CHAPTER 27
Thérèse Rein noticed the change immediately. ‘When Deng Xiaoping said you can sell your surplus product and keep the profit, overnight there were street markets; overnight you could buy silk nightgowns for one yuan – 50 cents; overnight you could buy unbruised apples.’ 1
It was a revelation for Ms Rein, the wife of the first secretary at the Australian Embassy in China, Kevin Rudd. Suddenly, in 1985, Beijing was on the move. And the future Australian prime minister was witness to the beginning of the greatest economic transformation in history. ‘It was a good time to be there,’ he said. ‘The smart thing to do was to go to the countryside and the provinces and find out what was going on. So I travelled a lot.’ 2
What he saw had been a long time coming. The triumph of Mao Zedong’s communist forces in 1949 ushered in three decades of disastrous economic repression and political manipulation. Only after the Great Helmsman’s death in 1976 and the subsequent fall of the Gang of Four did Deng rise to the leadership and begin the process of opening up the economy and giving vent to the commercial and entrepreneurial instincts of his compatriots. In the mid-1980s, his ‘socialism with Chinese characteristics’ became the new national modus vivendi as the sleeping giant bestirred itself.
Rudd would develop his own business consultancy in the mid-1990s to assist Australian firms seeking to establish themselves in China at the time of the great awakening. BHP was not among them. At the time, BHP was preoccupied with the fallout from its disastrous acquisition of Magma, the US copper miner.
After the 2001 Billiton merger, the company reappraised the potential of China. 3 ‘We saw what was going on in China, but China got delayed for two years because of 9/11,’ says Brad Mills, who was one of BHPB’s chief strategists at that time. ‘Within one month [of the attacks], we saw a decline in consumption in the Western world across a whole variety of commodities by about ten per cent. Chinese growth just chugged along during that whole period and it consumed all of the excess capacity that had been installed but was no longer being used by the West. It pushed out the current price expansion by a two-year period. While there was excess capacity, the Chinese were able to consume everything at very low prices.’ 4
BHP itself had traded with the Chinese for more than a hundred years – even before the creation of the Republic in 1912. In the 1890s, the company had sold lead and silver bullion from the Big Mine at Broken Hill to the Ching Dynasty. According to Brian Loton, the Chinese were big customers who once saved The Prop from bankruptcy. ‘There were disruptions in the United States and Europe, with people going off metallic currencies,’ he says. ‘But the Chinese stuck to their bargain, and if they hadn’t the company wouldn’t have survived.’ 5
In May 1971, before the Australian Government had recognised the People’s Republic, BHP negotiated pig-iron sales to the country. ‘Trade with China fluctuated over the years,’ Brian Loton says, ‘and in more recent times we started to put steel development there as a sole company [as opposed to a joint venture].’
In the early 1990s, Russ Fynmore was put in charge of BHP’s China trade, mainly in iron ore and coal. ‘We advertised for a Mandarin speaker, and a young man called Clinton Dines applied,’ Fynmore says. ‘He’d gone up there as a 20-year-old to learn Mandarin and was working in Hong Kong for a trading company. We liked him – he was a bit different: a modern style of person. He went to Beijing and did a great job for BHP.’ 6
In the new BHP Billiton, Mike Salamon was one of the most enthusiastic Sinophiles, along with the commercial chief Marius Kloppers, Brad Mills (copper) and Phil Aiken (petroleum). Salamon had first gone to China in 1992 when Samancor started to sell its chrome and manganese there. In 1993, the company hosted a major ferro-alloys conference in Beijing, for which it produced a ferro-alloy manual in Mandarin – nothing like that had ever existed. ‘We realised stuff was happening there – and not just in Shanghai,’ he says. ‘I went to cities you’d never heard of – getting to them was almost impossible. You started to realise this was much more than just some ephemeral boom.’ 7
By the end of 2001, BHP Billiton had opened the company’s biggest network office in Shanghai, and Clinton Dines moved down from Beijing to run it. ‘We didn’t shut the Beijing office, but Shanghai was the heart of China,’ Mike Salamon says. ‘It was one of the best strategic moves we made because by centralising everything we started to realise this was massive, and we saw that long before everybody else. We had source data which governments didn’t have, nobody had. Consequently, we could think about a business model which was more analogous to the 1950s and ’60s, when the world needed raw materials to rebuild Europe and Japan.
