The beleaguered China Iron and Steel Association will claim victory after wringing a small iron ore price compromise out of upstart miner Fortescue, but there seems little reason to believe that it is any nearer winning the bigger war with the world's top producers.
In an unexpected deal that saw Andrew Forrest’s Fortescue breaking ranks with its much bigger and more established peers, CISA said it had extracted a 35 per cent contract supply price cut versus last year - deeper than the putative benchmark agreed by non-Chinese mills in May at 33 per cent.
But even that extra 2 percentage point discount appears less sweet on closer investigation: Fortescue, which unlike its rivals is part-owned by a Chinese mill and sells only to China, said this morning that a condition of the agreement is $US5.6 billion ($6.8 billion) to $US6 billion ($7.3 billion) in financing from the Chinese side.
Without the incentive of much-needed funding, the dominant three miners Rio Tinto, BHP Billiton and Brazil’s Vale may not be so eager to close that small price gap, especially with spot market prices having surged by 50 per cent since the benchmark was agreed.
Fortescue's output is expected to ramp up to 95 million tonnes in 2010, CISA's secretary general Shan Shanghua said - equivalent to a mere two months of China's import demand.
Fortescue still on top
There are other reasons to think the price settlement is a better deal for Fortescue than the Chinese mills.
Although the Fortescue price is 3 per cent less than that agreed between Asian mills and rival Australian miners, its grade is 8 per cent poorer than the Hammersley fines sold by Rio.
And it also covers only the second half of this year, not the full 12-month cycle through next March as is the norm, suggesting a chance for an upward revision if price conditions remain buoyant on the back of reaccelerating economic growth.
Fortescue shares jumped on the news and were up 17 cents, or 3.8 per cent, at $4.62 in afternoon trade, while BHP shares dropped 80 cents, or 2.1 per cent, to $37.36 and Rio slumped $1.77, or 3 per cent, to $58.22.
Mr Shan said that next year's "actual conditions" will determine whether the Chinese industry continues to seek half-year deals.
Independent foreign suppliers may be unwilling to commit to deals whose term varies depending on the market.
An inflexible, one-year price deal clearly benefits the buyer in a rising market, while a shorter term benefits the seller in a falling market.
Last year, Australian miners broke the traditional system where all mills agree to the price first settled between any one mill and miner, by forcing the Chinese to agree to a higher price at the peak of the market.
Better defined price target
The deal also brings a new degree of transparency to CISA's negotiating stance, which has gradually softened from a 45 per cent or more price cut mooted last autumn - essentially a complete roll-back of last year's doubling in prices - to an ill-defined target of "better than 33 per cent" suggested in July.
CISA now says it plans to use the Fortescue prices as a reference to bring the other miners to a deal, although it's far from clear that BHP, Rio and Vale will embrace the 35 per cent price discount. If they did, CISA might gladly accept the opportunity to save face.
China plans to adopt an "acting agent system" for future imports, and reduce the number of licensed importers, Mr Shan said. He gave no details of the agent system.
CISA's past efforts to limit the number of importer have resulted large trading companies and mills with access to cheaper term ore fleecing their smaller rivals, by selling to them at the top of spot prices.
An even more rigid system that limits their resale margin could encourage bribery and distortions, as mills compete for ore to feed China's severe overcapapity.
Price talks too inflexible
Although all agree that the annual price talks are insufficiently flexible, CISA has adamently rejected BHP's proposal for an indexed price largely because it fears it would not be able to control a freely floating market.
Since there is no futures market for iron ore, as there is for copper and other refined metals, China's distrust of prices compiled by Western banks or industry publications is understandable.
But CISA's attempt to set prices by fiat, in a throwback to the planned economy of China's past, isn't working either.
CISA reputation at stake
CISA's Mr Shan has staked his reputation and CISA's power on his ability to wring out a lower price, implying that the nation's flagship mill, Baosteel Group, had failed to be tough enough in previous years.
CISA's attempt to reassert its power over the Chinese steel industry has alienated many of the country's savvier executives. Chinese media report that at least two executives have been detained, at Shougang Steel and Laiwu Iron and Steel, while four Rio employees were detained in July and arrested last week on charges of bribery and stealing commercial secrets.
The deal with Fortescue also flies in the face of the spot market, which has risen by more than 50 per cent since the Asian term deals were concluded.
It was that spot market rise that persuaded many of China's biggest mills to break ranks with CISA and sign interim deals with the miners.
Reuters
