In summer 2008, with spot prices of iron ore reaching historic highs of near US$200 per ton, China’s steelmakers agreed to a record 96.5% price hike for contract iron ore with mining giants Rio Tinto and BHP Billiton.
The steelmakers’ timing could not have been worse. Now, they are locked into long-term agreements at prices well above those available on the spot market.
"They have been doing everything they can in the past few months to not honor those [contracts]," said Paul Bartholomew, an analyst with Steel Business Briefing, an industry research house.
At the same time, demand for steel is drying up at home and abroad. Chinese steel product exports decreased by 36% in November. Steel mills have responded by cutting output, but Bartholomew says firms like Baosteel are still sitting on huge stockpiles of finished products.
A welcome boost?
Beijing hopes its stimulus package, which puts an emphasis on infrastructure spending, will provide a much-needed boost to related industries. But activity on the ground remains limited, according to Stefan Kracht, director at Fiducia Management Consultants, a firm advising Western investors in China.
"There’s a lot of hubbub around railroad and other infrastructure [projects]," he said. "We have not seen any indication … that any new orders or even request-for-proposal processes are under way."
However, Kracht is confident things will turn around once the stimulus package kicks in. With prices that have fallen so dramatically, he notes that it has become a buyer’s market for raw materials. Unfortunately, few buyers have enough cash and banks are reluctant to lend.
Low commodity prices will have the positive effect of reducing cost pressures for manufacturers. Producer price inflation hit 2% in November, down from a 6.6% rise in October. The World Bank expects a further deceleration in year-on-year raw material price growth into the first half of 2009.
Those kinds of expectations could prove helpful for steel makers as they attempt to renegotiate their expensive early contracts. Fidcucia’s Kracht notes that especially with BHP Billiton’s abadonment of its hostile bid for Rio Tinto, the latter company especially is open to talks.
"At Rio, BHP and Vale they have become softer in their stance. A year ago, they would not have renegotiated, but today they’ll be willing," he said.
This willingness is due, in part, to pressure from Beijing, but it may not be enough to get the 82% reduction in ore prices requested by the China Iron and Steel Association. Bartholomew believes a reduction of at least 25% is realistic.
Companies to watch: Angang Steel (0347.HK) has been hard-hit by high contract ore prices. Renegotiated prices could help, but Angang’s practice of buying raw materials on the cheap from its parent could limit potential benefits.
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