Miners braced for 30% drop in iron ore prices

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Sydney: Iron ore prices are set to fall in 2009 after six years of price hikes as deteriorating demand triggers severe production cuts in the steel industry, a Reuters poll shows. The fall will mark an end to a bullish run for miners BHP Billiton, Rio Tinto and Vale which last year secured hefty prices hikes, some of almost 100 percent. The trio control about three quarters of the 800 million tonne annual market in seaborne iron ore.
A Reuters survey of 15 analysts conducted in the last week showed Australian iron ore prices are expected to fall by 30 percent in 2009 annual contract talks. As recently as October analysts were forecasting no change from 2008 prices.
"After six consecutive yearly rises totalling almost 400 percent, iron ore prices are certain to fall due to major collapse in demand," Macquarie analyst Christina Lee said in a research note.
Negotiations between miners and steelmakers to set a benchmark price for 2009/2010 iron ore supply contracts are expected to be fierce, acrimonious and lengthy, as is often the case.
"Even with a 40 percent correction in contract price it will be second highest iron ore price in history and this is one of the worst recessions we've witnessed in 40 years," said Daniel Brebner, global head of commodities at UBS.
Analysts said miners are expected to try to limit a steep fall in the contract price by cutting iron ore output to help balance the market.
But with demand hit so hard in key steel consuming industries such as construction and automotive, steelmakers are likely to have the upper hand.
Analysts said iron ore miners have slashed production to match weakening demand, but not enough to prevent a glut of material.
"You have not seen enough cutbacks on the iron ore supply side," said UBS' Brebner. "We have seen significant cutbacks on steel...that should create a significant surplus on iron ore and thus pressure on price."
The $800 billion steel industry was hit it mid-2008, when the price went into free-fall, forcing steelmakers to cut back production sharply, lay off jobs and shelve investment plans.
Global crude steel production slumped by more than 24 percent in the last quarter of 2008. Rio Tinto's and Vale's iron ore output were down by 18 percent and 21 percent respectively.
Collapsing steel prices and demand have knocked down spot iron ore prices around 60 percent since last March -- making it impossible for miners' to come anywhere close to the near-doubling price hikes they have achieved last year.
Asian steelmills including Japan's JFE and major Chinese mills have said they want prices to fall at least to 2007/2008 levels, meaning Australian iron ore should fall by around 45 percent.
Yet Macquarie estimates that prices will not roll back to 2007/2008 levels as at current levels, already down to $80 per tonne from a high of around $200 last year, they remain quite attractive following output cuts by major miners in China.
The freight differential between Brazilian and Australian iron ore led to a rare divergence in the 2008 benchmark price and escalated discussions on alternative pricing mechanisms.
Miners have been keen to dump the traditional benchmark system and move towards a more flexible pricing mechanism to better align the dynamics of the steel and iron ore markets.
Several analysts believe steelmakers will want to stick to the existing benchmark system as it brings a certain amount of stability amid volatile prices -- the same reason why some analysts think steelmakers could sign up for more flexibility.
"Our view is that it leaves the way open for Australian iron ore producers to push for more hybrid contracts with linkages to benchmarks, indices and spot trades," said analysts at Royal Bank of Scotland.
"From a consumers perspective, this may not be a bad thing because it would enable them to reduce the cost of iron ore if demand falls further, as well as capture some of the benefit of low freight," it said.
In September, Rio Tinto said it was planning to sell more to the spot market in 2009 while BHP Billiton was in favour of moving away from the traditional benchmark towards index-based pricing mechanisms.
The world's top steel producer, ArcelorMittal, said in September that it supported the benchmark system as it provided a certain amount of stability.
Rio Tinto, BHP Billiton and ArcelorMittal were all recently contacted by Reuters but declined to comment.  [03/02/09]