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.

The world's biggest coal consumer and the largest commodity trader are fighting over a rich seam of the black stuff. They'd be better off working together.

Shareholders of Rio Tinto Group's U.K. listing were voting Tuesday on whether to accept a $2.69 billion offer to buy Coal & Allied Industries Ltd. from Yancoal Australia Ltd., which is ultimately controlled by the Chinese government.

Rio Tinto's management has declared the proposal superior to a bid from Glencore Plc, which has adjacent mines in Australia's Hunter Valley, north of Sydney, and has coveted Rio Tinto's deposit for the best part of a decade.

Adding It All Up
The potential spending on Yancoal's Coal & Allied takeover is well in excess of Yancoal's existing A$288 million market capitalization
Source: Company reports, Bloomberg

To date, Glencore's best hope of breaking up a deal has been the possibility that Yancoal -- market cap A$288 million ($219 million) -- would be unable to fund the $2.45 billion upfront payment. That's before $940 million to buy out Mitsubishi Corp.'s minority interests in the pits and some $240 million of longer-term royalties.

Of the $2.45 billion, Yancoal's immediate parent, Yanzhou Coal Mining Co., has pledged $1 billion. The remainder is to be met through the sale of new shares -- but that always looked hard to get away in one shot, given the speed at which coal is losing investors' favor. Global issuance of new coal shares over the 17 quarters through the end of 2016 came to just $1.16 billion.

Unfortunately for Glencore, China Inc.'s bottomless checkbook came to the rescue last week, with an announcement from Yancoal's ultimate state-owned parent Yankuang Group. In the (likely) event that the capital raising falls short, Yankuang will simply pay the missing $1.45 billion direct to Yancoal.

Capital Drought
The $1.45 billion that Yancoal needs to raise from shareholders is more than equity markets have provided to coal companies over the 17 quarters through December
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.

Where does that leave Glencore Chief Executive Officer Ivan Glasenberg? Not in quite as bad a spot as you might think.

After all, before China Inc. takes complete control of Coal & Allied because of a shortfall in Yancoal's capital raising, there must first be a shortfall in Yancoal's capital raising. And though the world as a whole seems reluctant to lay out multibillion-dollar sums on coal assets, there's one significant player that has already shown its willingness to spend big: Glencore.

Here's how it might work. Say Yancoal gets approval for the takeover and comes to the equity market to fund the first $1.45 billion tranche. If Glencore subscribes to the full amount, it gets a majority stake in Yancoal, and control of its assets.

That might be a little aggressive for a company that counts China as a critical customer, but it's not the only option. Buy $1.34 billion of Yancoal's new shares -- half what Glasenberg was prepared to lay out for Coal & Allied as recently as last week -- and Glencore would end up with about 49 percent of the company.

That would please Beijing by putting Glencore just shy of control, but it wouldn't leave Glasenberg without options. Yancoal has committed to pay another $710 million for Mitsubishi's minority interests in one of the mines and an optional $230 million for its stake in another of the pits, but it's not clear how that spending will be funded. Should Yancoal CEO Reinhold Schmidt (a veteran of Glencore's coal mining business) feel the need to tap the equity markets to fund those purchases, Glencore has another option to raise its stake.

Profit and Loss
Yancoal's losses would have eaten up all of Coal & Allied's profits in three of the past four years
Source: Bloomberg, company reports

Glasenberg could stand aside even from that opportunity and keep a trick up his sleeve. Yancoal hasn't posted a profit since 2012 and might struggle to make significant amounts of money, even after taking on Coal & Allied's much better assets. A combined business would have had losses in three of the past four fiscal years, barring synergies to reduce costs and ensure better selling prices -- and synergies are where Glasenberg has his real advantage.

Glencore is a much more natural fit for the Coal & Allied business than Yancoal. As Gadfly pointed out last month, the facilities are adjacent, offering potent opportunities to combine processing plants, blend coal to produce more valuable grades and, ultimately, link pits to reach otherwise-inaccessible seams.

That would work best if Glasenberg had control -- but if a push for a majority stake now might look too aggressive, it could prove oddly uncontroversial if Yancoal was in need of cash after several amicable years as a partner. Swapping stakes in joint-venture mines for cash is an established business in the Hunter Valley: Coal & Allied owes much of its current shape to decades of such horse-trading between Rio Tinto and Mitsubishi.

Many of history's biggest fights came down to coal. The battle for control of the Rhineland's deposits contributed to three wars between Germany and France between 1870 and 1945. The European Union owes its origins, in part, to an attempt to defuse tensions by creating a European common market for coal and steel.

Europe's struggles over its mineral deposits have usually ended in tears, but cooperation has yielded great dividends. There's a lesson in that for Glencore and Yancoal.

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

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

  1. We've excluded the $1 billion that Yanzhou Coal raised this year to fund its share of the Coal & Allied takeover.

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

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net