Sea-change

Iron ore: China looks cornered by a shift in the iron ore pricing system. Miners BHP Billiton and Vale have persuaded Asian steelmakers to accept quarterly prices for iron ore, moving closer to ditching the decades-old system of negotiating annual fixed-price contracts. China, which consumes around half of global iron ore, may complain. But its hunger for the commodity means its power to act is limited.

The move is a big symbolic victory for BHP, which has campaigned over five years for a move to shorter-term pricing. In the second half of last year, BHP sold 46 percent of its iron ore on short-term reference pricing, which includes spot sales and quarterly contracts. New agreements with a number of customers in Asia mean that short-term prices account for the majority of BHP's iron ore sales volumes.

Vale has traditionally been a stronger supporter of the benchmark system. Yet as spot prices have reached $150 per tonne - two and a half times higher than the last benchmark agreement by with the Japanese in June 2009 - the Brazilian miner has been more open to change.

The miners argue that index-linked pricing brings transparency to a traditionally secretive process, and will help to develop the nascent market in iron ore futures. Yet it is easy to see why Chinese government officials object. Price volatility makes it harder to plan long-term investment in new steel mills. When supply is tight, quarterly prices are also likely to mean that the country's mills will pay a higher price than they would have done under the annual benchmark system.

Yet in reality the benchmark system has been on its way out for some time. Steel mills around the world last year failed to honour their contracts when spot prices plummeted beneath the benchmark. China did not agree a benchmark contract at all after failing to secure a lower price than the Japanese.

If Rio Tinto follows BHP and Vale's lead, it will be hard for China to set its own benchmark: the three miners control 80 percent of sea-borne iron ore. That is bad news for China in the short term. However, supply should catch up with demand in the longer term. When it does, the quarterly pricing system will benefit the steel mills over the miners.