Iron ore prices drop, but supply still increases16 Oct 2010 • by Natalie Aster
Iron ore supply contracts for North American steel mills for fiscal 2009 appear to have settled around $76/long ton, some 25% lower than fiscal 2008 price of $102, since demand is running about half what it was a year ago. Meanwhile, the world price, reported to be $77 and usually set by Australian and Brazilian miners, is unsettled because of protracted negotiations with China well past the April 1 start of the fiscal year.
Cliffs Natural Resources of Cleveland, the largest regional supplier, is resigned to lower prices in a year where its iron ore mines are operating at half capacity because of reduced demand from steelmakers. In fact, it expects to defer about a million long tons of customer purchase obligations to the first quarter of 2010. The move reduces the company's contractual obligations for calendar 2009 to 17 million long tons of iron ore pellets. (A long ton is 2,240 lbs.)
As the third quarter came to a close, U.S. steelmaking remained below 60% of capacity. "While we have begun to see preliminary signs of stabilization in the North American steelmaking industry, we will continue to ensure our production and inventory are balanced with customer demand," Don Gallagher, president of Cliffs North American Business Unit, says in a statement. In 2008, Cliffs' sales volume was 22.7 million tons. The company's iron ore pellet capacity is 37 million annual tons.
Meanwhile, Asian iron ore negotiations are in overtime with no end in sight—especially since Rio Tinto's iron ore negotiating team in China remains in prison for allegedly stealing trade secrets. In recent months, China has arrested an Australian executive and three Chinese employees of miner Rio Tinto Group on downgraded charges of commercial bribery and industrial espionage. The initial arrests were on charges of violating state security and long-term bribery of Chinese iron ore buyers.
The arrest of Australian citizen Stern Hu, the lead iron-ore negotiator in China, and the Chinese national Rio Tinto employees followed the Anglo-Australian company's decision to ditch a $19.5 billion equity tie-up with state-owned Chinese firm Chinalco, opting instead to forge an iron ore alliance with rival global miner BHP Billiton. China also has cancelled a high-level political visit to Australia after Canberra gave a visa to an exiled Chinese dissident. Australian Foreign Minister Stephen Smith now expects a consular-level visit to China, which will include a call on Hu sometime in October.
Rio Tinto's iron ore chief executive Sam Walsh expects talks to resume, but doesn't know when: "Remember that we have our negotiators detained," he says. Although less contentious, contract talks with BHP Billiton and Vale of Brazil also have reached an impasse. However, analyst Fan Haibo at Xinda Securities in Beijing tells ChinaDaily.com that 2009 contracts talks are probably a dead issue. And, he adds, uncertainty also clouds the start of the fiscal 2010 contract talks that are supposed to open in December.
Big war over percentages of price cuts
Analysts say the world iron ore oversupply situation won't go away soon. In spite of falling demand in the fourth quarter, world production grew by 3.6% in 2008, to 1.67 billion long tons. New iron-ore mining capacity taken into operation in 2008 was estimated at about 87 million long tons, less than in 2007, but the total project pipeline contains more than 423 million long tons of new production capacity to come on stream between 2009 and 2011. According a Macquarie Bank analysis, 169 million long tons fall into the "certain" category, while 53 million are "probable" and 201 million are "possible."
International iron-ore trade also reached a new record level in 2008, as exports increased for the seventh year in a row and reached 868 million long tons, up 7.8%. In that year, the big three iron ore suppliers raised their prices substantially—actually by 96.5%—to world steelmakers in 2008. The 2009 iron ore supply brouhaha began after Rio Tinto, BHP Billiton and Vale agreed in the spring to a 33% cut in fiscal-year contract prices with steelmakers in Japan, Korea and Taiwan. Similar pacts then were settled with ArcelorMittal and other steel mills in Europe.
The new Asian benchmark is an average $77/long ton—$62 for the ore plus $15 in ocean-freight delivery charges. However, talks with the China Iron and Steel Association (CISA) stalled because the world's largest iron ore buyer has insisted that prices to fall back to 2007 levels, a price cut of 45%.
"It is hard to be fair to China if another country, with only 10 million to 20 million tons of imports, decide prices for China, which imports 500 million tons a year," explains Liu Zhenjiang, vice chairman of CISA. China overtook Japan as the world's largest buyer of iron ore in 2003 and accounted for 52% of iron ore traded globally last year, according to Morgan Stanley. That could increase to 65% this year, the brokerage forecasts.
So, for months, contract talks between the mining companies and China went nowhere. Then, in July, China detained four Shanghai-based iron ore employees of Rio Tinto on charges of violating state security, clandestine spying, theft and a long-time pattern of bribing steel industry buyers. Later that was downgraded to commercial spying allegations.
