Energy & Resources

Iron willed

Foreign mining giants – and not China’s steelmakers – win through

Iron willed

Sparks flew, but producers profit

“China is emerging on the global stage with unprecedented power and influence,” in the view of David Shambaugh of George Washington University.

The New York Times agrees. Over the past year it believes history has been “fast-forwarded” with China emerging as a superpower faster than anyone thought possible, pushing its own agenda on everything from climate change to sanctions (or the lack of them) against Iran. It is insisting on getting its own way – just ask Google executives.

But there is one glaring exception. The limits of newfound power and influence have been exposed by three companies – and the laws of supply and demand.

Despite thinking that it could control the market for iron ore – it buys 70% of the stuff that gets shipped internationally – China has crucially lost the battle to dictate its price.

That was the big news on Tuesday, with the announcement of the end of the ‘benchmark system’ – which the big three mining firms wanted abolished.

It brought to a close a longstanding clash – which had dragged on for nearly 18 months – that China had expected to win. Instead it was outflanked.

At the start of 2009 China demanded the price for iron ore be cut 50% from the previous year. The big three miners – BHP-Billiton, Vale and Rio Tinto – offered a reduction of just 33%, to $61 a tonne.

The China Iron and Steel Association (CISA) baulked, claiming the price was unreasonable. Talks that were supposed to conclude last March dragged on. Neither party could agree on the ‘contract price’ – the fixed price to be paid for iron ore in the year ahead. It was the first time in 40 years that a contract price could not be set.

But with the spot price of iron ore on an upward trajectory – it rose above $100 per tonne by the summer – Chinese steelmakers were soon ruing CISA’s negotiating style. They were left considerably worse off by not having taken the $61 per tonne deal that they’d been offered earlier in the year. The stalemate (an increasingly acrimonious one) led to BHP calling for a rethink on the entire ‘benchmark system’.

On Tuesday, BHP and Vale came up with a new approach. Rather than agree an annual price, they will set the price of ore each quarter, based on an average of the spot price over a pre-agreed period. Rio Tinto is expected to do likewise. The Financial Times described it as “historic” and quoted a mining executive: “The benchmark system has ended. There is no comeback.”

What will this mean for China? In the near term: considerably higher prices. The new price-setting system will lift the cost of ore – shipped between April and June – to $120 a tonne. Prices for succeeding quarters could well be higher, since the spot market hit $150 a tonne on Tuesday.

Chinese steelmakers have already indicated they may have to raise prices by around Rmb300 per tonne – that would mean steel at Rmb4,300 per tonne. And part of that price rise will get passed on to industrial consumers – not a pleasant prospect since the government already has serious worries about inflation.

Even with customers paying more, higher ore prices will still hurt the domestic steel industry. According to the Economic Reference newspaper, China’s 1,200 local steelmakers made a combined profit of Rmb69 billion ($10.1 billion) last year. If the price of iron ore doubles – as spot prices indicate is possible – that will add Rmb91 billion to their costs, and wipe out the industry’s fragile profit margins. A senior manager from one of China’s biggest steelmakers predicted a tough time ahead. Steel enterprises will have “almost no hope for profits”, he told the Xinmin Evening News.

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