The manipulation of iron ore prices

Who does fix the prices of iron ore? Steelmakers across the globe, but particularly the ones in China hold the triumvirate of Vale, BHP Billiton and Rio Tinto responsible for manipulating ore prices to its advantage. The trio in control of three quarters of global iron ore trade is eminently placed to do so. But whether any of the three or all of them together indulges in moving the market to producer advantage will remain a subject of never-ending debate.

Leading ore producers fell foul of steelmakers earlier this year when they virtually arm-twisted the latter in accepting quarterly price contracts, jettisoning in the process the nearly four-decade-old annual benchmark price. Steelmakers may still be nursing wounds over the system change, but the fact is quarterly contract rates are a faithful approximation of spot prices in preceding three months. Moreover, it is not going to be a one-way street. For instance, in reference to Platts’ index prices, iron ore contract prices for the October-December quarter should see a fall of 11 per cent to $129 a tonne. That will mark the first price decline since the new contract regime began three quarters ago.

 

Should not this be taken as validation of Vale chairman Roger Agnelli’s riposte to critics that “Vale is not fixing prices. Who is fixing the price is the market.” Of the big three, Vale with the largest iron ore portfolio is in the centre of controversy as speculation is rife that it could be trying to sell monthly price contracts to some of its clients. Whatever its pricing idea, Vale will do better without a controversy that may upset China, the world’s largest importer of iron ore.

Vale, as we know, can hope to get better access to China provided it could do something about high transportation cost. Iron ore originating in Brazil loses much of its competitiveness in Far-Eastern destinations vis-a-vis Australian mineral since in the case of the former the freight element is $35 a tonne. In an attempt to compete better with BHP and Rio in China, Vale is to acquire 16 very large carriers with capacity of 400,000 tonnes each to trim freight by 30 per cent. Interestingly, 12 of these carriers are to be built at a Chinese shipyard. Vale will be using all its diplomatic skills not to upset China, while still pursuing its goal of getting the best return from iron ore sale.

By way of pouring cold water on the controversy, a Vale official said, “As far as the price system is concerned, we just came from a one-year price system to a price that is established quarterly. So, it was a big improvement from one system to the other. We need a system that can cope with volatility and we believe the quarterly system can do that. We are very optimistic about the new system. We believe the quarterly pricing system will stay.”

The statement may or may not have assuaged the feelings of wary Chinese. But can this be taken as the final word on the subject? Doubts arise as the official did not rule out “adjustments” in pricing if “volatility remains high in spot market”. Significantly enough, citing the case of oil, he said oil prices were decided daily and the market would live with that. What adds a twist to the simmering controversy is the government-owned China Minmetals saying that all the three global minerals majors are likely to sign monthly iron ore price agreements with Chinese steelmakers. In a display of its frustration with the new ore price regime, Minmetal says as the ore market has become more complex, the index is open to manipulation. It further makes the observation that the present system is fraught with risk of breach of contract, as contract prices are “often higher than spot prices.” All this is confirmation that the balance of pricing power has shifted in the miners’ favour.

Even then, if there is a sneeze in the Chinese steel industry, there cannot but be a reaction in the spot ore market. In the wake of Beijing asking smaller but energy-inefficient mills in Hebei and some other provinces to cut output by up to 70 per cent, iron ore spot prices have slid to their lowest in seven weeks with no signs of Chinese demand picking up any time soon. China is reining in steel production with urgency to meet a five-year energy efficiency target by 2010.

An Indian exporter says the setback in the spot market may also have something to do with China doing everything possible to boost domestic iron ore production. China’s August ore production was up two per cent to 99.58 million tonnes. More significantly, as a Reuters report says, China’s ore production has tripled in the last four years. The frustrating factor, however, is the halving of iron content of ore to 20 per cent. Moreover, since the majority of Chinese mines are underground, the cost structure is very high.