August 19,2009

Fortescue's Lower Iron Ore Price Unimpresses the Big Three

By CSC staff, Shanghai

The China Iron and Steel Association (CISA) has finally managed to negotiate prices for iron ore that come in below those demanded by the dominant trio of miners, Australia's BHP Billiton and Rio Tinto and Brazil's Vale, but they are unlikely to shake the giants from their position.

 

Across the table from CISA was sitting Fortescue Metals Group, Ltd. (FMG), another Australian miner, which has promised to implement a unified iron ore price, FOB for powder ore (dry basis) at $94 cents per metric ton unit (mtu), down 35.02% from the previous year's price, and FOB for lump ore (dry basis) at $100 cents per mtu, down 50.42%. These prices are a bit lower than those agreed to between Japanese enterprises and major iron ore suppliers such as Rio Tinto.


But such prices are merely a gesture. FMG accounts for only 10% of Chinese iron ore imports each year. With its production of 20 million tons, only 1/17 of Vale's, 1/7 of Rio's, and 1/5 of BHP's, FMG does not rank among the world's top ten iron ore miners.

 

Although FMG is committed to a unified price, it is not universal. In the Chinese market, the proportion of ore imported on the spot market is as high as 60%, where the price is significantly higher than the regular price of the long-term agreement. Lured by the spread, iron ore producers have a strong rationale to sell at the spot price, and BHP and Rio have increasingly gone that way. In the current iron ore market, lacking excess supply, it is difficult to blame them.

 

The structure of FMG's shareholders may offer some reason for its slightly more reasonable attitude towards price negotiations with CISA.  Last spring, China's Valin Iron and Steel Group picked up 260 million new shares issued by FMG at 1.2718 billion AUD, gaining 17.34% of its stake and becoming FMG's second largest shareholder. Also, a group of Chinese institutions will offer financing of $5.5-6 billion to FMG, which is a typical of loan-for-price deal.

 

The China Investment Corporation (CIC), China's sovereign wealth fund, may also be involved in FMG. It is reported that CIC is negotiating with FMG on purchasing convertible bonds from the latter, but FMG CEO Andrew Forrest refused to answer questions, saying it is inconvenient to disclose details while negotiations are ongoing.

 

This is a new step by CISA, which is trying to draw Rio and BHP back into negotiations. A spokesman from Rio Tinto said that the price agreed between China's steel firms and FMG is not going to set the price level for the whole industry. BHP Billiton and Vale have refused to comment.

 

China is saddled with a vastly fragmented iron and steel industry and the control rights are scattered in the hands of various local governments, always a major factor influencing price negotiations. Japan's iron and steel enterprises are relatively concentrated, making negotiations easier. The Chinese government is promoting mergers and consolidation in the industry, but progress is slow to non-existent due to local government resistance.

 

The final result may be that this year will pass by in endless negotiations. The CISA may bargain with several major iron ore suppliers over next year's long-term price, but that may depend on who ultimately controls the demand of small and medium-sized iron and steel enterprises in China.


The small and medium-sized firms in China do not have the right to import iron ore, so they can only buy ore from dealers or larger enterprises at high prices. Major iron ore suppliers this year have tried to bypass CISA to negotiate directly with the SMEs. The CISA is trying to implement unified national import prices, but the SMEs are opposed.

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