AGO option's discussion, page-439

Australian Financial Review reported that the gaping delta between the prices paid for high grade and lower grade iron ores should ease in coming months as Chinese steel mills increase their use of lower grade products, according to analysts. The price gap between 58% iron ore and the 62% iron ore index has ballooned in recent months, robbing Australian lower grade producers of some of the upside from the rally in iron ore prices during the March quarter.

During the three months to March, the price for 62% iron ore averaged USD 85.52 per tonne, compared to an average price of USD 52.96 per tonne for 58 per cent iron ore. On Thursday the delta was USD 29, with the products at USD 65 and USD 36 respectively.

Chinese steel mills have been motivated to buy higher grade iron ore to maximise production as the price for coking coal, also used to make steel, soared and regulators restricted steel production during winter due to pollution concerns.

Fortescue Metals Group, which sells its product off the 62% price but at a discount, achieved a 76 per cent realisation of the index price in the March quarter with an average price of USD 65 per tonne

Chief executive Mr Nev Power said the "inelastic" market for higher grade ore meant the buying behaviour drove up prices for the product but argued the delta was not "structural" and was likely to normalise in the second half of the calendar year.

_Junior miner Atlas Iron managing director Cliff Lawrenson said if the company could keep its costs in the low $50s per tonne, it would make a fair margin once the gap narrowed._

Mr Lawrenson said that "It seems the discount will come off as the headline price reduces. If we are assuming an average price in that $US60 to $US65 range, that will return to us in Australian dollars, once we return to a normal value in use type discount, as something in the $70s per tonne."

AME Group chief economist Mr Mark Pervan said Chinese steel mills' return to lower grade iron ore was already noticeable in the turnover in port stocks, which built as the mills favoured high-grade product.

Mr Pervan said that "Back in the fourth quarter when coking coal prices spiked the steel mills moved quickly to higher-end iron ore because they needed to be producing quite a lot of steel at that time.”

He said that "Whereas now they are just pulling out of the market and drawing down [port stocks] because they are not too worried about producing too much steel. That is why you are seeing the drawdown in port stocks and it is one of the reasons the spread is coming in between 58 and 62 [per cent]."

UBS commodities analyst Daniel Morgan said while he agreed the current discount was not sustainable, largely because UBS expected coking coal prices to cool, China's crackdown on polluting steel mills was "a more sustainable threat"

Hope this helps the SP