The China Iron and Steel Association (CISA) in July took the drastic step of calling for limits to be imposed on steel mills’ access to imported iron ore. While such curbs would be an effective – if blunt and potentially damaging – solution to the industry’s overcapacity problems, this might not have been CISA’s primary objective. The association, locked in negotiations with Rio Tinto, BHP Billiton and Vale over the annual iron ore contract prices, was piqued that smaller private steel mills were going behind its back and striking side deals with the miners.
CISA rejected the initial 33% price cut offered by the big three miners, as it hoped to secure a bigger discount. But the delay has left steel mills in a bind: Keen to meet demand created by Beijing’s stimulus package, they are paying through the nose for iron ore from the spot market. As of August, the spot price was 40% above the contract price agreed by Japanese and Korean steel mills.
The smaller Chinese mills’ decision to make direct deals with miners may have been as much about thumbing a nose to CISA as saving money.
"CISA represents mostly large mills rather than small mills," said Hubert Tang, a steel analyst with UBS Securities in Shanghai. "That’s why the smaller mills wanted to reach a deal with the mining companies directly."
They may get away with it, too, as there is no evidence to suggest that limiting access to iron ore would actually work. Graeme Train, Asia research manager for market research company Steel Business Briefing, argues that allowing CISA to regulate iron ore supplies and pricing would open the door to more corruption. Unlicensed steel mills would inevitably try to arrange better side deals with licensed importers.
If CISA wants to control access to iron ore, analysts argue, it should get rid of the iron ore contract pricing system, allowing steel mills to make all their purchases on the spot market. It would be more transparent and only mills that could afford the spot market price could buy iron ore. If mills wanted to stabilize their input costs, they could buy hedging contracts.
There would be one additional benefit: Mills that could not pay for iron ore would be forced to close, helping Beijing to clean up overcapacity in the industry.
"High iron prices would knock out steel production, and the subsequent year things would correct to a level that can support the demand for steel," said Thomas Wrigglesworth, head of regional metals and mining at Citi in Hong Kong.