SBB Insight Issue 56 Iron Ore

8/6/2019 SBB Insight Issue 56 Iron Ore

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There is one thing everyone involved innegotiations to settle the 2008 contractprice for iron ore seems to agree on itwill be a protracted process. BHPBillitons takeover move on Rio Tinto is amajor distraction at the moment hardly

surprisingly given the supply and priceimplications of such a merger (seebelow).

The rest of the worlds steelmakers seemcontent to leave it up to Chinas Baosteelto settle the benchmark this year, as it didwith surprising efficiency at the end of2006, when a 9.5% rise was agreed onwith CVRD before Christmas. Resigned tothe fact that prices are more than likely toincrease, steelmakers remain confident ofbeing able to pass the costs on to

consumers.

Chinas share of global seaborne iron oretrade is likely to be close to 380m tonnes

this year - around twice that of Europeand some two and a half times more thanthat of Japan, the worlds third biggest oreimporter. The majority of seaborne tradeis iron ore from Australian and Brazilianminers. Each of these countries supplyabout three times more than India, andship around ten times more ore annuallythan exporters like Canada, South Africa,Russian and Ukraine.

Chinese steelmakers are publicly statingthat they see no reason why the

benchmark ore price should rise, butprivately are thought to be conceding thelikelihood of a 30% hike. Traders in Chinaalready say the steel market is readying

itself for such an increase, and the currentstrength of domestic steel prices is areflection of mills testing the waters tosee if buyers will accept higher steel pricesnext year.

Ex-works steel prices at Chinese mills arehigh and getting higher for nearly allproducts. Semi-finished steel markets,which are the most vulnerable to soaringinput costs, have recovered to hit recordhighs throughout the country and there iscurrently virtually no margin between billetand rebar.

Impact of spot pricesThe iron ore miners will no doubt arguethat the spot price of 63.5% Fe Indian iron

ore fines in China (at as high as $190/tonne cfr) is a clear indication that contractprices should rise. Indian spot prices havemaintained a growing upward trend sincethe beginning of the year, crossing the$100/t level during May and never reallylooking back.

A spot market this firm does not bode wellfor Chinese steel mills, but perhaps theirnegotiating power may improve if new ironore capacity expected on-stream next yearis taken into account.

All the big three suppliers of seaborneiron ore have expansion activities comingto fruition. BHP Billitons (BHPB) rapidgrowth project 3 to increase WestAustralian iron ore capacity by 20mtonnes/year is on target to beginproduction by year end. Rio Tinto will startdelivering ore from a 22m t/y project atHope Downs by the beginning of 2008.And Brazils CVRD says it will add 25m t/yof iron ore production next year, takingoutput up from 300m t in 2007. CVRDs

long term plan is to grow to 450m t/y by2011.

Iron ore prices: fundamentals point only one wayThe proposed merger of two mining giants is something of a distraction to 2008 iron ore contractprice negotiators. Steel Business Briefing describes the market fundamentals and other factorslikely to influence the outcome.

Issue 5617 December 2007

Steel Business Briefing 2007

Welcome to SBB Insight

Steadily rising global steeloutput means greater demandfor raw materials and thelikelihood of price increasesfor iron ore.

Steelmakers would prefer it ifthey didnt go up, butcustomers are assumed to beable to tolerate cost-relatedsteel price increases afterall, iron ore costs have shot upsubstantially in recent yearsand mills continue to enjoygood order books.

But important though theannual iron ore contractnegotiations may be, they arealmost a side issue comparedto the consternation that hasbeen caused amongststeelmakers by the prospect oftwo of the worlds largestminers merging.

If this happens, mills will thenbe talking to a smaller numberof suppliers about a largertonnage of ore and that isnot a position any buyer is

comfortable with.

