Andrew Trounson | April 21, 2008 IRON ore giants Rio Tinto and...

Andrew Trounson | April 21, 2008
IRON ore giants Rio Tinto and BHP Billiton are set to play hardball with Chinese steel mills and charge spot prices on contracted tonnage if the steel mills do not agree to pay an extra premium on benchmark pricing by June 30.

While it has not been tested, it has always been thought that the Australians have the right to switch contracted ore to higher priced spot markets if annual price talks extend beyond June 30. But with talks now at a standoff, the Chinese mills have complained that the Australians are openly threatening the mills with a potential wholesale switch to the spot market.

The mills do not like it and are warning that such a move would force them to switch to alternative suppliers in the long term.

But in the short term, tight supplies mean the miners have the whip hand, and they are already diverting new production into spot markets.

BHP chief executive Marius Kloppers yesterday said different contracts had different clauses.

But he confirmed that, in the event of no price agreement by June 30, some contracts allowed BHP to shift sales on to spot prices, while on others BHP would be freed of any obligation to deliver.

"On some of them you don't have to deliver at all," he told The Australian.

But Mr Kloppers declined to speculate on the price negotiations or what would happen post-June 30 if there was no agreement. A spokesman for Rio Tinto likewise declined to comment.

But according to the China Iron and Steel Association, Rio and BHP are warning some of China's 16 biggest steel makers that if a price agreement is not made by June 30, they will start charging spot prices.

"Selling the ore under spot prices is irrational. It will hurt demand for the Australian ore over the long term," CISA's head of market research, ChenXianwen, said on Saturday.

Rio Tinto yesterday announced the first delivery of a contracted cargo from its new Hope Downs iron ore mine in the Pilbara, more than four months after production started in November.

While it always takes time to build stockpiles to manage production from new mines, it is believed that initial deliveries from Hope Downs went largely into spot markets.

Rio chief price negotiator Ian Bauert and Rio's Hope Downs partner Gina Rinehart were at Dalian Port in China yesterday as customer Anshan Iron and Steel took official delivery of the first 170,000 tonne contract cargo from Hope Downs.

The 30 million-tonne-a-year mine came into production three months ahead of schedule.

But while the Australians are putting pressure on the mills by ramping up spot sales, the Chinese have also positioned themselves for a long negotiation by building large iron ore stockpiles themselves.

Last month, the Chinese iron ore stockpile stood at 59 million tonnes, or 50 per cent above the two-year average.

The Australians are believed to be seeking a 2008-09 benchmark price increase of about 85 per cent compared with the 65-71 per cent price increase agreed by Brazilian iron ore giant Vale, which in recent years has been the key price setter. But the Australians are adamant that their ore deserves a premium over Brazilian ore given the cheaper cost of freight from Australia to Asia compared to more distant Brazil.

While Chinese spot prices have eased in recent weeks to about $US195 a tonne, the price is still about $US75 a tonne above the landed price of Australian contracted ore even after factoring in the Brazilian price rise.

The new 2008-09 Brazilian contract price came into effect on April 1. Any deal with the Australians will now be backdated to that start date.

A high-priced settlement is particularly important for Rio as it seeks to stave off BHP's $160 billion takeover bid, given it has higher relative exposure to iron ore than BHP.

BHP is currently benefiting from a trebling in hard coking coal prices where it has significantly more exposure than Rio, as well as ongoing strength in oil prices, which is boosting earnings from its petroleum division. But BHP's third-quarter production report, due on Wednesday, is likely to show reduced coking coal, aluminium and nickel production, as it battles floods in Queensland and power shortages in South Africa, as well as a hangover from its Colombian nickel operations strike.

Separately, Rio and partner Ivanhoe Mines may have to agree to the Mongolian Government taking a 51 per cent stake in their giant Oyu Tolgoi copper and gold mine development in that country.

Under a draft proposal, the Government was entitled to a 34 per cent stake, but its parliament is expected to decide in the next two weeks whether the Government should claim at least a 51 per cent stake in "strategic deposits".

Rio is hoping that a final fiscal regime for the project can be agreed before a general election in June.