Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Is Glencore Plc's last-minute bid for Rio Tinto Group's Australian thermal coal assets about quantity, or quality? It's a bit of both.

With a tenement footprint that's more or less surrounded by Glencore's own mines, Rio Tinto's Hunter Valley pits have long been an obvious target for the trader.

In volume terms, the $2.55 billion offer looks like the sort of deal that typically went down a decade ago, when the thermal coal used in power stations was a hot commodity and the likes of Rio Tinto and Anglo American Plc were looking to add assets, rather than exit ones still on their books.

Digging Deep
Glencore is already by far the dominant coal producer supplying the Port of Newcastle
Source: Company reports and websites
Note: Saleable coal totals have been used where possible. Some other definitions of production may have been used where the company hasn't defined its terminology further.

Glencore is by far the biggest coal miner in the Hunter Valley, the region north of Sydney that supplies the world's biggest coal export harbor at Newcastle. But its mines are rapidly depleting, and will run out in about a decade at current production rates. Add Rio Tinto's vast resource base and lower output pace, and you could comfortably extend that deadline into the mid-2030s or beyond.

Coal Loader
Glencore will more than double its upper Hunter Valley coal reserves by adding Rio Tinto's mines
Source: Company resources and reserves reports
Note: Shows only mines in the upper Hunter Valley. Excludes more isolated Hunter mines such as Ulan.

Hang on, though. Won't the world have stopped burning coal by the mid-2030s?

Well, not quite. While coal is in a long-term decline, even the more aggressive decarbonization scenarios examined by the Intergovernmental Panel on Climate Change see it providing 10 percent to 14 percent of the world's primary energy by 2050 -- well down from about 30 percent at present, but still enough to represent a significant lump of carbon.

Burned Out
Coal is declining as a share of the world's energy mix under most climate scenarios
Source: IPCC

The bullish argument for Australia's coal industry has long been that many of its mines produce higher-quality product than the stuff being dug up in China, India and Southeast Asia, and will thus remain open in that 10 to 14 percent slice even as lower-quality pits are shut down.

That's the real kicker in Glencore's bid. As the company demonstrated in its announcement, buying Rio Tinto's mines will allow Glencore to link up a jigsaw puzzle of pits scattered across the upper Hunter Valley:

Glencore pits

That will yield opportunities to shift tonnage between mines and blend some of its coals with Rio Tinto's, to create an overall higher-quality product.

I've Got the Power
The energy content of Rio Tinto's Hunter Valley coal mines is higher than Glencore's
Source: Company resources and reserves reports
Note: Based on proven and probably marketable reserves. Rio Tinto figures have been converted from MJ/kg at rate of 1MJ=239kcal.

The gap between 6,100 kilocalories per kilogram at Glencore's Ravensworth East mine and 6,950kcal/kg at Rio Tinto's Mt Thorley may seem insignificant, but far smaller distinctions can have a dramatic effect on pricing: 6,000kcal/kg coal at Newcastle port typically sells for about 24 percent more than 5,500kcal/kg product, according to Gadfly's calculations. Geology tends to be destiny for miners, so opportunities to upgrade coal quality in this way are rare.

Whether Glencore's Chief Executive Officer Ivan Glasenberg gets his wish is another matter. There's already another bidder in the queue, in the form of Yancoal Australia Ltd., the local subsidiary of China's Yanzhou Coal Mining Co., which agreed to purchase the mines for $2.45 billion back in January.

Glencore is making such a low-ball offer -- just $100 million more than Yancoal -- because it doubts its rival will be able to raise the cash. Yancoal Australia's market cap is just $293 million, so it plans to get the money by selling new shares. Its 78 percent dominant shareholder, Yanzhou Coal, will provide only $1.03 billion, and the second-largest shareholder, Noble Group Ltd., is probably more likely to reduce than add to its 13 percent position, given its own pronounced cash difficulties.

Capital Drought
The share market hasn't provided $1.45 billion to finance a coal takeover in any quarter since 2010
Source: Bloomberg
Note: Shows quarterly value of acquisition-focused share sales in the coal industry. Excludes share sales carried out for reasons of paying down debt, general corporate purposes etc. "Yanzhou Coal offer" represents the capital raising by that company to fund its share of the Rio Tinto deal.

That means the bulk of the remaining $1.42 billion will have to come from new investors -- but shareholders haven't shown that sort of enthusiasm for coal acquisitions since 2010.

Hence the attractions of Glencore's offer, which isn't subject to the availability of finance.

Pity Rio Tinto's Chief Executive Officer Jean-Sebastien Jacques. With Yancoal still saying that it will be able to raise the funding, he must decide before Glencore's June 26 deadline whether to risk offending China Inc. by picking the greater certainty offered by the Anglo-Swiss company, or to risk the deal falling over altogether by going with Yancoal.

Mining bosses weighing multi-billion dollar bidding wars for their assets should normally be expected to be in a happy position. In this instance, Jacques looks like an exception.

Peter Grauer, the chairman of Bloomberg LP, the parent of Bloomberg News, is a senior independent non-executive director at Glencore.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net