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Big Discount in Iron Ore Price Can Hurt Steel Companies.

It’s a buyers market in the iron ore sector and Asian steel mills are pushing for the largest annual price cuts in history, but they are unlikely to seek prices so low that they hurt supply in the medium term.

Mining and steel analysts expect a 40 percent or less reduction in term ore prices, given weak demand for steel, the sole use for iron ore, and the massive increases that the big miners — Vale, BHP Billiton and Rio Tinto — pushed through over the past five years.

The biggest year-on-year cut previously was around 19 percent and modest by comparison, Jorge Beristain, head of Americas Metals & Mining Research at Deutsche Bank, said.

But cuts of up to 80 percent in ore prices, as a few in the market speculate, would affect miners’ ability to expand new production capacity three to five years out and set the scene for even bigger price rises than occurred over the past years once the economy and demand recover from the current crisis.

“Just like in real estate, it’s clearly a buyers market in the iron ore sector,” Beristain said. “But it’s equally important to realize that if the steel mills push too far, they’ll impair medium-term prices.”

If the world’s leading steel mills are unwilling to commit to a price for ore that the miners say they need to open new mines and boost capacity, the steel mills may face an ore supply shortage and much higher prices in the near future.

He added that Baosteel, which typically leads negotiations with iron ore miners for the Chinese steel sector, will unlikely push prices so low that it would put local miners, which are less efficient high-cost producers, out of business.

Deutsche Bank is forecasting up to a 30 percent cut in the price of iron fines — ore in small particles — and a 40 percent cut in pellet prices.

In November the world’s biggest steel mills in China, Japan and Europe began annual negotiations behind closed doors to set term prices for iron ore over the following year, which begins in April with the Japanese business year.

“Mills want to settle negotiations sooner as they are paying peak prices right now due to their contracts,” Paul Cliff, head of metals and mining at Nomura’s London offices, said. “Spot ore prices out of India are at around $70 a tonne, up from $65 in November.”

Asian steel mills committed to pay roughly between $91.85 a tonne for Pilbara ore fines out of Australia and $76.75-$82.60 for fines from Brazil in their term price contracts hammered out last year.
Vale and the Australian miners managed to raise prices 65-71 percent and 80 percent, respectively, for Asian mills, after spot prices reached nearly $200 a tonne earlier in 2008.

Nomura is forecasting roughly a 40 percent cut in ore prices, but Cliff said the recent recovery in the spot market suggested the cut could turn out slightly less than thought.

A major Canadian investment dealer that covers the mining and steel sectors is expecting a 15 percent cut in term ore prices. The dealer declined to be named.

Pedro Galdi, analyst at Sao Paulo traders SLW Corretora, said he considered a 40 percent drop in prices possible “given that people are already talking about an 80 percent cut,” but he expects a cut of around 15 percent as most likely.

“The ore stockpiles in China are being depleted — there was 60-65 million tonnes at the end of the year — but now the spot market is rising, which is positive and shows the market is turning around slowly,” Galdi said.