Iron men must steel themselves for change

March 29, 2010

The mad tussle continues. Another iron ore conference has passed without a resolution to the increasing chaos in iron ore pricing.

At the annual AJM Global Iron Ore & Steel Forecast Conference in Perth participants articulated wide-ranging views on the future of pricing.

BHP Billiton was consistent with its continued push for index pricing as its president for iron ore, Ian Ashby, explained that market-based pricing brought transparency and risk management tools to the market.

He noted that there were now three independent reference price providers, enabling the development of an iron ore swap market.

In response to a question on rumoured pricing settlements, Ashby replied that the company was currently in pricing negotiation season but would not confirm any settlement.

To be sure, the company's recent coking coal price settlements confirm a consistent strategy of shorter term market-based pricing for all of its products.

FMG's Andrew Forrest avoided getting drawn into a discussion on price levels and pricing mechanisms, and the company is likely to follow its previous policy of being a price taker. This policy was interrupted briefly last year when it settled a benchmark price 3 per cent lower than Rio Tinto's 33 per cent settlement with Nippon Steel in May. 

However, because this price was linked to a financing deal which fell through, the price settlement failed to gain traction.

Rio Tinto Iron Ore's chief executive, Sam Walsh, said that Rio Tinto would continue to support benchmark pricing "if it reflects market fundamentals".

The company would offer various pricing mechanisms including spot, long-term contract, and index pricing, which raises the question of whether or not there is any chance of establishing a new uniform pricing system. Moreover, if a company's product is sold in the same market but at different prices, there must be the potential for both confusion and frustration on the part of those customers who happen to buy at higher prices than others.

This situation can get increasingly contentious the more that spot and benchmark prices diverge. If, as happened in 2008, the spot price is double the benchmark, one steel mill can be at an enormous disadvantage to a mill that can buy at the lower price.

If, for example ,the spot price is $US190 a tonne and the benchmark price is $US90 a tonne, an additional supply of 1 million tonnes of benchmark cargo is worth an extra $US100 million in value to an end user.

Hence, one can only imagine the enormous pressure applied to iron ore sales people by customers to provide the cheaper tonnage. One could further speculate that such a dilemma could provide the incentive to end users to wine and dine suppliers in order to please them. While it should not be assumed that this would necessarily lead to bribery, the possibility cannot be discounted. If the cause for this perennial difference between the spot and benchmark price is not addressed, such sustained temptation for people in the industry will persist.

It is therefore important for the big suppliers and buyers to step forward and implement one system. Vale has recently signalled a more flexible approach to pricing, presumably hinting at a gradual departure from benchmark pricing.

While it looks like a consensus may be emerging for the three suppliers to move to quarterly pricing, we will continue to have the problem of daily spot prices sharply moving away from longer-term prices due to spikes in demand, albeit not as serious as under an annual settlement system.

As industry observers foresee tight markets for years to come the continual price disparity will get worse before it gets better.

Therefore, the industry must work together and agree on one system: annual, quarterly, or daily spot, but not all three.

Clinton Dines is a former chief executive of BHP Billiton China. Philip Kirchlechner was Hamersley Iron's chief representative in Shanghai in the 1990s and Fortescue Metals' head of marketing until 2006. He is now a consultant to mining companies.