Editor,[email protected]

More information

China's November raw steeloutput dips below 40m t - Friday,14th December 2007

Siderar will buy more ore, expects25-30% price rise in 2008 -Tuesday, 11th December 2007

Despite expansion, Vale willcontinue buying iron ore - Friday,

7th December 2007

Usiminas not worried aboutsecuring its own iron ore -Thursday, 6th December 2007

Edited by

Paul Millbank

It is increasingly acceptedthat Chinas steelmakerswill remain dependent on

imported iron ore for manyyears to come


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disagree with him, as Chinese millswould prefer to purchase CVRD,Rio Tinto or BHPB iron ore if givena choice between imported materialand domestic concentrates.

Martins joked with delegates that ifthe current situation of iron ore

supply were replicated in the carindustry, consumers would be ableto buy high quality, luxury modelsfor less than the standard offeringsfrom automakers.

Why this analogy? Well 66% FeChinese concentrates sold on aspot basis are currently fetchingaround $150/t including 13% VATon an ex-works basis, while 63.5%Fe Indian iron ore is now peggedaround $188/t landed in China.

Both are inferior in quality to any ofthe big three miners iron ore,

Steel Business Briefing 2007 Issue 56 - 17 December 2007. Page 2

which has remained constant at$50/t fob all year. And even thoughspot freight rates from Brazil havesoared to nearly $100/t, Indianproduct is still more expensive.

Chinas appetite grows

Chinas iron ore imports this yearhave already climbed 17.5%compared with the first elevenmonths of 2006 to almost 350m t,although the growth in imports fromIndia has lagged behind those fromChinas two biggest suppliers Australia and Brazil. Indian exportshave largely been constrained bypoor port and rail infrastructure,and there seems to be no near-t e r m s o l u t i o n t o t h e s eshortcomings.

SBB InsightIron ore prices: fundamentals point only one way

Domestic iron ore production withinChina will also no doubt increasenext year, but the extent to whichg o v e r n m e n t o f f i c i a l s n o wemphasise this as a realisticalternative to imported ore haswaned in recent years. It isbecoming more and more accepted

that Chinas steelmakers who areaiming to grow their product qualityand environmental efficiency willremain dependent on imported ironore for many years to come.

Sales are supply-constrainedAt the most important steelmakingraw materials conference of theyear in Dalian, China at the end ofOctober, CVRD's Jose CarlosMartins summed up the currentsituation: "Import penetration would

be higher if suppliers could supplymore." Few analysts would

BHP Billiton Mt Newman Fines export FOB W Australian port

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Chart 1

Source: SBB

Indian Iron Ore 63%Fe CFR China

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Source: SBB


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What isarbitrage?

Arbitrage is where a trader, broker orindividual sees and exploits smallvariations in commodity prices, or

currency conversion rates or thevalue of other financial instruments indifferent markets. The profit comesfrom buying at one price in onemarket and then immediately sellingthe same commodity in a differentmarket for a higher price.

With currencies, traders will takeadvantage of small differences inconversion rates. Currency exchangerates will also play a part incommodity arbitrage, but the scope

for arbitrage is reduced wherecommodity exchanges in differentcountries use a common currency(such as the US dollar).

Because the variations in values indifferent markets are usually quitesmall, it is necessary to engage in alarge volume of transactions, at lowtransaction cost, to achieve anysignificant gain. Consequently,arbitrage tends mainly to be theprovince of trading companies ratherthan of individual speculators.

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E-mail: [email protected]

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SBB Insight Editor

Paul Millbank

Steel Business Briefing 2007

Title Photos: Corus, ArcelorMittal.

SBB information will be helpful in foreign trade for every

professional company related to steel, like us

Ozgur Karabulut, Trsan Treiler Co.

high prices for Indian iron ore willnormalise as supply difficulties areaddressed.

But skyrocketing Indian pricesreveal, at the simplest level, thatChinese mills have had very littlechoice when it comes to securingtheir iron ore in 2007. Next yearsupply should expand, but what thismeans for prices is less easy topredict.

