Jeremy Warner's Outlook: BHP acts as if Chinalco never happened

BP emerges from dark night of the soul; MPC forced to grapple with slow-flation; Aviva's orphan estate is no laughing matter
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Marius Kloppers, chief executive of BHP Billiton, seems like a man determined to ignore the elephant sitting in the corner of the room. Last night's offer of 3.4 BHP shares for each Rio Tinto share is obviously a big improvement on what went before and might even have got the Rio board to the negotiating table but for one rather important fact.

The world changed when Chinalco, the government-controlled Chinese aluminium producer, last week snapped up a 9 per cent stake in Rio, lavishing an astonishing £7bn in cash on the exercise. BHP's new offer is still worth less than the £60 a share Chinalco paid. Under these circumstances, Rio's chairman, Paul Skinner, will feel under no obligation even to talk to BHP, let alone recommend its offer.

Mr Kloppers didn't really want to talk about Chinalco at all during last night's conference call. For all the world, he gave the impression that the Chinese are just another, albeit quite large, shareholder to win over. This they are quite plainly not.

As major customers of both companies, the Chinese are determined to scupper BHP's ambitions, which they see as essentially monopolistic and therefore inflationary for raw materials are key to China's industrial development.

The one thing Mr Kloppers has got going for him is that, of the two alternatives, the Australian government is likely to be rather keener on the BHP bid than a Chinese takeaway. Certainly he has been lobbying hard in Canberra to keep the Chinese out.

Even so, the Australian authorities would be hard pressed to stop Chinalco increasing its stake to the 20 per cent maximum it is allowed under Australian takeover rules without launching a full-scale takeover bid. BHP has made its own offer conditional on only 50 per cent acceptances, but it would none the less find such a minority highly restrictive. Mr Kloppers might like to think otherwise, but the world has changed, with the Chinese, previously just customers, determined to make their voice heard. Unfortunately for him, they've got the money to do it.

BP emerges from dark night of the soul

As stock markets worldwide took another hammering yesterday, BP was one of the few share prices which by the close of play was still showing blue in the FTSE's sea of red.

This was perhaps odd, because, alone among the oil majors to have reported so far, BP is the only one to have announced a fall in fourth-quarter profits. What's more, the number undershot even the gloomiest of the analysts' predictions, and these have come down a long way in recent months.

Yet this is where the bad news ends, and the view among oil watchers is that, having been through its dark night of the soul, BP is now actually better placed than most of its rivals. This is not just because of the scope for recovery under the new chief executive, Tony Hayward, who seems to be making good progress with previously announced plans to rationalise the business and cut costs.

It is also because the previous incumbent, Lord Browne, despite all his flaws, seems to have left the company in remarkably good nick in terms of its future development potential. Alone among the majors, BP is the only one to have recorded a reserve replacement ratio of more than 100 per cent for last year. Loosely translated, this means the company is replacing reserves as fast as it is expending them, which is no mean feat in today's world of ever rarer major finds.

As a mark of his confidence in the future, Mr Hayward is increasing the dividend by 31 per cent. He's also indicated that in future he'll favour dividends over buybacks, the latter of which seems in recent years to have used up an awful lot of BP's cash for no noticeable effect on the share price.

Judgement on Mr Hayward should be reserved until he's got at least a couple of years trading under his belt, but he seems to be off to a very promising start.

MPC forced to grapple with slow-flation

A quarter-point interest rate cut already looks a done deal for the conclusion tomorrow of the meeting of the Bank of England's Monetary Policy Committee (MPC). A Reuters poll of City economists last week was unanimous in predicting such an outcome.

Rather more interesting is what happens to interest rates thereafter, with opinion quite widely divided on precisely where they are headed. It can be safely assumed that the Bank of England is not going to do a Ben Bernanke, and be panicked into a steep series of quick-fire interest rate cuts that may ultimately turn out to be not entirely necessary. But neither is the MPC likely to be quite so reticent as the European Central Bank, where inflation rather than economic slowdown is still seen as the primary danger.

