With the acrimony of this year’s iron ore contract negotiations still fresh in the memory, China and the Big Three miners – Rio Tinto, BHP Billiton and Vale – are about to lock horns over prices for 2010.
The 2009 talks, though protracted, never reached a satisfactory conclusion as the China Iron and Steel Association (CISA) refused to budge. Chinese steel mills were left to buy their iron ore on the spot market at a time when prices were on the rise. Few analysts are willing to bet against a repeat performance this time around.
“It will take a long time to come to a satisfactory agreement because at the moment China’s steel production is too high and its iron ore imports are too big,” said Dr Xu Zhongbo, head of Beijing Metal Consulting.
The miners are likely to ask for a price increase, but strong Chinese demand – reflected by the continued rise in spot prices – isn’t the only driver. They also want to protect their profit margins against unfavorable movements in the foreign currency markets, according to Thomas Wrigglesworth, head of metals and mining at Citi in Hong Kong. The rise in the value of the Australian dollar against the US dollar means that Rio Tinto and BHP Billiton both need a 17% increase in the price of iron ore if they are to match their 2009 profits.
The Big Three will probably negotiate with Japan’s steelmakers first. The yen has appreciated against the US dollar this year, which means Japanese mills can absorb an increase in iron ore prices while keeping a lid on production costs. Once a benchmark has been set, the miners are likely to offer the same price to CISA. As with last year’s negotiations, that price is not likely to be accepted.
“Last year, CISA has said ‘we’re the good guys, we can do it’ and they got egg on their face,” said Michael Komesaroff, principal with Urandaline, a mining consultancy. “Not to come up with a reduction is going to be very hard for them politically and internally. I’d be very surprised if there is an agreement.”
CISA is projecting that excess steel inventory will limit the growth of steel demand to just 5% in 2010 to the 19% this year. Yet the organization is asking for fixed-term iron ore contracts stretching from January 1 to December 31, with mills that put in big orders receiving big discounts. Analysts say this approach is a tell-tale sign of an impending rise in steel demand.
“If you’re a miner you don’t really want that, because if the Chinese want that it means demand is going up,” said Wrigglesworth. “[What the miners] don’t want to do is limit their upside. So I don’t think that’s going to happen.”
CISA’s position isn’t helped by accusations that it is out of touch with the demands of the steel mills. Xu of Beijing Metals suggests that the organization is so removed from reality it thinks it is still living under a planned economy.
Matthew Whittall, Australian resource analyst with brokerage CLSA, added: “The problem with CISA is that CISA is not a steel producer. I think the iron ore miners want to deal with a steel producer, someone who is involved in the market and has a better understanding on price.”
Those with a more direct connection to the steel industry, such as executives with China’s largest state-owned metals trader China Minmetals, say that steel mills should look to sources other than the Big Three. Steel mills appear to have answered the call: Of the US$31.18 billion China spent on overseas M&A for the year through August, 29% was channeled into Australian mining deals, according to Dealogic.
This diversification strategy is helpful, but it’s no big fix. The second-tier iron ore miners Chinese firms are targeting cannot supply iron ore of the quality and quantity that steelmakers need; only the Big Three can meet these demands on a consistent basis. Chinese mills are therefore bound to the larger miners, regardless of the fraught contract negotiations.
“[Steel mills] will stick with companies that have a good reputation and a product they like to use,” said Citi’s Wrigglesworth.