Faced with Skyrocketing Iron Ore Costs, China's Baosteel Rolls Two Rivals into a Joint Venture

By Mike Caggeso
Associate Editor

Baosteel Group Corp., China's largest steel producer, will pay $4.2 billion in cash for an 80% stake in a new Guangzhou-based steel mill that will merge two rivals, Shaoguan Iron & Steel Group and Guangzhou Iron & Steel Group.

China is already the world's top steel consumer and producer, churning out one-third of the global supply. This newly formed company, Guangdong Iron & Steel Group Corp., will boost Baosteel's capacity by 33% to 40 million tons.

Specifically, it will help supply steel-hungry Toyota Motor Corp. (ADR: TM) and Honda Motor Co. (ADR: HMC), both of which have plants in the city of Guangzhou.

Baosteel also wants to build a new 10 million ton-capacity mill in Zhanjiang, Reuters reported.

Baosteel is making a fervent effort to squash local competitors and streamline operations - now more than ever - because it's facing skyrocketing costs of iron ore, the key ingredient used in steel production.

The day it announced the merger, it also agreed to pay Australia-based Rio Tinto PLC (ADR: RTP) an average of 85% more for iron ore this year, Australia's The Age reported. The price increase is a result of fierce demand for iron ore, but also because Rio Tinto and Aussie rival BHP Billiton Ltd. (ADR: BHP) have significantly lower shipping costs than Brazil-based rival, Vale (RIO), the world's largest iron ore exporter, which allows them to charge a premium. 

According to Bloomberg data, shipping iron ore from Australia costs about $55 a metric ton less than from Brazil. But China doesn't have much of a choice, as its economy is growing at a 10% annual clip.

And that extra coin Rio Tinto and BHP have pocketed is dually driving up global prices and testing China's patience.

It's also playing a huge role in Australia's commodity-exporting industry, which may earn 12% more than forecast for March and a record $203 billion for the year, Bloomberg reported.

"The consistent story here is that producers haven't been able to match the ever-growing demand from China," Gerard Burg, an energy and minerals economist with National Australia Bank Ltd. (OTC ADR: NABZY), told Bloomberg. "China's demand is still going and still very strong."

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