Throwing a spanner in the steel price works won't help
Yesterday, China's Ministry of Commerce broke cover and declared it was monitoring the mainland's imports of iron ore for unfair pricing. The announcement comes a week after officials quietly imposed price caps on ore imports from Australia and Brazil in what represents a blatant effort to interfere in pricing negotiations between ore exporters and China's big steel mills.
Most of China's iron ore imports are purchased under long-term supply contracts. But because spot prices for ore can be volatile, contract prices are renegotiated each year when a new benchmark price is set for the following 12 months.
In past years, China's steel producers have been content to go along with the prices negotiated by Japanese and European steel producers with the big three mining companies - Brazil's Companhia Vale do Rio Doce and Australia's Rio Tinto and BHP Billiton.
In February last year, however, Chinese steelmakers were outraged when Japan's Nippon Steel agreed to a 71.5 per cent price increase with Companhia Vale do Rio Doce, setting the benchmark price for the rest of the industry. This year, as the world's largest ore importers, a group of mainland steelmakers led by Baosteel has insisted on taking the lead role in global price talks with the miners.
The Chinese steel companies desperately want a cut in the ore price. After massive investment in production capacity, China's mills turned out 350 million tonnes of steel last year, up 28 per cent from 2004. As a result of the glut, prices for their finished product have collapsed by more than 30 per cent over the past 12 months.
Unless they can secure cheaper ore imports, their profitability will be threatened. Earlier this month, Baosteel announced its earnings for last year were flat, after a 65 per cent increase in 2004. Last month, Angang New Steel issued a profit warning.
Even so, China's steel firms may still have to swallow a price rise. According to Harry Banga, vice-chairman of the Noble Group, China's demand for imported iron ore is likely to hit 275 million tonnes this year, up by 42 million tonnes from last year.
The ore suppliers have been investing in new capacity to meet Chinese demand, but digging new mines or expanding old ones takes time and supplies remain tight. 'Given the supply-demand equation, ore prices should go up,' says Mr Banga. 'The question is: By how much?'
Judging by spot market prices, the answer could be: Quite a lot.
Under last year's contract prices, Chinese steel firms are paying about US$49 a tonne for Australian ore (including freight rates) and US$60 for Brazilian ore. In contrast, Chinese buyers are paying about US$70 a tonne for Indian ore on the spot market, up from US$65 in November.
The high spot price is at least partly due to two recent cyclones which temporarily halted shipments from Western Australia's ore-producing Pilbara region. Even so, Beijing appears anxious not to allow the mining firms to cite Chinese steelmakers' willingness to pay high spot rates as a justification for raising long-term contract prices.
This fear would seem to explain Beijing's apparent imposition last week of a price cap of US$54 a tonne on spot market imports of Australian ore and US$70 on ore from Brazil and the ministry's warning about unfair pricing.
Whether Beijing can succeed in its heavy-handed attempt to hold down next year's contract price for iron ore is doubtful. Jim Lennon, the head of commodities research at Macquarie Bank, is forecasting a 15 per cent rise. He points out that past attempts to influence the price negotiations through public pronouncements have failed dismally.
Last year, for example, Guy Dolle, chief executive of European steelmaker Arcelor, threw out suggestions that the ore price could rise as much as 50 per cent as 'absurd'. In one way, of course, he was right. Prices actually went up 71.5 per cent.