Asia Train Wreck du jour:
The great iron ore goldrush begins
Producers have been caught napping by a spectacular price rise, writes Andrew Trounson
February 26, 2005
"SOMEONE has stuffed up big-time," an MBA graduate schooled in the virtues of market research declared over her wine after hearing news that Australia's iron ore miners had secured an unprecedented 71.5 per cent hike in iron ore contract prices.
On top of a 120 per cent rise in coking coal contract prices earlier this year, the deal, effective from April, means Australia is set to reap billions of additional export dollars as it basks in the sunshine of one of the biggest commodity booms in history.
The surprise cave-in by the Japanese steel mills on benchmark contract prices also underscored the complete turnaround in recent years in the balance of power in the global minerals game, with the miners now able to dictate terms.
The coal and iron ore price rises will boost the Commonwealth Bank's index of Australia's commodity export prices by 19 per cent, putting the US dollar price index more than 40 per cent above the previous peak in 1989.
Shares in major miners BHP Billiton and Rio Tinto soared to record highs on the news, while shares in Australia's largest steel maker BlueScope dropped in the face of galloping raw material costs.
"What is going on in the raw materials area is quite frankly inflationary," BlueScope chief executive Kirby Adams said this week.
Steel makers are already raising prices and are considering slapping customers with surcharges.
But the MBA graduate couldn't quite believe that in this modern age of elaborate market analysis and forecasting such a price rise could have happened.
The easy answer is that no one had fully reckoned with the massive commodity demand that has been unleashed by China's rapid industrialisation and its emergence as the world's largest steel market, which feeds on the key raw materials iron ore and coking coal. China's steel consumption is set to rise over 10 per cent this year compared with 5 per cent growth forecast globally.
But the commodity price boom has been exaggerated by the unpreparedness of miners that are now struggling to ramp up production quickly enough after years of under investment because of previously low prices. And even as they scramble to dig more out of the ground, rail, port and shipping infrastructure can't keep up, causing bottlenecks and delays globally. In Australia, queues of shipping off ports has reached 50 vessels in some instances.
BHP Billiton chief executive Chip Goodyear said this month there was little spare capacity in the industry and that supplies of major commodities were set to continue to lag behind global demand this year.
"Demand romps on and the supply side is muted," Mr Goodyear said.
The shortage of shipping has caused the average freight rate from Australia to Japan to blow out to an average $US21.15 a tonne last year, compared with a previous 10-year average of $US7.74/tonne.
"Once miners see that the demand is real, then it takes time to bring production on, and, even if they accelerate, they face bottlenecks," Dallas Horadam, steel analyst at AME Mineral Economics in Sydney said.
The answer to the question, then, of who "stuffed up" lies partly with the miners, though they are hardly suffering for it as they pop their champagne corks. But the steel mills must also shoulder blame for not sending the right price signals to ensure a more orderly ramp-up of production.
Back in the 1980s and 1990s, Australian coal and iron ore price negotiators would troop off to Tokyo every year to bargain for prices, only to be played off against one another by the steel mills. The first to cave in of either BHP or Rio would be granted extra tonnage, sometimes only after the miner had agreed to a secret price discount. On returning to Australia, they would be routinely be criticised by unions facing job losses for not having bargained hard enough.
But the world has now been turned upside down.
In a sure sign that the boot is on the other foot, BlueScope's Kirby Adams this week complained that BHP Billiton and Rio Tinto, along with Brazil's CVRD, were effectively a cartel. Between them, the three miners control about 77 per cent of the global seaborne iron ore trade.
"There was a period when the steel mills were in the box seat, but and now the miners have the box seat," said Dallas Horadam.
Macquarie Equities said in a recent report: "Since 2003 the market has been transformed for the first time really since the early 1980s into a seller's market."
Certainly it was competition from China for scarce iron ore that forced the hand of Japan's Nippon Steel to accept on Tuesday CVRD's 71.5 per cent price rise. The deal reportedly followed threats from BHP Billiton that it was prepared to divert production into the Chinese spot market as the Australians pressed for a premium to reflect their lower freight cost advantage over Brazil.
But Rio Tinto quickly fell into line, securing from Nippon Steel the same 71.5 per cent rise, hiking the price of lump iron ore to $US50.41 a tonne and the price of iron ore fines, or powders, to $US39.50 a tonne.
BHP Billiton, however, appears to be holding out for a freight premium and has yet to settle.
Talks in China are now under way, with both BHP Billiton and Rio believed to be pushing for a freight premium of up to $US10 a tonne on top of the 71.5 per cent price increase offered by the Brazilians.
The extent of the price rise has raised concerns that the major miners will alienate the steel producers and that a backlash is looming.
China's largest steel maker BaoSteel has condemned the price rise as too high, as has Europe's largest steel company Arcelor.
All three of the major suppliers are aggressively ramping up production, with significant fresh supplies hitting the market in 2006 and 2007. On top of that, the Chinese and Japanese are actively encouraging new entrants, especially in Western Australia. Rio and BHP Billiton dominate Australian production but face challenges from the likes of Andrew Forrest's Fortescue Metals and Gina Rinehart's Hope Downs development.
But the preparedness of the majors to push through hefty price rises shows they aren't worried by the competition, which they expect, or hope, would fall by the wayside in any price downturn.
When such a downturn will hit is uncertain. UBS is forecasting a 20 per cent fallback in contract prices in both 2006-07 and 2007-08. But ABN AMRO is expecting largely steady iron ore prices next contract year, before a 30 per cent fall the year after as new production comes on. |
