Are the days for the long-honoured single benchmark system for iron ore over? The outright rejection of the 33 per cent cut in ore fines prices that Rio Tinto has agreed with Japanese steel makers for the current season that began in April, shows that the wind is blowing strongly against the consensual reference price.
Halving of steel prices in the wake of the global economic meltdown made last season’s benchmark iron ore prices grossly irrelevant and steel makers everywhere turned more and more to the spot market for their immediate and future requirements of the raw material. Mining groups also had to contend with the fact that responding to major falls in demand for both construction and auto grades of steel, ArcelorMittal and the rest shaved production by anything between 30 and 50 per cent.
But why did Japan, which saw its steel production slipping by as much as 42.9 per cent in the first quarter of 2009 to 17.6 million tonnes, made the deal with Rio when China is relentless in putting pressure on miners to cut prices of fines by nothing less than 40 per cent. The China Iron & Steel Association (CISA), which is conducting ore price negotiations on behalf of the country’s major mills, is, however, targeting a price reduction of 50 per cent.
Did Nippon Steel, JFE and Sumitomo Metal give in to pressure from miners or were they driven by a desire to replace the Chinese from the main negotiating table? None of this. Japanese steel makers could not have waited any longer as the jousting between China and miners showed no signs of ending too soon. The Japanese need to know the ore contract prices for doing their budgets. Now in the post Rio deal, they can work out steel prices for their customers.
Posco’s decision to go along with the 33 per cent cut in benchmark prices is not surprising. However, it will be virtually no dice for the benchmark prices worked out between Rio and Japanese groups till China comes on board. This needs some explaining.
China currently consumes nearly half of the world ore production and it is unarguably a market of strategic significance for the global mining groups as also for India, which finds in that country an outlet for over 100 million tonnes of ore, says RK Sharma, director general of Federation of Indian Mineral Industries.
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Which other country but China could raise crude steel production, marginally though it was, to 127.4 million tonnes in the first quarter of 2009 when world steel production was down 22.8 per cent to 263.7 million tonnes. Our own production fell 7.9 per cent to 13.2 million tonnes. But China is under pressure to cut steel production costs where 48 producers posted losses of 4.35 billion yuan ($637.4 million) in the first quarter.
What is also stacked against ore exporters is that in the four months to April, China imported 188.5 million tonnes of the mineral, a rise of 22.9 per cent from a year earlier. The country also has the comfort of an inventory of nearly 80 million tonnes of ore. It is, therefore, likely that the pace of imports will taper off in the coming weeks.
China factor and low world steel production besides, when some of the big mines expansion programmes of Rio, BHP Billiton and Vale, launched in boom times, get completed, there will be supply overhang in iron ore. That can only drive down prices.
The one factor that undermines the bargaining position of China vis-a-vis the mining groups is the reported sharp fall in domestic ore production. Chinese ore deposits being particularly low in iron content but with high traces of silica and alumina, these require washing, sizing and benefication and also blending with good quality imported mineral.
This explains why the Chinese ore production costs are high. Not surprisingly, therefore, the recent major falls in spot ore prices have reportedly led to the closure of about half the mines in China. This will also explain its recent large ore imports.
Why should CISA give its seal of approval to the just concluded benchmark deal which gives Rio a $5 premium on one tonne of ore to the delivered China spot price? The issue for China is whether it can let go off the benchmark system assuring stability in long-term supply in favour of spot deals which are reflective of market fundamentals.
General bullishness in commodities alone could not have scripted an unbroken rise in ore prices since 2002, including a 96 per cent jump last year unless China’s imports had quadrupled in the same period. So expect China to have the last word on price issue.