Iron-Ore Contract Prices Up on Chinese Price-Cap Talk

CAPE TOWN (Business Day) -- Iron-ore contract price negotiations have heated up this week, with rumours that the Chinese government has issued an unofficial directive to cap the prices paid by domestic steel makers.

The world's biggest iron-ore producers are BHP Billiton [NYSE:BHP; LSE:BLT, Companhia Vale do Rio Doce (CVRD) [NYSE:RIO] and Rio Tinto [NYSE:RTP; LSE:RIO]. Iron ore is a major export earner for Australia and a major export earner for South Africa, too, accounting for about 10%, or R3.4 billion ($508.8 million), of base minerals exports in 2004.

Annual price increases for iron-ore supply contracts take effect from April 1 each year. Last year the price rose 71.5% and the resulting squeeze on steel makers' margins, and a predicted slowdown in Chinese steel manufacture, was expected to make price negotiations hard this year.

Suppliers have been lobbying for another price increase, while steel makers have pushed for a decrease. The China Iron and Steel Industry Association forecast recently that growth in China's production of crude steel would slow to 10% from 24.6% last year.

But Brazil's CVRD said at a conference this week that Chinese demand for iron ore in January suggested the country's demand would rise 20% this year.

Last year, China bought 43% of global iron-ore shipments. Goldman Sachs said in a note to clients that China's share of world shipments this year was expected to be 45%.

CVRD CEO Roger Agnelli said on Tuesday that China was taking a tough line but prices could not be set arbitrarily.

Wire services reported this week that Chinese traders and shipping officials were capping Australian iron-ore imports at $54/tonne and Brazilian and Indian product at $70/tonne.

Numis Securities analyst John Meyer said the negotiations could become political. If negotiations remained unresolved, the issue could come up for discussion at next month's meeting of the Chinese and Australian prime ministers. But if all participants took a hard line and supplies to China were disrupted, it could cause Chinese producers to cut production or close smelters, which could be expensive and damaging to the industry.

Meyer continued to recommend Rio Tinto and BHP Billiton as "buys" because of their sensitivity to iron-ore prices and the potential for a positive settlement in this year's negotiations.

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