Recently, a smaller Australian miner, Fortescue Metals Group, inked a supply deal for the second half of this fiscal year, starting in October, to supply about 18 million long tons iron ore at $61/ton, which is 3% cheaper than the benchmark price set with the Japanese and Korean mills. Then, in mid-August, Shan Shanghua, the secretary general of CISA, announced the Chinese were scaling back demands for a larger reduction and would settle for the 35% cut they got from Fortescue.
However, analysts dismissed the Fortescue deal as a trend-setter. Hu Kai, a Shanghai-based analyst with Umetal Research Institute, told Bloomberg: "Fortescue is too small to be representative in setting benchmark prices." The China Metallurgical Mines Association agrees, pointing out that Fortescue is supplying just 5% of the 345 million long tons the nation's steel mills will be buying in 2009. Also, the Fortescue deal included $6 billion worth of operational financing for Fortescue from Chinese lenders.
BHP Billiton, Rio Tinto and Vale also rejected the new deal, saying they have been selling iron ore into China anyway—either through the Chinese spot market where the spot sales price is $63/metric ton or on a provisional price of about $60/metric ton, based on the Japanese-contract benchmark. (These prices exclude $14–$15/long ton shipping charges from Australia and somewhat higher ocean freight fees from Brazil.)
BHP becomes iron ore price leader
While all this is going on, the largest world consumer of iron ore appears to have lost its position as the trendsetter for world prices with the new pricing arbiter becoming a mining company.
Late this summer, BHP Billiton, the world's largest miner, announced it had settled iron-ore price negotiations with most of its steel industry customers—either on contract terms (at the 33% discount) or in agreements to negotiate prices quarterly based on the spot market and indexed futures markets. This is a breakthrough for BHP and the iron ore industry since spot market prices more immediately reflect high and lower demand. So, the miners would be allowed to more quickly capitalize on upswings in demand while it would allow steelmakers to save when demand is low.
The agreements weaken the decades-old system of settling iron ore prices on an annual basis, which BHP has increasingly criticized as outdated. The "current settlements are indicative of continued progress towards transparent market pricing," says a BHP statement.
Russell Clark, managing director of another Australian miner, Grange Resources, says the existing benchmark system of setting iron ore prices is in disarray and there is a continued push by steel companies across Asia to use market prices. So, while some of BHP's steel customers will still purchase their iron ore annually, more steelmakers are opting out of the system and hoping that they will be able to buy iron ore at below contract prices. As a result, steel prices worldwide may become more volatile as the raw material, iron ore, fluctuates along the lines of supply and demand.
China's demand for iron ore prices had been riding high for several years as steelmaking had expanded to 502 million metric tons in 2008. But, Zou Jian, a consultant for the China Metallurgical Mines Association, says ore imports are falling by 21% this year off the 436 million long tons bought in 2008. He says that's because China is developing more domestic iron ore mines.
But, Baosteel Group, the largest steelmaking assembly of mills, and numerous smaller steel firms have been buying this year at the Asian benchmark price on the spot market or under those provisional price deals with the major mining firms. And now, South Korea's POSCO Research Institute, a unit of the South Korean steel giant, has issued a report stating that the traditional annual contract benchmark system is about to be replaced by various price systems with supply based on spot, quarterly sales and six-month contracts between the mining companies and steelmaker groups.
The United Nations Conference on Trade and Development (UNCTAD) believes the current benchmark pricing system for iron-ore faces an uncertain future, but its successor is not likely to appear any time soon. "The benchmark pricing system is under attack and its future looks bleak," UNCTAD says in a recent statement. A new price setting mechanism will, however, not be introduced overnight. "Instead, it will take several years to find a new model and probably there will be several models in use in parallel."
As for the current Chinese contract negotiations, the outlook is muddled. "The top three miners and the Chinese buyers are unlikely to achieve an agreement this year as both sides are intransigent," says Yu Liangui, director of the research center at the Mysteel consultancy in Shanghai. "And the negotiations for next year also bristle with difficulties." First, the State Council, China's cabinet, has issued a statement backing the plan to have one iron ore price within China as a cornerstone of the 2010 contract talks. But, CISA hasn't yet decided if the negotiations would be for annual or semi- annual contracts.
Mysteel's Yu says another difficult part of the next round of negotiation was whether and how China would insist on a so-called "Chinese mechanism"—in effect, using the Fortescue Metals prices as a reference point. "The China mechanism is just a rough concept, without a clear-cut framework," Yu says. Atop that, CISA lacks communication with other international competitors such as Japanese and Korean steel makers. "It will be difficult for Chinese negotiators to fight in isolation," he tells ChinaDaily.com.
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