News Room - Steel Industry

Posted on 19 Mar 2008

China and M&A drive ore pricing revolution

Iron ore prices around the world have been settled in the same cosy way for a good half-century. 

One of the three dominant miners, which between them control almost three-quarters of the global market – Rio Tinto, BHP Billiton, both Anglo-Australian, or Brazil’s Vale – would agree the price for long-term contracts with their steelmaker clients and that would be taken as the industry benchmark.

There are clear signs, however, that this traditional model is now falling apart.

Cracks have appeared over the past couple of years, as Chinese steelmakers, led by Baosteel, have taken on the lead role in global pricing negotiations with the iron ore miners, after decades of dominance by Japanese groups, led by Nippon Steel.

In 2005, the first cracks appeared when Chinese millers took the lead in negotiations and agreed to a 71.5 per cent price increase, an historic jump away from previous price stability.

But amid the frenzy of Chinese industrial expansion, the miners are convinced they can do even better if they have more flexibility to raise prices quickly as demand rises.

One sign of that trend is the growing tendency for customers to buy iron ore on an ad-hoc basis on the spot markets.

Spot prices jumped last week to an all-time record of $210 a tonne, between $50 and $75 higher than current contract prices.

Now, the mergers and acquisitions drive in the mining industry – with BHP attempting to buy Rio and Vale angling for control of Xstrata, the Anglo-Swiss miner – is providing the final push to end the traditional benchmark contract system.

Indeed, this year’s contract talks are still open.

Vale, the world’s largest iron ore producer, last month agreed price rises for long-term annual contracts of up to 71 per cent.

Normally, Rio and BHP, the second and third-largest producers, would have followed suit within days.

That has not happened, however.

With less than a fortnight to go until the April 1 date for the introduction of a new contract, the Anglo-Australian groups are still holding out for more.

This year’s negotiations point to the companies’ different priorities as they navigate their multi-billion dollar takeover deals. When Vale settled with its customers last month it was on the verge of launching a takeover bid for Xstrata and needed some good news to boost its share price and clinch the deal on favourable terms.

Vale also wanted to give its bankers certainty on its earnings for 2008 so they would agree to finance the Xstrata bid. In contrast, Rio is in no hurry to settle.

The group is fighting a $140bn (￡69.4bn) hostile takeover bid from BHP Billiton and is trying to convince investors that its future prospects – and pricing power – are much better than the stock market has given it credit for.

Since BHP announced its acquisition plan in November, Rio has been notably aggressive in its pricing policies, abandoning its natural inclination towards caution.

Sam Walsh, head of Rio’s iron ore division, said recently that the group was “sitting tight, waiting for the market to recognise the fundamentals”.

While BHP takes a back seat in the negotiations this year, possibly so as not to antagonise the Chinese government, Rio risks alienating China, its main customer, by pushing for higher contract prices and tripling its sales in the lucrative spot market.

There have even been suggestions that one way for China to retaliate against the Anglo-Australian miners’ aggressive tactics would be through a counter-bid for Rio Tinto.

Indeed last month, Chinalco, the Chinese state-owned mining company, surprised the market by buying a 9 per cent stake in Rio, a move which many saw as a prelude to a full bid.

On balance, however, analysts believe that is a non-starter. Damien Hackett, metals and mining analyst at Canaccord Adams, says: “They would not be allowed to do it, [Australia’s] Foreign Investment Review Board would stop them.”