July 08,2009

A Looming Panic for Iron Ore by China's Steelmakers

By CT Johnson

In what can only be seen as a tragedy for China’s steel producers, the China Iron & Steel Association’s (CISA) comedy of errors culminated on June 30 with the passing of the traditional June 30 deadline for reaching agreement on iron ore benchmark pricing.  In the absence of a deal, Chinese steelmakers must now look to the volatile spot market for their supplies.

Ore prices reached a four-month high of $82.50 per ton during the week of July 3 according to Metal Bulletin.  With no other place to acquire ore, China’s mills have turned to imports, which showed a 32% increase in cash prices from lows in April.  Falling stockpiles are forcing the country’s steelmakers into a bidding war that threatens to derail the industry’s fragile profit recovery.

As the June 30 deadline for an agreement came and went, China’s mills have begun making independent moves to secure their ore supplies.  Two weeks ago, mills in the Shanxi region entered into separate agreements with the three largest producers for 50 million tons of ore. 

"Mills and suppliers may reach agreements through private negotiations," said Zhu Limin, of Shanghai Securities Co. "That would make it hard for the mills to predict production costs."

Because of CISA’s inability to reach a compromise and agree on a long-term price for ore, more steelmakers are likely to follow suit.  This would put further pressure on the domestic market and increase distribution channels available to the large producers.

"Then China will probably start to panic because Rio, BHP and Vale [the three largest ore producers] will probably start switching their tons to the contract levels they’ve secured with Japan, Korea and with Europe," said Tom Price of Merrill Lynch & Co.

"If spot prices move for a sustainable period of time to levels higher than the contract prices for 2009-2010 set with South Korea and Japan, the willingness to hold out for a better outcome by the Chinese steel mills will lessen significantly," said Tim Schroeders of Pengana Capital Ltd. in Melbourne.

CISA, who is responsible for negotiating long-term ore supply contracts for China’s steelmakers, has consistently misjudged the market and the negotiating position of the major overseas producers.  In contrast to the business acumen shown by the nation’s mill owners in building China into the world’s leading steel producer, the CISA negotiators have been caught flat-footed at every turn.

CISA’s problems started with a negotiating position they could not support ?namely, the threat that they would walk away from any deal that did not meet their demand for a 40% reduction in ore prices.  As the world’s largest ore consumer and home to an economy expanding at a mind-bending rate of 8% per year, China was never in a position to forego a basic input needed to fuel its economic growth. 

The trade association’s position was further undermined by its failed attempt to regulate the ore spot market, the opening of an iron ore trading center in Rizhao, and the agreement by Japanese and Korean steel mills to accept a 33% reduction in long-term ore prices.

"The pressure on the Chinese was always on after the Japanese and the Koreans settled," said Prasad Patkar of Platypus Asset Management in Sydney. "They seem to be capitulating now that spot prices are firm and idled steel making capacity around the world is being brought on line."
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