False victory

China/iron ore: China wants to treat a deal with Fortescue Metals as a precedent. The Chinese Iron Ore and Steel Association (CISA), a government body leading the country’s annual price negotiations, insists the Australian miner’s new contract — at 35% lower prices from last year’s benchmark — should be used as a reference for settling the remaining contracts. But top suppliers BHP Billiton, Vale and Rio Tinto are unlikely to be persuaded into a price-match.

Even the stated price represents a retreat for CISA. True, it is a three percentage point larger drop than the benchmark reductions already agreed elsewhere in Asia. But it’s a long way from the 45 per cent reduction CISA was originally looking for before a commodities rally pushed the iron ore spot price well above even Fortescue’s agreed price.

While CISA can be pleased to have signed up a below-spot contract, there’s a catch. The agreement is conditional on “Chinese financiers” supplying Fortescue with up to $6 billion of debt finance by the end of September “on terms acceptable to Fortescue”. With no further details, outsiders can presume that what is attractive to Fortescue is costly to the Chinese. It sounds like an expensive way to try to get a better price out of the big three, which control 75 per cent of the sea-borne iron ore trade.

But China may also have longer term objectives for this deal. The financing will help Fortescue expand the Pilbara assets in western Australia and ramp up production from 31 million tonnes in the past twelve months to a target of 95 million tonnes by 2012. That will provide what China sees as vital competition in the market following a joint venture agreement between BHP and Rio to consolidate their regional operations.

Of course, it’s difficult to put a tangible long-term value on the benefit of shoring up alternative iron ore suppliers, particularly as BHP and Rio intend to continue to operate separate marketing arms under the joint venture agreement. But for now at least, China’s deal with Fortescue is unlikely to push its larger suppliers into slashing prices.