‘From somewhere in the 1970s all the way through to 2000, that changed. All of us became fat and happy; that was how it was for 25 years until China got into its creation. We were already approving projects while other people were still in the old mentality, but it wasn’t easy.’
In strategy meetings, Marius Kloppers maintained that BHPB’s resources in the ground were now ‘a hell of a lot more valuable’ than they had been ten years earlier. Kloppers recalls leading a session on the subject at the Danesfield conference in June 2002. ‘Because we had restructured our operations on the back of the merger, it gave us the opportunity to do a more holistic assessment of what was coming in terms of demand in China,’ he says. ‘Part of how we set ourselves up was to look at what we anticipated as demand pictures in China across the range of products.’ 8
China had already become the world’s largest copper consumer and accounted for roughly a third of the world’s steel exports. In 2002, BHP Billiton’s sales to China were pegged at US$742 million, but they rose to US$1.2 billion in 2003 and in the first half of the 2004 financial year leaped to $1.1 billion, almost as much as in the entire previous year.
In March of that year, Chip Goodyear initiated an unusual equity deal with four big Chinese steel mills that locked them into an iron-ore contract worth US$9 billion over 25 years in return for equity in a new mining operation. The four mills – Wuhan Iron and Steel, Maanshan Iron and Steel, Jiangsu Shagang group and Tangshan Iron and Steel – each took ten per cent of Jimblebar mine, east of Mt Newman. 9
One month later, the Chinese Government ordered banks to cut lending for iron, steel, aluminium and automobile manufacturing in an effort to cool down the red-hot economy. Commodity prices – and the shares of BHP Billiton and other resource companies – tilted sharply south. 10 Betting that China’s demand for raw materials would survive the slowdown, Kloppers and his marketeers kept their nerve and pressed for more investment. The chief concern was still whether a lack of mine capacity would make it difficult to meet demand.
‘Nobody had invested in development or reinvested in any new mines – there was no pipeline; all the exploration had been cut,’ Brad Mills says. ‘One of the big strategic arguments inside BHP was what was going to happen with the future of these metals? Would they really ever get back to some long- term normative number? In fact, would they start going to a real price appreciation? It was a huge battle inside BHP.’ 11
The board backed the strategists’ confidence and agreed to invest US$5.4 billion over the next five years to expand production of its copper, nickel and alumina. ‘In the long haul, we believe that China is a strong and robust story,’ Chris Lynch, the chief financial officer, told the New York Times. ‘We fully expect bumps and hiccups on the way.’ 12 Investments included US$1.1 billion for a new nickel mine in Western Australia and US$300 million to expand the Queensland nickel refinery; US$870 million to enlarge Escondida yet again; US$192 million to increase the output of the West Australian alumina refinery; US$213 million to boost production at its iron-ore mines there and an additional US$351 million to expanding port and rail facilities.
The final sales figure for 2004 was US$2.4 billion, which meant that China had accounted for ten per cent of BHP Billiton’s total sales and more than 20 per cent of its sales growth. Don Argus told investors at the annual general meeting in Sydney on 22 October, ‘We expect China’s economy to ease modestly from current near-double-digit growth rates, yet remain a large and sustainable consumer of raw materials and resources in coming years.’
China had rapidly become the leitmotif of Chip Goodyear’s reign as chief executive and would remain so. ‘We need to recognise there may be something different happening today than there was ten years ago,’ he said in March 2005. ‘And that is that 1.4 billion people in China and a billion people in India may be saying, “Hey, this is our century. This is our chance for a television set, a refrigerator, an air conditioner or ultimately an automobile.” And when that population says that this is something they want to strive for, its consumption of raw materials will be quite significant, just as it was in the world that we see today as a developed economy. And when that happens, there’s a great draw on the things that we produce. It will have its cycles just like every other economy we’re involved in. So, China is important to what we do, but we don’t build it on the basis that it’s going to grow to the moon.’ 13
Goodyear produced a chart of commodities prices going back to the Anglo-American War of 1812 that he called the ‘200-year view’. He argued that the Chinese bull market for resources was on a par with the Industrial Revolution and the rebuilding that had followed the Second World War. During both those periods, commodity prices experienced a 25-year increase. ‘Do we think that China is going to be a place that’s going to be a significant resource consumer for the next 20 to 30 years?’ he asked. ‘The answer is yes, we do.’
