Monday, May 19, 2008

Risks Of Steps Taken By China And Japan To Hedge Against Raw Material Price Shocks

Nippon Steel Corp. is seeking to invest in Cia. Vale do Rio Doce's $1.4 billion planned coalmine, according to Bloomberg. This is a natural progression for companies being hit with continually increasing price of its basic raw and intermediate materials. Taking a script from the major oil refiners, Nippon Steel, the world's second-biggest steel maker is looking for ways to lessen the risks of price shock from rapid costs increases.

Nippon Steel’s move closely follows the China model, which is trying to secure sufficient raw materials for steel manufacturing by buying into BHP Billiton. The rationale is simply to ensure steady supply of material at a reasonable rate, something that China has not been able to with Rio Tinto. As BHP Billiton pursues merger with Rio Tinto, the need for Asian industrial companies to buy into suppliers of raw material becomes more pressing.

However, as China and Japan continue to buy stakes in leading mining companies, there is a growing risk that other nations may experience raw material shortage or be forced to pay a higher price on the spot market. Since Vale, Rio, and BHP control more than 50% of world’s iron ores, the investments by Japan and China bear watching.

Of the two, China will be more aggressive as they are still in the development stage of the country’s lifecycle. As such, their economy will require more and more raw materials in the years to come. This will put China in direct collision course with its SE Asian neighbors, especially India. This will fuel increase in national protectionism and may lead to increased international friction between developed and developing nations. The friction will come from developing nations crying foul as more raw materials are diverted to developed nations while developing nations are forced to may ever increasing prices in the spot market.

Ed Kim
Practical Risk Manager

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