Glenstrata is still far from a done deal

Financial Times

“Glenstrata” will be big. When Glencore and Xstrata announced their proposed merger they talked of the “enhanced scale and market position” the combined group would have. Ivan Glasenberg, Glencore’s chief executive, described it as a “new powerhouse in the global commodities industry”. Yet the companies are walking a tightrope between hyping the size and potency of the new company, and playing down potential regulatory concerns.

The announcement last week that they would notify the European Commission of the merger – an action which had not been a foregone conclusion – is a reminder that, beyond debates about valuation, another question could still throw a spanner in the works: will Glenstrata be so big that its size becomes a problem for regulators?

The group would be the largest miner of zinc, lead and ferrochrome, and the largest supplier of thermal coal to the global market. For all that, the answer appears to be no.

 “The parties expect the merger between Glencore and Xstrata not to result in any negative impact on competition in the commodity markets in which the two companies operate,” Glencore said in a statement last week.

That is not merely corporate spin. Analysts at Jefferies have looked at the merger using the Herfindahl-Hirschman Index (HHI), a measure of market concentration that is popular among regulators.

Based on the combined group’s market share in mining of thermal coal (9 per cent), coking coal (5 per cent), copper (7 per cent), nickel (6 per cent) and zinc (12 per cent), they find no commodity for which the merger would trigger warning levels on the HHI index. Indeed, Glenstrata could buy Anglo American and still avoid any competition issues, they say.

There are two key assumptions that underlie this confidence. The first is that regulators will look at market share of the group as a miner, not including Glencore’s trading activities. In thermal coal, for example, Glencore supplied 28 per cent of the global seaborne market in 2010, according to its IPO prospectus (that number includes Xstrata’s production, since Glencore has an advisory agreement over it) – much higher than Glenstrata’s 9 per cent market share as a miner.

The second is that regulators will look at commodity markets on a global, not regional, basis. While Glenstrata’s share of global refined zinc production is less than 10 per cent, it would have 35 per cent of production capacity in the European zinc market, according to International Zinc Association data. According to RBC Capital, the group’s share of the North Atlantic coal market would be 34 per cent by 2015.

There is a preview of the arguments likely to be used by Glencore and Xstrata in the judgment on Xstrata’s acquisition of Falconbridge, the Canadian miner, in 2006.

On the first point, Xstrata argued that “the ability to acquire metals from producers and resell it on the markets does not give metal traders the same market power as metal producers”.

How the Glencore and Xstrata merger stacks up, updated as the deal progresses

Brussels decided not to pass judgment on the issue, but noted that “the vast majority of end customers buy indifferently from metal traders and metal ] Metal producers and traders therefore play either a producers [ . . . complementary role or a competing role vis a vis customers.”

On the second issue, the companies will no doubt argue that commodity markets are global in nature. When there are regional supply imbalances, traders can move material around the world to resolve them, taking advantage of the difference in prices – such “geographical arbitrage” is the lifeblood of trading houses such as Glencore.

But Brussels may disagree. In a 2001 ruling on a merger between Outokumpu and Norzink, for example, the European Commission decided that Europe constituted a separate market for zinc metal.

Once the Commission has been formally notified of the deal, it will have about a month to decide whether it raises “serious doubts as to its compatibility with the common market”. If so, it will be referred to a deeper “phase 2” investigation.

Beyond Europe, regulators in South Africa, China, Australia and the US are all expected to take a look at the deal. China’s regulator, Mofcom, has a record of dragging its heels, while in South Africa regulators have yet to approve Glencore’s purchase, announced six months ago, of Optimum Coal.

At the moment, the most likely spanner in the works for the Glencore-Xstrata marriage appears to be truculent Xstrata shareholders. But when questions of share exchange ratios have long been forgotten, Mick and Ivan may still be waiting on Brussels, Beijing or Pretoria.

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