In February 2006, BHP Billiton announced it had broken the record for the highest six-monthly net profits at an Australian company for the fifth consecutive year. The US$4.36 billion profit for the last six months of 2005 confirmed the strength of demand from China, which was paying higher prices for iron ore, coking coal and copper. Iron ore alone rose 70 per cent. In 2005, China accounted for almost $3 billion in sales, 16 per cent of the company’s income. Chip Goodyear said, ‘We don’t see much reason that [China] would be below eight per cent GDP growth, certainly for the next number of years.’ 14
The chief concern was that a lack of mine capacity would make it difficult to meet demand. ‘You realise this is an entire changing of a massive society,’ Mike Salamon says. ‘The standards which the Chinese aspire to are yours and mine – they’re not some second-class standards. They want nice apartments, decent airports, cars, then universities – and they want a clean environment. You look at modern Chinese buildings – they are the most modern, the most environmentally friendly. There’s a lot of baggage there but they want to change it. Then you work out what does this mean in terms of materials and energy. If you add North America to Europe, it’s much smaller than China, and then you’ve got India waiting in the wings.
‘Visionaries like Andrew “Twiggy” Forrest 15 saw it and we saw it. And we had this incredible platform that we’d created for a different world, but it was the strongest platform ever in terms of its asset base and its global reach.’ 16
It was now apparent that China and India – ‘Chindia’ to the economists – had triggered a supercycle for commodities that would last for decades. Most of the economic activity in India, however, had been in call centres, computer software and the IT industry, none of which required huge infrastructure. But in China, airports, railroads, power stations and whole new cities – all big infrastructure projects – were being built on a massive scale.
In order to feed the voracious demands of the supercycle, Chip Goodyear had to swallow his reservations about Russia and compete for its largely untapped resources of copper, nickel, coal and bauxite. He took the first step in June 2006 by setting up a joint venture with two of Russia’s oligarchs, Mikhail Prokhorov and Vladimir Potanin, controllers of Norilsk Nickel, Russia’s biggest mining company. Ignoring his caution of the previous year, when he had described Russia as an ‘immature’ investment arena, Goodyear said during a visit to Moscow, ‘This alliance with Norilsk is a win–win – it’s an important step for BHP Billiton.’ 17
In fact, BHP Billiton was following the lead of Rio Tinto, which had completed a similar agreement with Norilsk just six weeks earlier to explore for base metals in remote regions of Siberia. President Vladimir Putin demanded that Russia retain control over core natural-resource assets, so the BHP Billiton venture was split 50–50 but Norilsk would own one extra share. 18
After a meeting with Putin, Goodyear declared that Rosatom, Russia’s atomic energy agency, would be a potential customer for its uranium when BHP Billiton increased mining at Olympic Dam. ‘What Gazprom 19 is to natural gas, we are to uranium,’ he told Reuters. ‘We are about to go through a big expansion at Olympic Dam and make a decision to triple uranium production, so we need to find markets.’ 20
Back in Australia, the usually self-contained Goodyear could barely restrain himself when he reported BHP Billiton’s third consecutive record full-year profit on 23 August 2006. ‘What a year!’ he declared during presentations to journalists and analysts in Sydney. ‘We are clearly at an interesting time in our industry. The world has rediscovered resources and how critical they are to our daily lives. In developing countries, they are fundamental to economic development.’ Net profit had risen 58 per cent to US$10.2 billion in the fiscal year ended 30 June, with revenue climbing 25.5 per cent to US$39 billion. Investors’ expectations were now so high, however, that BHP Billiton’s shares actually fell 36 cents to close at $28.30. 21
With mines operating at full capacity, trade unions demanded higher wages for their members in several of BHP Billiton’s operations. The most serious strike had begun on 7 August of that year when some 2000 workers at Escondida downed tools. Soon after the strike started, the company reported first-half profits for the mine of close to US$3 billion, more than triple its profits in the same period the previous year. Infuriated, the miners held their ground.
