party from perceived threats to its existence, such as Tibetan or Xinjiang ethnic separatists, foreign spies, political dissidents and activist lawyers.
According to some analysts, that executives at the world's third-largest mining company were being treated as threats to China's national security signalled that conservative, hard-line and less economically literate forces were getting the upper hand in Beijing.
The detentions were endorsed by the Communist Party's Standing Committee, chaired by the President, Hu Jintao, according to sources in a Chinese security agency.
Stern Hu and his three Chinese colleagues have now been charged with receiving bribes and commercial secrets. People close to the case note the opportunities for bribery that can present themselves in a climate of iron ore shortage and large price differences between contract and spot market purchases. Many say the Chinese Government is unlikely to have gone as far as it has without what it considers to be sound evidence that is prepared to publicly present. A trial is likely to proceed by early next year.
But the Chinese Government's initial framing of the case as one of "national security" suggests Rio and Australia may also have been caught up in a larger struggle for influence over China's 540 private and state-owned companies, which together produce more steel than the rest of the world put together. Steel, with its central, visceral place in China's modernisation and national mythology, can provide a proxy battleground for the path of Chinese development.
"This is about: do you let the market determine prices domestically and internationally or do you insist on political intervention? " David Goodman, a professor of Chinese studies at the University of Sydney, says. "How do you allocate resources, politically or economically? Within the leadership you can imagine the arguments going on between those calling for a more open political and economic system and others saying, 'You must not rock the boat.' ''
The stakes at play in China's steel industry were illustrated in an investigative story this week about how the new manager at the Tonggang steel factory in north-eastern China was recently beaten and thrown from a building to his death. The manager had been appointed by China's richest steel entrepreneur, Zhang Zhixiang, who had been attempting to take over the inefficient state-owned company in line with a provincial government reform drive. But the old guard managers and their local supporters fought back. Would the disgruntled managers of a local state-owned company resort to murder in order to keep their jobs?
Rio Tinto's immediate problems began with BHP Billiton's takeover bid in November 2007. The event immediately steeled Chinese leaders to push back against what they saw as an Australian iron ore monopoly. And Rio responded to BHP's aggression with new aggressive marketing strategies, including diverting iron ore from long-term contracts to the more lucrative spot market.
Chinese steel mills were furious. Rio itself was divided on the long-term wisdom of hurting its considerable standing in China. ''We acted in accordance with the letter of the contracts, but not the spirit,'' Stern Hu conceded in conversation with BusinessDay at the time.
The incarceration of Hu suggests Rio and the Australia Government may have under-estimated the humiliation and legitimate economic anxieties that could be generated in a country that is so dependent on steel.
If there was a single turning point, it probably occurred at a conference room at Baosteel's sprawling factory and corporate headquarters in north-eastern Shanghai, on June 23 last year. It was there that the lead negotiator, Will Malaney, and his negotiating assistant and translator, Stern Hu - with Bauert giving instructions from backstage - secured a jaw-dropping 79 per cent price rise for iron ore ''fines'' and 96.5 per cent rise for ''lump''.
At 6pm, after four months of deadlocked negotiations and a tense four-hour stand-off in that room, Malaney and Hu jumped up and clasped hands with Baosteel's Ding Shouhu and the three members of Ding's team. They cracked a bottle of fine champagne.
For Ding, the spontaneous joy was borne of relief that his torture was finally over, seven days before the majority of China's iron ore contracts would technically expire. But Baosteel's public and political standing had crumbled because the costs of Chinese steel production, the nation's inflation problem and its nationalistic sensitivities had all been raised.
The initial relief and exhilaration at Baosteel headquarters subsided as one of the four Baosteel representatives in the room phoned both the China Iron & Steel Association and the Ministry of Commerce to get final authorisation. News leaked out between the cracks of China's political bureaucracy before Rio had a chance to tell the stock exchange.
It was an ominous interregnum that hinted at the turf wars to follow. Steel officials saw the opportunity to secure new political patrons and try to balance Australia's iron ore "monopoly" by marshalling China's buying power - something that Japan had done successfully in the past, if not in such heavy-handed terms.
It is not just the Ministry of State Security that has intruded in this year's iron ore wars. A new super-ministry of industry and information technology has supplanted the Ministry of Commerce. And Baosteel, the innovative national champion that understands how both politics and markets work, has been pushed out by the retired steel mill officials and bureaucrats who run the China Iron & Steel Association (CISA).
Steel executives and industry analysts enjoy nothing better than belittling association officials behind their backs. But influential Chinese analysts, such as the steel consultant and academic Xu Zhongbo, are now prepared to do it publicly. This is his appraisal of the association's secretary-general, Shan Shanghua, its deputy president, Luo Bingsheng, and its director of iron ore, Chen Xianwen:
"Shan was a director of steel planning initiatives in the past, when he was part of the Ministry of Metallurgy [now disbanded]. He has good experience for planning economics but not for international co-operation and business," Xu says.
"Luo is also a very stupid guy. If someone has a higher position than him, then he will always follow that position. And he can change his position very quickly. He did very poor work when chairman of Shougang [Capital Steel].
''And Chen Xianwen was director of iron ore purchasing at Wisco [Wuhan Iron & Steel Company]. But iron ore purchasing was an easy task five years ago; every iron ore miner wanted to make friends with him."
