Ironing Out The Issues

By Kishori Krishnan Exclusive To Iron Investing News

With key indicators across developed economies showing an improvement in the quarter, mining heavyweight BHP Billiton Ltd has teamed up with rivals Rio Tinto Group and Posco, Asia’s most profitable steelmaker, in raising iron-ore production.  An uptick in demand from automakers and builders has ensured a good camaraderie between the trio.

The steel market is also set to expand by 9.2 per cent in 2010, on rising demand from the US, Japan and Europe, according to the World Steel Association. A report from the Association added that given the increase in demand, Posco is also planning $30 billion of overseas expansion in India, Indonesia and Vietnam to regain its spot as Asia’s largest steelmaker.

What has also aided sentiment is the rise in output by both BHP and Vale. For the largest mining company, BHP, fiscal second-quarter iron ore output rose 11 per cent to a record high. Output of the ore, the company’s biggest earner in fiscal 2009, was 32.45 million metric tons in the three months ended December 31, up from 29.4 million tons a year earlier, BHP said in a statement.

Citigroup Inc has added BHP to its “most favored” stocks on January 18, citing growing output.

Last week, Rio Tinto, the second-largest iron ore exporter, reported a 49 per cent gain to 47.2 m tonnes in the fourth quarter. Rio’s total iron ore sales, which include stakes in its operations held by third parties, rose to a record 61 million tonnes in the fourth quarter, with calendar 2009 sales reaching a higher than expected 217 million tonnes.

Also, last year, both Rio and BHP had agreed to an Australian iron ore joint venture that, is expected to save the duo at least $10 billion. The venture is expected to be completed in the second half, Rio said last week.

Chinese demand

What has helped pump demand? Hot-rolled sheet prices in China, the largest consumer of steel, have gained 15 per cent since the end of September, as the nation’s $586 billion stimulus spending boosted demand from builders, automakers and manufacturers of appliances.

“During the December quarter, we saw strong price recovery across the commodity suite driven by demand in China and restocking in the developed world,” BHP said.

China’s exports rose 17.7 per cent in December and US manufacturing expanded at the fastest pace in more than three years, boosting demand for raw materials and London metal prices by 18 per cent.

The Anglo Australian mining group Rio Tinto has continued to reap the benefits from strong demand from Chinese steel mills.

Vale too sold a record 110 million metric tons of the raw material to Chinese buyers in the first nine months of 2009 and intends to keep this year’s sales to China little changed from 2009 levels, the company has said.

Volatile times

But things are not all that rosy, despite the fact that contract iron ore prices under negotiation with steel mills are forecast by analysts to rise as much as 40 per cent this year.

With several customers moving to prices linked to the spot market, there is enough evidence to show that the old mechanism to set annual prices for iron ore is losing its relevance in the current scenario.

Johan Rode, a mining analyst at Citigroup in London, says that, excluding freight, iron ore prices averaged $82 a tonne in the spot market in the second half of last year, 36 per cent above the $60 a tonne level at which the annual contracts were settled.

For more than 40 years, the first price agreed between a miner and a leading steelmaker set a benchmark that was followed by the rest of the industry for a year. But Since 2007 however, the traditional “benchmark system” has been under pressure.

Analysts in China say BHP has recruited many new Chinese customers over the past year or so, charging them prices tied to the spot market. Though Vale and Rio Tinto continue to sell the bulk of their ore production at annually settled prices, Rio is also increasing its spot sales, analysts add.

However, Vale’s Ferrous Minerals Director Jose Carlos Martins told reporters that the company expects to reach a “mutually interesting solution” with its Chinese iron-ore buyers in 2010, after “overcoming” 2009’s stalemate.

“This year’s going to be different,” Martins said. “Vale’s relations with its Chinese clients are very good. We have more than 120 clients spread over all Chinese provinces.”

Last year, talks between global miners and China over the 2009-10 annual benchmark got heated. China was adamant in demanding a bigger iron ore price discount than the amount agreed with Japanese steelmakers. Even two months ago, the China Iron & Steel Association told Vale, Rio Tinto and BHP Billiton that it would be taking a harder line and would not accept anything less than a discount `China price’ compared with Japan and other countries.

Hu Kai, an analyst with Shanghai consultancy Umetal.com, has predicted CISA might get its `China price’ after all, but it would be higher than everybody else’s. “Japan and Europe stick to contracts and China imports all from the spot market,” he said. “That means China will pay a different price to every shipment.”

A situation that could well unsettle the market price.

Ironically, the tense situation over pricing could well benefit Canadian producers, say some analysts.  Not only can Canadian producers look forward to around 12 per cent jump in prices, junior resource firms can also expect to see their share price increase on speculation over asset sales, analysts have said.

There is another catch to the story. The discovery of 5 billion tonnes of new iron ore reserves in 2009 could place China ahead in the race during this year’s benchmark price talks with foreign suppliers, but some term the new iron ore finds “more rhetoric than substance.”

Analysts’ concern

“The speed of recovery in the developed economies remains uncertain,” Paul Galloway, a Sanford C Bernstein Ltd analyst in London, wrote in a note, adding: “particularly considering the eventual withdrawal of government stimulus. We expect some degree of volatility. While we share some of BHP’s short-term cautions, we remain positive on the mining sector in the medium term.”

BHP fell 75 pence, or 3.6 per cent, to 2,005 pence at the close of London trading on Wednesday. The shares gained 0.2 per cent to A$ 43.41 in Sydney.

Speaking about Rio, James Wilson, Perth-based resources analyst at DJ Carmichael, said it was unclear how much of Rio’s iron ore was being sold on the spot market.

“At these prices, there is some big money to be made. Rio is in an expansion phase and in the next few years they should go over 300m tonnes [of iron ore a year].”