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Wednesday, July 08, 2009

China faces higher iron ore prices as contract talks stall China

China, the world’s biggest buyer of iron ore, faces the risk of higher cash prices as annual contract talks stall with producers.

Ore for immediate delivery rose to a four-month high of $82.50 a metric ton in the week ended July 3, according to Metal Bulletin. The China Iron & Steel Association has rejected London-based Rio Tinto Group’s offer of a 33 percent cut in annual prices, accepted by Japanese and South Korean mills, and let a June 30 accord deadline lapse.

China’s mills last week signaled they may agree to trim their price demands after imports rose, driving a 32 percent gain in cash prices from an April low. A wrong-way bet on prices could stifle a nascent profit recovery for Baosteel Group Corp. and rivals, forcing them into bidding wars for ore supplies.

“If spot prices move for a sustainable period of time to levels higher than the contract prices for 2009-2010 set with South Korea and Japan, the willingness to hold out for a better outcome by the Chinese steel mills will lessen significantly,” said Tim Schroeders, who helps manage the equivalent of $1 billion at Pengana Capital Ltd. in Melbourne.

Rio Tinto, the world’s second-biggest iron ore exporter, fell 1.6 percent to A$48.80 at 12:29 p.m. Sydney time on the Australian stock exchange. BHP Billiton Ltd., the world’s third- largest, dropped 2.2 percent to A$32.69.

Brazil’s Vale SA, the world’s biggest, has said it’s waiting for Australian producers to set prices with China before concluding its own agreements.

Supplies will tighten and cash prices gain, should other markets, such as Europe and Japan, recover this half, said Tom Price, a commodities analyst at Merrill Lynch & Co. in Sydney. “Then China will probably start to panic because Rio, BHP and Vale will probably start switching their tons to the contract levels they’ve secured with Japan, Korea and with Europe.”

China’s mills, who had demanded a cut of as much as 45 percent, are ready to discuss a reduction of between 33 and 40 percent, Caijing magazine reported last week. They’re aiming for an agreement by the end of this month and want Rio to consider contracts that run for less than a year, Tian Zhiping, vice president of Hebei Iron & Steel Group, said this month.

“A compromise could be struck in which Chinese mills agree to the same terms as Japan, if miners concede quarterly or semi- annual price revisions,” Peter Richardson, Melbourne-based chief metals economist at Morgan Stanley, said in a July 2 report. “Failing this, Chinese mills would have to risk the spot market price.”

This is the first year in at least a decade that Rio hasn’t agreed to prices with most customers by June 30, a deadline when some contracts can revert to prices for immediate delivery. China, which overtook Japan as the biggest buyer of iron ore in 2003, has cited domestic stockpiles, loss-making mills and an oversupply of steel, in resisting the Rio settlement.

Implied prices for ore to China, excluding freight costs, are at their highest since September 2008, Macquarie Group Ltd. said today in a report. Japanese and South Korean mills have agreed to pay about $61 a ton for the contract year, which begins April 1. That’s still the second-highest on record.

Cash prices tracked by Steel Business Briefing are also trading near a four-month high of $77 a ton. The cost of freight for ore shipped from Australia to China was about $18.30, according to SSY Futures Ltd.

“The pressure on the Chinese was always on after the Japanese and the Koreans settled,” said Prasad Patkar, who helps manage the equivalent of $930 million at Platypus Asset Management in Sydney. “They seem to be capitulating now that spot prices are firm and idled steel making capacity around the world is being brought on line.”

To be sure, cash prices will struggle to move above $80 a ton for a sustained period in the absence of “a major positive surprise from non-Chinese demand, which for the moment remains elusive,” Goldman Sachs JBWere Pty analysts Malcolm Southwood and Paul Gray said in a June 30 report. The broker, who flagged the introduction of a possibly more flexible pricing system, estimates that the spot market accounts for about 30 percent of the annual global seaborne trade.

“Rio Tinto has long been a supporter of the benchmark system but if customers choose to buy on the spot market instead they will,” Rio spokesman Gervase Greene said by phone on June 29. “BHP’s negotiations are continuing and the company declines to comment further,” Kelly Quirke, a spokeswoman for Melbourne- based BHP said June 30.

Talks are continuing, Ding Shouhu, chief iron ore negotiator for Shanghai-based Baosteel Group Corp., China’s biggest steelmaker, said June 30.

“Mills and suppliers may reach agreements through private negotiations,” said Zhu Limin, an analyst with Shanghai Securities Co., who doesn’t expect spot prices to extend gains because of the stockpiles in China. “That would make it hard for the mills to predict production costs.”
Source: Bloomberg