During the first quarter of 2010, Rio Tinto plc (NYSE:RTP) boosted production of iron ore by 39% compared with the same period last year. The primary driver, as expected, is China, where the still-booming economy can’t seem to satisfy its demand for steel. According to Rio Tinto’s operational review issued this morning, the company produced 41 million metric tons of iron ore (it’s share of the total 53 million metric tons mined) in the quarter. Annualized shipments, including shipments to China totaled more than 217 million metric tons for the past 12 months.

Rio Tinto, BHP Billiton Ltd. (NYSE:BHP), and Vale S.A. (NYSE:VALE) control two-thirds of the world’s iron ore supply. These three also combine for more than 23% of the total assets of the Market Vectors Steel ETF (NYSE:SLX).

But not everything is coming up roses for Rio Tinto. The company is seeking approval of a joint venture with competitor BHP Billiton that is running into sharp opposition in China and Europe. All three have announced a recent move to quarterly pricing that has also raised more questions about anti-competitive behavior in the iron ore markets. China, in particular, is not amused and is trying to begin a boycott of iron ore imports.

Last year Rio Tinto agreed to sell 9% of the company to Aluminum Corporation of China Ltd. (NYSE:ACH) for $19.5 billion in a deal that got shot down by the Australian government and some loud noises from BHP Billiton, which had offered to buy Rio Tinto in 2008 for $140 billion, an offer Rio said “undervalued the company and its prospects.” This was hard on the heels of Rio’s $39 billion acquisition of Alcan. The company ended up doing a $15.2 billion rights issue and an iron-ore mining deal with BHP Billiton that saved Rio from collapsing entirely.

The soaring prices for iron ore make that $116 billion joint venture between Rio and BHP look less attractive to Rio’s management today. The Wall Street Journal reports today that some Rio shareholders are demanding that the company ditch the joint venture, which is estimated to have the potential to save up to $14 billion. Rio also stands to benefit from an equalization payment of $5.8 billion from BHP, which will raise BHP’s stake in the joint venture to 50%.

Rio Tinto’s management probably doesn’t want to do anything to remind shareholders that it turned down a $140 billion offer for the company two years ago. It’s market cap today is shy of $120 billion, and although its share price is very near its 52-week high of $248.97, two years ago Rio shares were priced about $550.

The joint venture with BHP is still on track, but that doesn’t mean that the track is a smooth one. Customers, including China and the European Union, don’t want to see further consolidation in iron ore mining, and are especially unhappy about the new quarterly pricing scheme that has doubled the price of iron ore.

Charges of anti-competitiveness are unlikely to stick because Rio and BHP will independently market the joint venture’s production, and quarterly pricing that is partly set by spot prices cannot be readily manipulated. Supply, however, could be manipulated, and it is on that basis that the EU is likely to object. EU approval is required because Rio does business in London as well as Australia.

Chinese trade organizations trying to establish a two-month boycott of iron ore purchases from Rio, BHP, and Vale are reportedly having a hard time getting traction. A two-month boycott is unlikely to have much lasting effect on prices, and some claims that iron ore prices are being driven by speculators have not been substantiated. And of course the Chinese steel makers could always hedge their contracts.
All in all, the miners appear to have the upper hand here, and China’s growth simply won’t sit around and wait for iron ore prices to fall. The government can always step in and make the steel companies whole, just as it does for crude oil refiners who are forced to pay market rates for crude but are only able to charge regulated prices for gasoline and diesel fuel.

Rio Tinto showed EPS of $2.76 in 2009, and estimates for 2010 are to more than double that to $6.33. For 2011, EPS is targeted at $7.26. Provided that the company can steer clear of the speed bumps in its path, its earnings could be even better than that.

Paul Ausick

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