Iron ore prices is a unique determinant of where commodity prices are headed. Iron ore does not have a futures market. Its demand and supply are negotiated on a yearly basis. The sellers would sit down with major buyers to agree on the price for the next twelve months. The speculation element is largely removed from the negotiations. Its a pure interplay of demand and supply.
A couple of months back, the Chinese agreed to a heft 90% odd price increase for the next 12 months. Oil prices have led a tumble on commodity prices over the past few weeks. However what we have now was a surprising move by Brazilian miner Vale which attempts to increase term iron ore prices by 20%. Steel industry sources in China confirmed on Thursday that Vale had emailed Chinese customers a day ago to announce it would charge 20% more for iron ore effective September 1, an exceptional mid-cycle increase in prices that are normally agreed on a full 12-month basis. That was an exceptional request because its a mid-term increase.
The Chinese are balking at Vale's audacity of course. That would bring the increase in Brazilian ore in line with the bigger rise that Australian miners won in July, heaping more margin pressure on an industry struggling to pass on higher raw material costs to end-users. China's top mill, Baosteel, which takes the lead in negotiating term ore prices for all Chinese mills, is consulting with the government on an appropriate response after Vale approached it in mid-August. Chinese mills declined any officially comment on the demand. Japan's Nippon Steel on Thursday also declined to comment about whether it had also been approached for a price hike. South Korean steel maker Posco said it had not had further negotiations with Vale since it completed negotiations in February .
A sharp fall in freight rates, which has made long-haul Brazilian shipments relatively cheaper compared to nearby Australian cargoes, gave Vale the opening it needed to push for the additional increase. Chinese mills have some cushion to stave off Vale's demand, with stocks in Chinese ports hovering above 60 million tonnes - about one month's consumption. Nonetheless, mills can not afford to ignore Vale. Vale's strength is they sell super-high quality ore. Anyone making high quality steel needs it to blend, and that leaves them in an extremely strong position.
The additional charge would mean that the price of South System fines from Brazil would increase by 86.4% compared with 2007, while Carajas fines from northern Brazil would increase by 92.4%. High quality Brazilian ore can now arrive in Northern Chinese ports at about US$144 a tonne, just over the US$136.50 a tonne for lower quality Indian spot ore. Australian fines cost about US$115 a tonne, reflecting an unusually narrow premium for better-quality Brazilian ore. Vale had negotiated a price rise with term Asian customers of 71% and 65%, depending on the grade of iron ore, for the year beginning April 1. But its deal was eclipsed by Australian rivals Rio Tinto and BHP Billiton, which wrung out bigger increases from Asian mills in later negotiations based on the added savings due to the shorter shipping distance. It would explain the fact that the Brazilians are bitter over the better price the Australian's were able to get this year. It would also help set the platform for next year's negotiations, which will start in November.
China's leaders are considering an economic stimulus package of about 370 billion yuan (HK$420.7 billion), including a 220 billion yuan new expenditure and 150 billion yuan of tax cut plan, that may ease the government's monetary policy by the end of the year. The expenditure part will include the spending of 45 billion yuan on social welfare, 46 billion yuan on agriculture, 38 billion on education, 35 billion yuan on construction, and 28 billion yuan on import of energy and commodity products.
The generally accepted fact is that China will see a slowdown following the successful Olympics. Many consider the infrastructure development would slow dramatically. Let's get real for a moment. The total investment in infrastructure which was related to the Olympics totaled between US$40bn-50bn. Now, let's take the China's actual budget for its 5 year plan already announced for 2006-2010:
Transportation Infrastructure US$554bn Power Grid Projects US$1,000bn
Even if you average it over 5 years, that easily US$300bn a year (or 6x the Olympics related budget on infrastructure). This is one of the main reasons why I think the commodities upcycle is far from over... and this is just China. In fact, infrastructure projects would speed up after the Olympics as these projects may have had to take a backseat to allow the Olympics related projects to be rushed for completion.
p/s photos: Irene Santiago