November's inflation report forecasts were based on market assumptions of a 1.25 percentage-point cut in interest rates by the end of this year. Since then we have already seen a quarter point sliced off rates. Tomorrow's cut will bring the tally to 50 basis points, leaving another 75 to come if things had remained the same as they were in November.

But this they plainly haven't. Hopes of an early abatement in the credit crisis have been dashed, making the outlook for growth even weaker than it was back then. The same is true of inflationary pressures, which have got worse since November, with the pound off about 5 per cent on a trade-weighted basis.

Together with rising energy prices, this is likely to be manifest in some quite extreme, at least by the standards of the last 10 years, inflationary pressures later this year. The Consumer Prices Index will likely again brush the 3 per cent mark which necessitates a formal letter of explanation from the Governor of the Bank of England to the Chancellor.

Mervyn King is still said to feel the humiliation of his last letter much more acutely than any supposed failings over Northern Rock. He won't want to pen another. The more relevant measure of inflation – the Retail Price Index – is meanwhile expected to spike up to 5 per cent. More worrying still for the Bank's policy makers, inflationary expectations are rising.

David Blanchflower, the MPC's resident dove, may be right to argue that changes in the labour market mean there is little danger of these pressures prompting an inflationary wage spiral of the sort that was commonplace in the 1970s.

Despite the long boom, job insecurity remains quite high with immigration and rising labour participation continuing to feed a large element of slack in the labour market as a whole. All the same, 5 per cent inflation is not a number that can easily be ignored. The Bank needs seriously to anchor expectations back at its 2 per cent target rate to avoid long-term inflationary consequences.

All this would argue for a rather smaller cumulative total of rate cuts than the markets are expecting. On the other hand, economic growth is slowing fast, and personally I don't buy the argument that the UK is better placed to weather this slowdown than the US. To the contrary, in many respects we would seem to be in a structurally weaker position than America, with greater levels of personal indebtedness, a bigger house-price bubble, a proportionately higher exposure to the recession in financial services, and even less scope for offsetting fiscal stimulus.

Yet if you take the view that the main cause of the present mess is too much cheap credit, then you plainly don't treat the problem by providing even more cheap credit. Never in the MPC's 10-year reign has the policy dilemma looked more challenging.

Aviva's orphan estate is no laughing matter

Clare Spottiswoode used to be known as the laughing regulator when she was at Ofgas on account on her generally sunny disposition, yet she seems to be treating her role as the policyholders' advocate at Aviva with requisite seriousness.

The first half of her job in ensuring policyholders get their just rewards out of the division of the inherited estate now seems to be largely over, with the terms set along conventional lines at 90 per cent to the policyholders and 10 per cent for the shareholders.

Ms Spottiswoode has still got reservations about the three-year time frame over which the money will be paid, but on the whole this seems a pretty good outcome. For many, the money will make a real difference, transforming some endowment policies at high risk of a shortfall into relatively low-risk investments that may even pay off the mortgage as promised. So far so good.

Yet it is what happens to the other half of the roughly £5bn at stake which is where the going gets tougher. Aviva promises to pay out more than the £450 per policyholder that Axa offered in similar circumstances eight years ago, but so it should. The Axa offer was widely condemned as a complete rip-off, prompting changes in the procedures for realising the inherited estate, including the mandatory appointment of a policyholders' advocate.

Nobody's saying at this stage exactly what the Aviva offer is, but if we assume that there is approximately £2.3bn at stake and the offer is, say, £500 per policyholder, or £550m in total, it doesn't on the face of it look like a great deal for the policyholders. For the shareholders, on the other hand, £550m for access to £2.3bn of capital seems very acceptable indeed.

Ms Spottiswoode doesn't want to push Aviva so far that it gives up the chase and finds alternative ways of raising the capital for business growth. That way the balance of the inherited estate remains as dead money and nobody ends up getting anything. But nor does she want Aviva to be laughing all the way to the bank at the policyholders' expense. It's almost as tricky as regulating British Gas. Still, perhaps best to get it sorted out now before the Chinese or some such other sovereign wealth fund rides in and swipes the lot.

j.warner@independent.co.uk

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