This week’s stand-off between Australia’s three biggest iron ore producers hammered home a few painful lessons.
One is that Australian prime ministers fear nothing more than the wrath of BHP Billiton.
Another is that the mining industry is seriously rattled by China’s plummeting demand for iron ore.
But it has also thrown up a deeper question about the accountability of big corporations, and their (mis)alignment to the wider interests of the nations in which they operate.
That makes it a debate about free market capitalism.
Twiggy’s gripe in a nutshell
Andrew ‘Twiggy’ Forrest, chairman of Fortescue Metals Group, says BHP Billiton and Rio Tinto are ramping up production of iron ore when there is already an oversupply.
This, he says, is forcing the price down, making it unprofitable for all other higher-cost miners to carry on producing iron ore, resulting in mine closures and job losses.
BHP Billiton and Rio Tinto deny they are doing it on purpose, and accuse Mr Forrest of trying to interfere with the natural operations of a free market.
Mr Forrest appeared momentarily to persuade Tony Abbott to support a parliamentary inquiry into this issue.
But Mr Abbott quickly and mysteriously backed away from this, presumably after a visit from BHP and Rio representatives.
An argument against government intervention
The argument against intervention is very simple, and rests on free market principles.
China’s insatiable demand for iron ore over the past decade saw the price of the commodity skyrocket. This brought many new players – including Fortescue – into the market.
But these companies were immature, meaning they didn’t have the infrastructure or scale to keep the cost of production low. This didn’t matter when prices were well above $100 a tonne, but it does now.
On Tuesday, BHP Billiton’s Andrew McKenzie said these new players knew full well that the boom would end, and so they can’t really complain now that it has.
Mathan Somasundaram, a strategist with stockbroking firm Baillieu Holst, agrees.
“In theory it’s an open market, it happens in all industries. When you have competition, the lowest cost provider generally prevails and the high cost players generally struggle,” he said.
“Demand is expected to decline. It’s not expected to remain at these high levels. As demand declines it makes sense for the lowest cost provider to protect their market share.”
Given BHP Billiton and Rio Tinto are still making huge profit margins – as much as 50 per cent – on their iron ore even at current prices, expecting them to wind back production just to save their competitors goes against the logic of free market capitalism.
The argument for government intervention
If you want to criticise the behaviour of BHP and Rio, you therefore need to move away from free market capitalism, and look at the national interest.
Richard Denniss of The Australia Institute argues that it is a matter of national interest to control the production of iron ore, for the simple reason that it is a finite resource, and Australia’s future depends on how we use it.
“Australian citizens have inherited a significant, but not enormous, bundle of natural resources. We can sell them off as quickly as we want, but we never get them to sell again,” he said.
“Simple economic analogies about free trade are being used to justify the decision making of BHP and Rio Tinto, but if flooding the market and sinking the price was the best way to get rich then why do Apple make so much money selling such expensive phones, and why have OPEC made so much money selling such expensive oil?
“A parliamentary inquiry into how Australia’s scarce resources are managed is well overdue.”
Given how reliant the Australian economy is on hard commodities (it’s really the only thing that sets us apart from any other developed economy), selling them quickly at a low price intuitively seems like a bad idea.
But ‘Australia’ and ‘BHP Billiton’ are two very different entities, however much Mr Mckenzie insists BHP has “always looked after the best interests of Australia”.
If BHP is purposefully flooding the market with iron ore in order to push down prices, then it may well be squandering a finite resource from Australia’s point of view. But that could actually be in the interests of its shareholders. It means more profits now, higher dividend payouts, and continued market dominance.
And the chances are, whenever Australian iron ore runs out, BHP Billiton – which by all accounts is a very well-run company from the point of view of its shareholders – will have moved on to other resources, quite possibly in other countries.