After a 25-day strike that cost the company about US$200 million in lost profits, the miners returned to work on 2 September, but only after reaching a deal that, according to union officials, made them the highest-paid workers in South America. It included a five per cent real-wage increase, new education, health-care and housing benefits, an end-of-strike bonus worth an after-tax US$4600 and an unheard of bonus of US$12,000 on account of high copper prices. 22
Nothing, however, could interrupt the progress of the Chinese economic miracle. ‘Once the genie is out of the bottle,’ Goodyear liked to say, ‘it is very tough to go backwards. Once people know you can have a fridge, education and so on, if you say, “Oh, I’m sorry, no more,” then you have a problem.’ 23
No Chinese leader in the post-Deng era would volunteer for that problem. On the contrary, the Communist Party leadership showed themselves acutely aware that continued economic growth and rising living standards were central to their maintaining political control. And a significant element of that growth has been the raw material and energy supplies so abundant in the so-called Lucky Country. 24 Indeed, the complementary nature of the two economies was forging a new political climate within the respective leadership.
John Howard, who brought his conservative, anti-communist attitudes honed in the cold-war years to the prime ministership in 1996, would become an enthusiastic salesman for Australian mining groups. This culminated in a special 2006 trip to Shenzhen in support of a massive deal under which Woodside Petroleum would supply US$37 billion worth of liquefied natural gas to PetroChina over the next 20 years. Chinese Premier Wen Jiabao joined him in welcoming the deal. And by identifying himself so closely with the China connection, Howard opened the door for his successor to expand the relationship beyond the commercial boundaries.
Indeed, it provided opposition leader Kevin Rudd with a political coup in his quest for power in 2007. In the lead-up to the November election, Howard had planned a meeting of Asia-Pacific Economic Cooperation (APEC) leaders scheduled for Sydney in September as the perfect stage on which to parade his international leadership credentials. His friendship with the American president George W. Bush – a sure-fire electoral winner in the past – would contrast Howard the international statesman with the relatively young and inexperienced Rudd. 25 In the event, Bush’s personal unpopularity and inept performance at the meeting (at one stage confusing the gathering with OPEC) neutralised the American connection. Then Rudd finessed Howard comprehensively at a luncheon for the Chinese president Hu Jintao when he addressed the visitors in perfect Mandarin. A clearly delighted Hu Jintao enthused, ‘You know China inside and out,’ while Howard squirmed in his seat. Suddenly, it seemed, it was Rudd who represented the future direction of Australia’s commercial and political diplomacy.
However, Rudd’s Chinese expertise, accumulated through an honours degree at the Australian National University, further language study in Taiwan and Hong Kong, the diplomatic posting to Beijing and his China consultancy, brought with it some unexpected constraints. His conservative opponents began a whispering campaign that Rudd was ‘the Manchurian candidate’, 26 suggesting that he was too familiar with the Chinese for Australia’s good. This caused him to cancel a planned trip to Beijing prior to the election and to operate circumspectly in his dealings with the Chinese leaders.
By the time Rudd had swept to victory in November 2007, Chip Goodyear was in his last month as chief executive. The timing was unexpected, but Goodyear, still only 49, had always made it clear that he did not intend to stay at the company for a long term. He had presided over an incomparable boom that had made record profits almost the norm. Indeed, at the time he announced his resignation in February, the company posted its highest earnings ever for the second half of 2006. Led by soaring Chinese demand for copper and nickel, net profit rose 41 per cent to US$6.2 billion. 27
‘When I went down there, it was just to right the ship,’ he says. ‘I don’t think this is well known, but the Sunday after taking the job I did tell Don [Argus] that it’s a five-year commitment and that’s essentially what it was.
‘I’m a big believer in change. It’s good for people and it’s good for companies. You have a lot of good young people in the company and if they thought I was going to stay there till I was 65 they would have left – they should have left. We needed to move on.’ 28
Although headhunters scoured the global-resources industry for a replacement, it was generally thought that the two outstanding candidates to step into Goodyear’s shoes were Marius Kloppers, a noted archer in his youth, and the former footballer Chris Lynch, both of whom had been elevated to the board in January 2006 and given new executive roles.
