Oh how good it must feel to be an Iron Ore exporter. After all...

Oh how good it must feel to be an Iron Ore exporter. After all the dirty tricks by the Chinese I hope FMG just goes spot at up to $130te.

From The Australian

.Spot market for iron ore may sink contracts Michael


WHAT if they held iron ore negotiations -- to set the terms of an estimated $20 billion worth of trade between Australia and China this year -- and nobody came?



That is the scenario now being posited by former BHP Billiton China chief executive Clinton Dines, a 20-year veteran of the company and China, who stepped down last year.

"It's a monstrous waste of time," Dines says.

He says there is a fair chance that no one will negotiate and, like last year, no benchmark price will be reached between the Australian iron ore providers and China's steel mills.

As senior executives from BHP and the two other iron giants, Rio Tinto and Brazil's Vale, which share an effective oligopoly on high-quality iron ore, prepare to face down increasingly aggressive Chinese steel mills, prices are soaring again for the red dirt that it is essential for China's massive urbanisation and infrastructure programs.

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Related CoverageSteel glut tipped to worsen Herald Sun, 3 Nov 2009
Rio pedal to the metal The Australian, 7 Sep 2009
Fortescue sets price with China Courier Mail, 17 Aug 2009
Ore negotiations continue Perth Now, 12 Aug 2009
Crackdown fuels price The Australian, 10 Aug 2009
.End of sidebar. Return to start of sidebar.
China's biggest steelmaker, Baosteel, has publicly admitted that producers will seek a price hike of up to 30 per cent this year, a rise that it says it will not be able to accept.

But in the week since the group offered its views, things have become worse for the Chinese.

Spot prices for iron ore are now 84 per cent higher than the contract price agreed with Japan in May last year.

They are up 20 per cent this month alone.

The seaborne market for iron ore is genuinely tight, Goldman Sachs JBWere analyst Malcolm Southwood says in a client note this week.

" Seaborne trade is expected to grow by over 100 million tonnes this year, which is twice the average growth rate seen during the past five years," he says.

"Supply will inevitably catch up, but probably not until 2011. We expect supply and demand to be much more closely aligned from 2011-12 with potential for an oversupplied seaborne market from 2013-14.

"But 2010 should be a very good year for the suppliers."

After bitter negotiations last year, the China Iron & Steel Association ultimately turned down the top three iron ore giants' offer of a 33 per cent cut on the 2008 price -- an offer Japanese and Korean steelmakers were prepared to accept.

The Chinese later signed a deal with Australia's No 3 producer, Fortescue, to cut the price by 35 per cent, but it meant little because no agreement could be reached on price with the major producers, forcing steel mills to buy their iron ore on the volatile spot market from individual miners.

Now China is making a last-ditch attempt to corral its mills behind Baosteel, which will lead negotiations again this year after CISA failed last year in its first attempt at heading the talks.

But the market seems, like last year, to be moving almost deliberately against it.

"While the supply/demand dynamics for seaborne iron ore are genuinely tight, other factors have contributed to the rally which has pushed spot prices above $US125 a tonne," Southwood says.

"The sustainability of recent price gains depends on many things, not least the ability of Chinese steel mills to pass through higher raw material costs.

"With prices for both steel products and metallics now rising across all major regions, spot iron ore prices should remain well supported in the short term."

The situation means that China is facing the possibility that it will fail to negotiate a price for iron ore in 2010 for the second year running, potentially costing it billions of dollars and forcing its steel mills into a price rise of 30 per cent or more with Australian producers, who are increasingly reluctant to engage in benchmark negotiations they view as anachronistic.

Only about 60 per cent of iron ore sold to China last year was done so at "contract" prices.

"The benchmark system as we knew it is dead," Dines says.

"It has got a stake through its heart and it's still staggering around but it's dead; the sooner the buyers realise this, the better for everyone in the system."

Last year was the annus horribilis for the annual iron ore talks, which, in a continuing volatile economic situation, look like a throwback to the smoke-filled rooms of yore.

Still smarting from the eye-watering price jump of 70 per cent from 2007 to 2008, which topped off seven consecutive years of price hikes, China wanted to leverage the global recession and demanded a price cut of 45-50 per cent last year.

Its steel mills could not make money, it moaned when talks began in March.

Yet by May they were in profit and the country -- boosted by its government's multi-trillion-yuan stimulus package -- continued to buy record amounts of ore.

The benchmark system was dreamed up four decades ago by the Japanese, who the ruled the market for years, as a way to keep the Brazilians supplying the far-off Asia-Pacific.

This was to give the buyers an alternative to the Australian oligopoly of BHP and Rio. Contract prices were all FOB (free on board), which meant it cost Australian producers; they gained no advantage for having far cheaper freight rates due to their better proximity to the market.

Freight can cost Vale $US4-$US30 extra per tonne, but under the contract system, all producers get the same price.

Preparation for the talks has tended to commence late in the previous year -- in November or December.

A buyer would pick up the phone and ask to talk prices. Not too many years ago it was the Japanese, then the world's biggest steelmakers, who would make the call.

A team would board the plane from Australia to Tokyo and the process would start.

For decades it was a buyer's market and prices deteriorated over time until 1999 when supply started getting tight as a major new buyer -- China -- emerged. The first shock came in 2004 when the basic laws of supply and demand saw a spectacular 70 per cent jump in the price. BHP wanted more, but the buyers baulked. Australian producers caved in to their demands but put major expansion projects on hold and on go-slow.

"The system has cost the Chinese billions," Dines says.

"By creating such a kerfuffle in 2004 they stopped low-cost producers investing in more capacity. By being short term and bloody minded they encouraged the expansion of high-cost capacity and effectively promoted the spot market, where high-cost producers sell their iron ore. They shot themselves in the foot."

BHP has long advocated a move away from benchmark pricing to index pricing based on averaged spot prices and has been quietly striking its own deals with Chinese mills. Rio has been more committed to the system, but things are changing.

Instead of trying to make peace with its suppliers, China has taken the other tack, committing billions of dollars of investment to developing high-cost iron ore alternatives in Australia and South America.

While there was great gnashing of political teeth over the proposed increase in Australian mining investment by Chinese mining group Chinalco -- never a direct customer of the sector -- China's largest steelmakers are now openly throwing their cash at plans to build alternative supply lines. But these are long-term projects of three to five years that will end with the development of iron ore producers at a higher cost than the major players.

"The Chinese obsession with trying to argue the iron ore price on a short-term basis from year to year rather than taking a strategic perspective to encourage the expansion of low-cost iron ore capacity has been a major contributing factor to the situation they find themselves in year after year," Dines says.

"This mostly reflects a lack of experience in global commodities markets and a slightly suspicious xenophobia, which has prevented the relationship between suppliers and end-users being more civil and productive."

It doesn't help China that its steel sector is also in a state of flux. An overhaul, long desired by the government and big players, finally seems to be under way due to economic imperatives rather than government edicts.

As the miners and the mills contemplate talks, there are two other major elephants in the room. This week, four Rio executives, including Australian Stern Hu, will find out whether they are due to face trial soon -- six months after they were arrested on industrial espionage and bribery charges -- or be given another few months in their Shanghai prison. The arrests put the final nail in the coffin of last year's talks.

And the BHP-Rio iron ore joint venture in the Pilbara that the miners say will save them $10bn -- a deal loathed by the Chinese -- continues to move ahead.

This year, the Chinese are likely to find the Australian companies aligned at long last, and that may well be enough to torpedo the benchmark system forever.