China steels for shift in iron ore pricing

Reuters | Tue, 09 Jun 2009 11:19
[miningmx.com] -- A new settlement regime for iron ore prices could come sooner rather than later as China, the world's biggest consumer, persists in holding out for price cuts bigger than those settled with other Asian steelmakers.

For more than a year, analysts have been predicting the demise of the annual benchmark system by which three key miners -- Anglo-Australian firms BHP Billiton and Rio Tinto and Brazil's Vale -- thrash out prices with their customers.

Increasingly volatile markets have turned the decades-old contract system into a dinosaur, its opponents say.

Steel mills were paying record iron ore prices through the second half of 2008, for instance, despite the global economic slowdown, while spot prices fell 60 percent, in line with declines seen in copper and other exchange-traded commodities.

Adamant calls from the China Iron and Steel Association, the country's lead negotiator, for a cut of 40 to 50 percent in annual rates, larger than the 33 percent cut miners have agreed with Nippon Steel, JFE Holdings and POSCO, make a traditional settlement unlikely.

"CISA has drawn a line in the sand," said Mark Pervan, a senior commodity analyst with banking group ANZ.

"A backflip from their position would be a huge loss of face. That means another resolution is most likely -- either annual prices on a landed China basis or the spot market."

But questions remain. Rio Tinto is in a stronger position to hold out for the deal it wants after jilting Chinese state metals firm Chinalco over a $19.5-billion bailout offer, making chances yet slimmer for a deal to be cemented in the next three weeks.

Rio plans to team with BHP in iron-rich Western Australia in a joint venture the steelmakers fear could turn out to be monopolistic.

SPOT MARKET ALLURING BUT RISKY

A Cost Insurance Freight China deal would shift the freight risk to the miners and eliminate freight premium arguments that delayed the talks last year, Pervan said.

"A CIF China price of around $80 a tonne will appease the producers and offer a way out for the Chinese who can play up that they are no longer vulnerable to swings in freight costs," he added. "It's fifty-fifty from where I sit."

Alternatively, Chinese buyers could turn to the spot market, which is looking the most attractive for them at the moment, but is also the most risky.

Australian iron ore landed in China would cost around $72-$73 a tonne, making for a CIF price of around $80 if China accepted the Japanese benchmark. Spot market prices have been volatile, however, rising as high as $180 last year.

But some analysts still expect a traditional settlement before the end-June deadline.

U.S. analysts at Dahlman Rose said China was close to accepting a 33 percent reduction, echoing a report in trade publication Steel Business Briefing last week.

"According to our industry sources, the China Iron & Steel Association and Baosteel are close to accepting the 33 percent cut in benchmark prices for iron ore fines set by Rio Tinto," Dahlman said.

But Shan Shanghua, the Association's general secretary, denied reports that mills would accept a cut of only so much.

"The Chinese aren't going to budge on prices. They know what the cost savings will be and will use that to justify calls for a cut. They want a 40 percent reduction and they won't settle for less," a commodities trader in Singapore said.

"At the same time, Rio's in a better position than it's been in for months. The risk is the talks stalemate."

Rio has said that if contracts are not settled by the end of June, contracted material will be priced on a spot basis.

A deal last year was struck in the last week of June when China agreed to a near doubling of prices on worries that spot prices would rocket.

This time round, with the world arguably experiencing its worst economic crisis since the 1930s, China is in a much stronger position to win concessions from the miners.

WILL CHINA CAVE?

Whether China caves will come down to a couple of factors -- how it views the outlook for the spot market and whether it thinks it can eke out its own large port stocks of iron ore, augmented by domestic output and other sources, such as India.

China holds more than 75 million tonnes of iron ore at its major ports, enough to cover around six weeks of imports and about 125 percent of its monthly domestic mine output.

Using those stocks judiciously, China could reduce its demand for imported iron ore by a quarter for six months, putting pressure on prices -- a possibility not lost on the miners.

"This is one of the reasons China built up those stocks -- to use as leverage. They could reduce their demand for imported iron ore for a time. The question is, for how long, and how low are they willing to let them fall?" the Singapore dealer said.

"They could end up even more worse off if they get it wrong."

One option for Chinese buyers would be to use one of the flurry of iron ore swaps contracts launched in the last year or so to hedge their positions and lock in prices.

"There are clearly big issues with the contract price system, otherwise they would have settled. Increasing volume through the spot market is probably unstoppable," a specialist commodities researcher in London said, on condition of anonymity.

"Right now the annual settlement probably doesn't benefit anyone. The days of annual contract prices for bulk commodities are over. What we are watching right now are the last death throes."