The smart money was always on Kloppers. At the time of the merger with BHP, he was Billiton’s chief marketing officer and went on to develop a formidable reputation in all aspects of the business from mergers and acquisitions to copper, iron ore and alumina pricing. He was now president of non-ferrous materials. 29
Chris Lynch, with his roots in Broken Hill, took over as president of carbon steel materials following the retirement of Bob Kirkby, and when Mike Salamon also retired he found himself in charge of the China office as well. At 51, he was seven years older than Kloppers.
The rivalry was intense but, according to insiders, the two candidates kept up appearances throughout the struggle. At the end of May, Don Argus announced in a press release that the contest had been won by ‘Dr Kloppers, an achievement-driven individual’, who would become chief executive on 1 October. Although Chip Goodyear would officially step down the day before, he would remain with the company until the end of the year to work on several projects. Chris Lynch promptly resigned.
‘Marius is an extremely talented guy and was clearly the best qualified person to take over,’ Lord Renwick says. ‘He is very relentless and go-getting, and it took a while for the Australian directors to warm to him, but in the end they did. He’s more of a deal guy than Chip. Western Mining was really done primarily by Marius and Don rather than Chip – Chip was more cautious: he’s not an instinctive deal guy.’ 30
Don Argus dismissed suggestions that Kloppers’ style was similar to that of his Billiton mentor Gilbertson. ‘Marius is his own man,’ he insisted. ‘His vast experience in the resources sector and his demonstrated strategic capabilities provide the skills we need in the next leader of our great company.’
Gilbertson described Kloppers’ appointment as ‘an inspired choice’. ‘He is a man of formidable intellect,’ he said. ‘He is a very good decision-maker. He can be tough and ruthless when he needs to be and he can be absolutely charming – which he is most of the time.’ 31
When Goodyear presented his last set of BHPB results in August, he unveiled a 21 per cent jump in pre-tax profits to US$18 billion for the year ending 30 June 2007. While BHPB had benefited from higher commodity prices, especially in nickel, copper, iron ore and aluminium, Goodyear said the ‘absolutely outstanding’ results also stemmed from greater production from the company’s mines, smelters and oilfields.
China now accounted for no less than 20 per cent of sales. ‘We believe the industrialisation and urbanisation that have driven China’s growth will continue for several decades as billions of people strive for a better quality of life,’ he said. ‘This growth is resource-intensive and it represents a steep change in resource demand.’ Turning to his favourite metaphor, he added, ‘Once people get visibility to a better way of life, and governments see that as a good thing, it’s very difficult to put the genie back in the bottle.’ 32
Goodyear also sounded a clear warning to his successor. ‘China now represents in excess of 45 per cent of global seaborne iron-ore demand, 22 per cent of copper, 25 per cent of aluminium and 17 per cent of nickel demand,’ he said. ‘While this represents a significant business opportunity, our exposure to China’s economic fortunes and economic policies has increased ... a slowing in China’s economic growth could result in lower prices for our products and therefore reduce our revenues.
‘China is increasingly seeking self-sufficiency in key commodities, including investments in other countries. These investments may impact future demand and supply balances and prices.’ 33
Goodyear’s comment triggered speculation that the China Investment Corporation might use some of China’s immense sovereign-wealth fund – then estimated at US$200 billion – to take a ten per cent stake in BHP Billiton, and perhaps Rio Tinto, in order to gain some measure of control over its supplies of iron ore, copper and aluminium. Kevin Rudd, still opposition leader, commented that a Labor Government would welcome Chinese investment, and even takeovers, if he won the November election. ‘The Chinese are on a global-investment push,’ he said. ‘It is virtually impossible to kick through one [international] capital and not run into a Chinese investment team.’ 34 However, as Rudd would discover when elected, it was not that simple. Chinese economic expansion would become a double-edged sword and he would soon have to contend with the disturbing consequences arising when, against all predictions, the Asian supercycle suddenly imploded and Chinese investors went shopping for bargains on the severely depressed Australian stock market.