Vale may move to monthly price contracts for iron ore

The commodity market remains rife with rumours that the Brazilian Vale may shift
from quarterly to monthly price contracts for iron ore, with some clients
to start with. Vale, the world’s largest iron ore producer and exporter, says the
market will be the final ‘arbiter’ as to whether this mineral price will continue
to be fixed on a quarterly basis or there will be a shift to still shorter period
contracts. A Vale official meaningfully says, “oil as a commodity is many times
bigger than iron ore. But oil prices are established daily and the market lives
with that. But for the time being our customers are committed to the
quarterly system.” In a not-so-veiled rebuttal to the critics insinuating that the
major ore producers earlier this year arm twisted steelmakers into moving
from yearly benchmark prices to quarterly contracts, CEO Roger Agnelli
says, “Vale is not fixing pries. Who is fixing the price is the
market.”
The second quarter net profits rising sharply from $1.6bn to
$3.7bn and iron ore prices having recovered strongly led Agnelli
to remark, “we are in a very strong position, I should say we are
in the best moment of our history. The scenario is very
positive… We are here to look at the next 20 years and we are
confident that we will sell everything we produce.” The prerecession
glow has returned to Rio Tinto also. It is principally on
the back of iron ore that the Anglo-Australian group could more
than double profits in the second quarter while cutting its debts
drastically. Incidentally nearly 70% of Rio’s profits came from iron
ore business where profit margins are as high as 68%. Rio CEO
Tom Albanese thinks ore at $120 a tonne is the new floor price,
at least for the next few years till mines now under development
get commissioned. “These prices are not permanent. There will
eventually be supply response,” says Albanese.
However good the ore market has now become, mining
groups got themselves in a pickle a year-and-a-half ago when
commodity prices collapsed across the board. But the
experience proved particularly hurtful for Rio since just ahead of
the world slipping into a crippling recession it bought the
Canadian aluminium maker Alcan at top dollar of $38 billion. As
it started living with the draining takeover experience, it also
faced a will-they-won’t-they nerve-wracking kind of takeover bid
from the mightier industry peer BHP Billiton. This became a
story of many twists and turns with Rio first seeing in Chinalco
the white knight and then turning away from China’s leading
resources group to form an alliance with BHP in mining iron ore
in Australia’s Pilbara region.
Rio’s relationship with China became further soured when last
year four of its employees were arrested suspected of espionage.
But if one’s bread and butter is in iron ore then rest assured that
sooner than later, one will make up with China, the world’s
largest importer of the mineral. Rio and Chalco, a Chinalco
subsidiary which with 9% is the single largest equity owner of
Rio, have entered into a joint venture agreement to develop
Africa’s largest integrated iron ore mine and infrastructure
project at Simandou in Guinea.
Let’s consider their compulsions to start working together. In
the words of Rio chairman Jan du Plessis, “Developing our
relationship and business links with China are key priority. This
agreement takes our relationship with China to a new level.” As
for China, Chinalco is state owned. The ownership of 44.65% of
Simandou venture with capacity to raise 95mt (million tonnes) of
ore annually will give a sense of security in supply of steel
industry’s principal raw material.
It is principally on the back of iron ore making a resounding
break from last year’s slump that ore producers are seeing
renaissance in their fortunes. To go by Albanese, minerals and
metals groups should watch out “two big things… One is the
structural defect in the West particularly around sovereign risk.
The second would be how does China maintain the growth of
the economy without over stimulating, but also without making it
— tightening it too hard — that Goldilocks point.”
Because of the sheer size of its steel industry and the volume
of its ore imports, China should be bearing heavily on the
mineral prices. In the first seven months of 2010, Chinese
imports of ore totalled 361.2mt. See this against leading
shipbroker Clarkson’s forecast that global shipments of ore this
year will advance six per cent to 961mt. Ore price movements
are not necessarily in sync with the steel industry’s ground level
reality. Similarly, ore prices have remained strong even while the
Chinese July production of crude steel of 51.7mt was 3.9% down
on June output and August output was also marginally down to
51.64mt. Production is unlikely to rise this month also as Beijing
is pushing for phasing out 35mt of old, inefficient and polluting
steel capacity. Last year, China shut 21.1mt capacity. As against
this, ore producers will argue that Chinese steel production
rising 21.8% to 323mt in the first half was enough justification for
advancement in mineral prices.
But why is not China’s near record inventory of 80mt of ore
at different ports reining in the mineral prices? The big inventory
will suggest that the actual iron ore demand is not growing as
fast as prices. What is also not factored in is the prospect of
property prices in China falling further and the country not
By Kunal Bose in London