These three men, masters of a different era, have been endorsed this year to harness China's hugely fragmented steel industry and leverage their buying power. So far, the experiment has not worked.
Malaney, Hu and their boss, Ian Bauert, were no doubt bemused at the association's negotiating tactics. Rio would refer to what was happening in the underlying data about profits and production in the Chinese steel and iron ore mining industries. But negotiators across the table, including Chen Xianwen, would reply with political diatribes.
CISA seemed to think that asserting steel production would slip would ensure that iron ore prices would also fall. These days Rio thinks China will produce about 570 million tonnes of steel this year, based on Chinese steel production and iron ore imports rising to new records almost every month.
But CISA has gone out of its way to ignore official public information - including the People's Bank of China's estimate that GDP grew 4 percentage points between the March and June quarters - to forecast 2009 production at just 500 million tonnes. CISA persists in arguing that this time, unlike every other year, it will be able to "control" the steel industry in accordance with Government directives by closing down small and allegedly inefficient mills and preventing new capacity from being installed.
In May the association missed its chance to follow Nippon Steel in agreeing to a 33 per cent cut in the benchmark contract price. The June 30 negotiating deadline came and went, and spot market prices soared higher.
Ironically, on July 6 the steel association held an internal meeting where it agreed to accept the Nippon Steel benchmark price subject to face-saving clauses that would allow them to renegotiate later if spot prices fell, according to senior Chinese journalists who spoke with the association's president, Shan Shanghua, that evening.
But news of the detention of Rio's Stern Hu broke the following day, July 7, before the association had an opportunity to inform the Anglo-Australian miner of its change of heart. Shan must have known about the Ministry of State Security's ongoing investigation - Rio's iron ore tendering results were being covertly supplied to CISA - but he evidently had no idea that Mr Hu and his colleagues had been detained.
If the detention of Rio's China iron ore team on national security grounds was a sign that China was drifting back towards central planning and tighter political control, then the downgrading of the Rio charges to stealing commercial secrets and receiving bribes may indicate the tide has since turned the other way.
China's leadership appeared to form the view that heavy-handed attempts to impose its will on the country's iron ore market was not working and not worth the costs to its international reputation.
Zhang Peihong, the lawyer for Rio Tinto's Wang Yong,said this week that China's top intelligence agency has handed the case to criminal authorities.
"The Ministry of State Security has handed the case to the Public Security Bureau," he said.
The politics of the Stern Hu case have largely been defused ahead of what may turn out to be relatively transparent legal proceedings. Rio Tinto's chief executive, Tom Albanese, said yesterday that "the grounds for [Hu and the others'] arrest do not seem to be as serious as first reported".
But Fortescue's Andrew Forrest gambled this week that the political winds continue to favour the steel association and its attempts to control the market.
"CISA was once viewed as a dog with a lot of bark. I think it is now viewed across China as a dog with a lot of bark and bite," Forrest told Australian journalists in China, after agreeing to a slightly larger price cut of 35 per cent on the condition of up to $US6 billion ($7 billion) in finance from an as yet undetermined Chinese institution.
Forrest said CISA has the political leverage to enforce the Fortescue price as the new benchmark price for all imported iron ore.
"There have been hundreds of other contacts and actions taken where there is a discipline being asked of steel companies to cease short-term profit-taking and encourage long-term price stability and move towards a uniform price," Forrest said.
"China's actions have gone way, way beyond Stern Hu."
But so far the big miners, led publicly by Rio, have ignored the Fortescue settlement and continued selling ore into China at the slightly higher price set with Nippon Steel.
This year's price negotiations are being seen as a costly debacle in Chinese industry circles, with the steel association wearing most of the blame. The drumbeat of discontent is getting louder.
A report this week by a Shanghai steel consultancy, Umetal.com, slammed the association's inability to comprehend economics. It pointed out that its 2 percentage point face-saving price deal with Fortescue would save China $US35 million, based on Fortescue's 10 per cent import market share, and contrasted this with the $US6 billion that the association had agreed to arrange to pump into Fortescue.
"The iron ore negotiations turned into a political struggle which China must win and cannot lose," the report said. "It is about the credibility of [CISA] in the whole industry. This is no longer about the simple issue of dozens of steel mills signs agreements with miners when prices are acceptable."
The Umetal report said that the Fortescue deal was an irrelevant face-saving deal for the association, as the big miners and Chinese steel mills were buying ore at the Nippon Steel price regardless.
"What is not important is that China gets the final say," it said.
Xu Zhongbo, the steel consultant, supports efforts to resist Australia's dominant market power. But he also believes the association has dealt itself out of play.
"This year CISA has lost power, it took too long to reach an agreement," he says. "Maybe next year Baosteel will have the power again."
Some reports say the decision has already been made to restore Baosteel's role as China's lead negotiator and boot aside CISA.
But CISA fought back this week and revealed the existence of "the State Council's No. 6 document", by which the cabinet-like body had empowered it to "prevent" speculative iron ore trading and "reasonably unify the price".
"It's not true that Baosteel will lead negotiations," a senior association source said yesterday. "Like this year, Baosteel will represent China to talk, under the lead of CISA, also with a group of China's 16 largest steel mills formed to make decisions."
But the iron ore wars are far from over and CISA is sticking to its guns.
