According to our coal industry sources, it appears that Australian hard coking coal producers are on the cusp of a stunning +206% increase in contract prices for JFY09. This is above all expectations and would surely make resource bears, who believe this is all a speculator led bubble, reconsider their position. With speculators unable to influence the contract price of hard coking coal, how else can anyone legitimately explain a hard coking coal price rise from US$98t to US$300t other than demand being far greater than available supply?
The answer lies in the fact Chinese and Asian steelmakers can still make wonderful margins despite these huge input price rises as the rate of final price rises they are generating are far greater than the incremental input price rises. This stunning coking coal price rise is telling you what is coming for Australian iron ore. This coal outcome absolutely justifies BHP Billiton's stance in attempting to break down the antiquated and grossly unfair benchmark pricing system.
There is an old Chinese proverb which loosely translated says "a contract is only good if it's in your favour". As experienced Asian businessmen will tell you, the Chinese have plenty of form in reneging on contracts that go against them. This is one of the reasons that BHP greatly reduced the number of Chinese steelmaker counterparties it dealt with a few years ago. They wanted to reduce their counterparty risk to only financially strong and mostly Government backed Chinese counterparties.
However, while this reduced BHP's counterparty risk and ensured they had contracts that stuck (and they got paid), it led to internal profiteering by the Chinese steel mills who did deal direct with BHP at the benchmark price. As the internal Chinese spot iron ore price raced ahead of the benchmark contract price, the steel mills that dealt direct with BHP then "onsold" part of their allocation at the prevailing internal Chinese spot price to smaller steel mills and locked in transfer pricing arbitrage profits. The major Chinese steel mills have made billions via this transfer pricing arbitrage and you can see why they are resisting change to a system they are basically abusing internally for their own gain.
To be fair, there is no doubt that the differential between the spot price and the benchmark contract iron ore price would narrow a little if more volume was sold onto the spot market, but the chart below clearly shows you the arbitrage that the Chinese steel mills who buy from BHP are exploiting. These are profits BHP shareholders (and Australia) should be receiving and you can understand why BHP are pushing so hard to break down this system.
RIV Price at posting:
0.0¢ Sentiment: Buy Disclosure: Held
