Monday, July 20, 2009

WSJ: Industry Pushes New Iron Ore Pricing Plan - Quarterly Rather than Annual

We just talked about the iron ore industry last week [Jul 11, 2009: NYT - China, Australia: Where Iron is Bigger than Gold & Oil] so this is an interesting development. Apparently, instead of the annual negotiation that used to be good enough in the "old days" when prices of commodities were not being shifted +/- 10% on a weekly basis by computer speculation on the behalf of hedge funds and investment banks - market conditions change so rapidly now that the industry is considering a move to quarterly pricing. And of course as we wrote last week, China demand is pretty much driving the entire market now.

The upshot? Much like the wild swings in oil [Jul 7, 2009: NYT - Swings in Price of Oil Hobble Forecasting] are creating havoc for any long term planning in industries that rely on it, I could see this creating a lot more uncertainty in industries that rely on steel i.e. autos for example. That said, less of our economy is about "making stuff" and more of it is about speculating on said movements (i.e. pushing electronic paper around in millisecond movements to create profit) so I guess it's not that much of an issue for most US companies anymore. Steel usage is sooOooOoO 1970s.

As an aside it sets up an interesting conflict between Vale (VALE) and BHP Billiton (BHP) - the latter prefering shorter term contracts and the former longer. Rio Tinto (RTP) which is the 3rd of the "big 3" in mining has not ventured an opinion.
  • The world's biggest miners and steelmakers are on the brink of forging a new system for setting iron-ore prices that is expected to increase the volatility of steel prices, but perhaps make the process more transparent.
  • The new system would set iron-ore contract prices on a quarterly basis -- rather than annually as it is currently. Quarterly sales of iron ore -- used almost exclusively to make steel -- is likely to mean global steel prices will be more volatile.
  • Theoretically, steelmakers would pass on any lower prices to their buyers (yeh right!) and raise them in the reverse. They also might be likely to rely more on market supply and demand, and less on secretive criteria, as currently is the case.
  • Miners and steelmakers are in a battle for power for control of iron-ore prices. Over the past few years, the commodity boom has given most of the power to miners, who constantly raised prices. But since the global economy slowed late last year, steelmakers, particularly in China, have been pressuring for lower prices.
  • Last year, steelmakers were locked into annual pacts when the price of iron ore fell. The spot price of iron ore is about $80 a metric ton, compared with this time last year when prices topped $120 a metric ton.
  • Steelmakers are betting the price will continue to fall, and so prefer longer-term contracts. Likewise, big buyers of steel, such as auto makers, prefer longer-term agreements when prices are favorable because it allows them to rely on a predictable amount of steel coming into their plants, ensuring efficient operations.
  • For miners, the proposed changes may make profits fluctuate. But in the long run, the short-term pacts could shake out high-cost ore producers.
  • Ian Ashby, chief of the iron-ore division at Australia-based BHP Billiton, the world's largest miner, says lower-cost producers of iron ore, such as his company, function better in a quarterly system.
  • "The spot market is where buyers and sellers meet to find the true market price for iron ore," said Mr. Ashby, quoted in a transcript from a bank-investors meeting in Australia in May. "From my perspective it should be clear to everyone that the changed market dynamics, created by China's voracious appetite for iron ore over the past five years or so, makes obsolete a system whereby pricing is locked in for 12 months, based on little or no transparency."
  • BHP Billiton has been pushing to abolish the current iron-ore pricing system. Brazil's Vale S.A., meanwhile, has lobbied to keep the current annual contracting system. Brazilian ore is more expensive than Australian ore, so is at a disadvantage in spot pricing. Rio Tinto, based in the U.K. and Australia, which sells about half of its iron ore on the spot market, hasn't taken a strong public stance.
  • The agreement could be in place as soon as year's end, according to miners and steelmakers involved in crafting the deal. To be sure, the pending changes are not a panacea. There likely will still be a fair amount of secretive dealing.
[May 17, 2008: WSJ - Fast Rising Steel Prices Set Projects Back]

Long BHP Billiton in fund; no personal position

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