The body count is five and rising.
First, the Beijing government arrested four Rio Tinto (RTP) staffers  in China to negotiate the price of iron ore with Baosteel and other Chinese steel makers. Then, the Chinese detained an executive at steelmaker Shougang Group and announced that Baosteel, Anshan Iron & Steel, Laigang Group, and Jigang Group are all under investigation.
The charges? Spying, specifically stealing state secrets, and bribery. (And just in case you think the Chinese aren’t serious, on July 15, Chinese courts sentenced Chen Tonghai, former head of Sinopec, to death (suspended for two years) on a bribery charge.) 
But with the question of what constitutes a state secret so vague in China—if the authorities so decide even doing due diligence on a company about to list on the stock exchange could involve state secrets—no one doubts that the arrests are merely another round in the battle for control of the world’s raw materials.
I don’t know how that battle will ultimately come out, but I can name two companies that stand to come out ahead just while the fight rages.

The July arrests come hard on the heels of the June death of a deal that would have given Chinalco or the Aluminum Corporation of China (ACH), a stake in cash strapped Rio Tinto, the second largest iron ore exporter in the world, in exchange for $19.5 billion in cash. The collapse of the deal was a big set-back in China’s drive to secure the raw materials that its steel industry needs if the country is going to continue to be the world’s factory. And if the Beijing government didn’t have enough reason to be paranoid about the global conspiracy to control China’s access to critical commodities such as iron ore and oil, the death of the Chinalco bid was quickly followed by the announcement of a new joint venture between Rio Tinto and No. 3 iron ore exporter BHP Billiton (BHP) to create the largest iron ore producer and exporter in the world.
The joint venture could still fall apart–it has to pass anti-trust review in Australia—but China isn’t going to sit around idly hoping that regulators decide to set aside a deal that many in Australia see as way to “rescue” an Australian industry from the Chinese. China’s steel industry is too important to the Chinese economy.
And while the battle isn’t over, I think we can already see the winners: iron ore exporters such as Australia’s Fortescue Metals (FSUMF) and Brazil’s Vale (VALE). These companies are already reaping the reward—in higher ore prices and cheaper capital—for being among the few alternative suppliers for Chinese steel companies looking to escape the embrace of the Rio Tinto/BHP Billiton tie-up.
Look how that’s played out to the advantage of Fortescue Metals. At the height of the global financial panic, investors were fleeing the stock because the company needed capital that it didn’t have to meet its plans to expand production to 200 million metric tons a year by 2012 from the 45 million tons now projected for 2010. In an effort to conserve cash the company cancelled several long-term shipping contracts with high rates set during the commodities boom and found itself in court facing potentially crippling damages. Only some very creative—and very expensive—financing kept Fortescue liquid.
Now, however, the company is suddenly the darling of Chinese investors. At the end of April the Australian and Chinese governments both signed off on a deal that would give Hunan Valin, China’s ninth largest steel company, a 17% stake in Fortescue Metals for $462 million and a seat on the Fortescue board for Hunan Valin chairman Li Xiaowei.
That’s not the end of Fortescue’s need for capital, of course. Chinese steel industry executives think it will cost $3 billion to $4 billion in total to expand production from 2010’s 45 million metric tons to the 90 million annual rate that’s Fortescue’s next goal.
But now investors believe that they know where the money will come from: China. Fortescue shares rallied a huge 21% on June 11 on rumors of a pending investment by an unnamed Chinese steel company. And Hunan Valin has openly spoken of brokering an investment in Fortescue from China Investment Corp., China’s state sovereign wealth fund.
The result has been a huge turnaround in Fortescue shares. The stock, which had fallen 94% from its June 2008 high of $11.96 to November 2008 low of 77 cents, traded at $2.97 on June 17. That’s a 286% gain from the November low.
The stock, which had fallen back from that June high along with the rest of the market, rallied again on July 14 on news that production in the fiscal year that ended in June were above projections.
Australia’s third largest iron ore producer isn’t the only beneficiary of the Rio Tinto/BHP Billiton marriage and China’s search for alternative supplies of ore. Brazil’s Vale is also a big winner, although its gains are more subtle and more long-term.
At the time of the Rio Tinto/BHP Billiton tie up, iron ore producers were in the midst of contentious discussions to set the price of iron ore for the next year with the steel producers of Japan, Korea, and China. Given the drop in global demand for ore, clearly some price cut was in the cards, but how much? Chinese steel makers took a hard line, calling for at least a 40% cut that would return iron ore prices to 2007 levels.
Early negotiations with Korean steel giant Posco and Japan’s Nippon Steel left the outcome in doubt. In May Posco and Rio Tinto agreed on a 33% reduction in prices for fines iron ore that left open the possibility that China’s steel makers could still win their desired cut.
But the Rio Tinto/BHP Billiton deal seems to have put an end to efforts by Asian steelmakers to cut the price of Brazilian ore significantly below that shipped from Australia. China and other Asian steel makers were arguing that Vale’s ore should sell for a lower price than that from Australia to make up for the higher shipping costs from Brazil. But in the aftermath of the deal, Vale agreed with Posco and Nippon Steel on a smaller 28% cut in the price of fines iron ore. That’s less of a cut than Australia’s iron ore producers accepted for their cheaper to ship ore.
The Japanese and Korea’s have apparently decided that having a second Brazilian source to the two Australian giants is worth something. Actually quite a lot of something.
I think the odds are that Chinese steel makers will come to the same conclusion in their negotiations with Vale.
I own Fortescue Metals in my Jubak’s Picks portfolio and both that stock and Vale in my long-term Jubak Picks 50 portfolio. If you own those shares, I’d hold on. If you’re looking to buy, I’d hold off: With global steel production still falling but with hording by Chinese companies driving up iron ore prices in recent days, I’d look to buy these two stocks when investors are feeling more pessimistic about the pace of the global economic recovery later this year.
I’ll have an update on  Fortescue Metals with a new target price later today.