Monday, April 13, 2009
Monday, 13 April 2009
China's steel mills are locked in annual price talks with foreign iron ore suppliers, with demand for the raw material slowing for the first time in over a decade, pointing to the possibility of the first price cut since 2002. Following is background information about the negotiations. HOW IT WORKS
Instead of relying on commodity exchanges, the world's top three iron ore suppliers and their major customers gather at the end of each calendar year to determine free on board contract prices for deliveries made in the following fiscal year (April 1-March 31).
Australia's BHP Billiton and Rio Tinto, together with Brazil's Vale, control around three-quarters of the global iron ore export market, putting them in a strong position to dictate terms.
Insiders say the negotiation process remains largely informal and bound by a "code of honour". However, both sides have routinely accused the other of bad faith and sharp practice.
The three major suppliers have been accused of behaving like a cartel, setting prices only once a year and forcing the import-dependent Asian market to pay 15 percent more than Europe.
To improve China's negotiating position, the government expressly forbade others from making their own deals, entrusting all negotiations to Shanghai-based Baoshan Iron and Steel. China's biggest steel producer has been the exclusive representative of the country's steel mills since 2006.
If the three mining giants constitute an oligopoly, China's steel firms are an oligopsony, the source of almost half of worldwide iron ore export demand. But until this year, they still haven't been able to influence prices in their own favour.
Convention dictates that once one steel mill agrees a price, that price is then accepted by all.
In 2005, Chinese steel firms had no choice but to acquiesce after their counterparts in Japan agreed to a 71.5 percent price increase, and there have been calls for China, Japan and Korea to work together at future talks.
The negotiations normally begin in earnest in December and can last until the April deadline or beyond. Last year, Baosteel's final settlement with BHP was not secured until July, and the talks could be just as protracted this year, according to Shan Shanghua, secretary of the China Iron and Steel Association.
China became the world's biggest iron ore importer in 2002, when its steel mills were still signing individual supply contracts or buying on the spot market. While China's spot market remains the world's biggest, with ore from domestic producers and from India, contracts and collective bargaining are now the norm.
China only became fully involved in the talks in 2005, effectively replacing Japan as Asia's leading negotiator.
Since then, it has fought hard during tense and protracted discussions with the three giants, but in the end, with supplies tight and spot prices soaring, the country's steel firms have had little choice but to tolerate one big price rise after another.
In 2005, China was alleged to be turning expensive Australian iron ore away from its ports in order to improve its negotiating position, contravening World Trade Organisation rules.
Similar accusations arose last year, when Chinese executives grumbled about the "outrageous" demands of foreign miners before eventually accepting a rise of up to 96 percent from the two Australian firms.
BHP Billiton and Rio Tinto broke with Vale in order to charge a "freight premium" on Chinese, Japanese and South Korean consumers, thereby taking into account the relative proximity of Australian iron ore to Asia's eastern coastline.
Vale had earlier agreed a hike of 65-71 percent and failed in a bid to bring that into line with the Australian shipments.
This year the global economic crisis has given extra clout to China's steel mills. They are pushing for cuts in the range of 40-50 percent, and with spot prices already down by a similar margin, China might just get its way, analysts say.
Normally, Rio Tinto and BHP Billiton are expected to supply iron ore at last year's prices until negotiations are completed. But the position of the miners has weakened so much that both companies have agreed an interim price cut of 40 percent with their Chinese customers, according to media reports.
There might have been no other option. According to the China Iron and Steel Association, China's steel mills have only been paying 60 percent of the agreed 2008 contract prices over the first three months of the year and are pushing the miners to backdate any negotiated price cut to January 1.
While iron ore sales to the United States and Europe have been virtually wiped out by the economic crisis, imports to China reached a record high of 46.7 million tonnes in February and even more is expected in March. But end-user steel demand is expected to remain weak and analysts still anticipate the first benchmark iron ore price drop in seven years.
Shan said last week he expected the talks to last until May "at the most optimistic", and they might not finish until July.
Desperate economic circumstances are likely to put the big three suppliers under pressure to give way to China on price cuts or risk losing out in one of the few markets still showing signs of life. But if no price agreement is secured by July, China will once again be at the mercy of the spot market.