BHPB/Rio bombshellS t e e l m a k e r s h a v e a l m o s tunanimously decried the merger ofBHPB and Rio Tinto as harmful to

upgraded to 12m t/y of capacity,while Vizag and Paradip ports arebeing deepened to accommodatelarger vessels.

Admitting that facilities are currentlystretched to the limit, MMTCs chiefgeneral manager, William Saldanda,believes India should remain a keyiron ore supplier to China in thefuture. Tirimulai Srinidhi, director of

India's ministry of commerce, sharesthis view and says India will continueto be a dependable supply sourcefor China. Srinidhi believes current

Indias MMTC is leading an initiativeto permit about 3m t/y of exportsfrom the Ennore Jetty near Chennaion Indias east coast, whilerecommencing exports f romKakinada in Andhra Pradesh, andKarwar and Belekeri in Karnataka,has also added a further 7m t/y oftotal port capacity.

Port upgrades at Vizag, Chennai,

Goa, Paradip, New Mangalore andHaldia have boosted capacity from48m t/y in FY02-03 to 93.8m t/y lastyear. Ennore is later going to be

Mark these 2008 Dates:

10-11

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8-9April

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28-29April

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18-19June

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New Indian Iron Ore report

available from SBB

SBB is pleased to release a new report

"Iron Ore: Indias Resources, Global

Dynamics", written by Dr Firoz.

In the last 5 years India has emerged as

the 3rd largest global supplier of spot iron

ore, behind only Brazil and Australia. With

current spot prices reaching almost US$

200 in November, this is a strategic and

vital resource for the steel industry.

Some analyst predict a 25% to 50% year

on year increase in 2008 on long-term

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Current high pricesfor Indian iron orewill normalise as

supply difficulties are

addressed


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the industry. All express concernthat a combination of the twocompanies gives them much morecontrol over pricing mechanisms.

Chinese steelmakers tell Steel

Business Briefing they areconcerned that even though BHPhas proposed to deliver moreproduct more quickly, they wantassurances that the companywould not seek to again limitproduction once the market entereda period of oversupply.

BHP chief executive MariusKloppers, together with his topmanagement, toured Asia toassure steelmakers of the value themerger proposal could bring them.But he doesnt seem to have beenvery successful, for none of thosecontacted by SBB expressed anybelief that it would help them.

The Rio Tinto board, meanwhile,continues to refuse to engage withBHP until it comes back with morethan the 3-for-1 scrip offer on thetable. And as SBB Insight went topress, Rio had asked the UKtakeover panel to issue a deadlinefor BHP to either put up an offer orabandon the proposal. Klopperssays this put up or shut up tactic

Steel Business Briefing 2007 Issue 56 - 17 December 2007. Page 4

would put pressure on BHPB justas it had been hoping to discuss ascheme of arrangement with theRio Tino board, rather than table ahostile bid.

Is indexing the future?Adding more controversy to theiron ore sector has been BHPBsannouncement that it intended tooverhaul the pricing mechanism foriron ore and do away with what itnow labels the unrepresentativebenchmark price. After originallypledging it would seek a freightpremium for its product in 2008, thecompany backed down and insteadoutlined plans to introduce indexed

pricing that better reflects themarket value of iron ore.

Steelmakers are worried thatwithout the certainty of the annualbenchmark price, controllingproduction costs and ultimatelyprofits would become increasinglydifficult. BHPB says it wants toestablish an index similar to thatused to price thermal coal, butopponents of the idea point out thatthe thermal coal supply base is far

more diversified than that ofseaborne iron ore, which isessentially controlled by just bigthree miners and maybe beforelong by just two.

Report prepared byAyesha de Kretser,

SBB Shanghai

SBB InsightIron ore prices: fundamentals point only one way

Indexed pricing betterreflects the marketvalue of iron ore

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SBB Insight Issue 56 Iron Ore