Rio’s Deal With Nippon Steel Won’t Set Iron Ore Prices For Chinese Mills

By Don Miller
Associate Editor
Money Morning

The iron ore market, which has been roiled recently by rancorous pricing negotiations, found some common ground today (Tuesday), as Rio Tinto PLC (NYSE ADR: RTP) agreed to a 33% price cut in a contract agreement with Japanese steelmakers.

Still, the lower prices are under assault by Chinese steelmakers, who are seeking to undermine the benchmark pricing formula, which is established each year in talks between miners and steel mills. 

The testy negotiations are sure to heat up as China, which imports more than half the world's iron ore production, is believed to be seeking price cuts of as much as 50% after enduring seven years of skyrocketing prices.

In fact, the Chinese may be looking to get rid of the benchmark price altogether and set the market by paying only spot prices, which more clearly reflect current demand. Spot prices for iron ore imported by China have dropped by 66% since setting a record in February 2008.

"The deal with Japan doesn't necessarily tell us anything about China," one Sydney-based dealer told the AFP. "The benchmark pricing system is becoming a bit of a dinosaur. It's likely to continue to exist for Japan, but not necessarily China."

The long-awaited settlement by Rio, the world's second-largest iron ore producer, with Nippon Steel Corp (TYO: 5401), marks the first deal of the contract year, even though it officially started April 1. 

The talks had been deadlocked for months, as demand for steel and its main ingredient, iron ore, has disintegrated.

Nippon agreed to pay 112 cents per dry metric ton for Rio's premium Pilbara Lump product, 44% lower than last year's contract price, according to a statement released by the company. The agreement calls for the Nippon to pay 97 cents per dry metric ton for Yandicoogina fines ore - a 33% drop. Chinese mills buy mostly iron ore fines.

Last year Rio negotiated an 80% increase for fines and a 97% increase for lump prices with its Asian customers.

The new prices are still the second highest on record and are in line with a surge in commodity prices across the board, as China's building boom has stressed supplies of raw materials around the globe.

The majority of analysts saw the settlement as favorable to the iron ore producers.

"The fines settlement is better than most brokers expectations for a 35% to 40% fall," Marcus Padley, a broker at Paterson Securities Ltd., wrote in his trading newsletter, according to Bloomberg.

But other analysts said miners will find it tougher going when trying to reach agreement with Chinese steelmakers like Baosteel Group Corp. (SHA: 600019), who are insisting on at least a 40% to 50% cut in prices that have approximately quadrupled since 2002.

"They struck the deal with the Japanese first as they realize it will be tougher task with the Chinese, which is a much bigger market - you could see a further 5% to 10% added to the cut," Mark Pervan, head of commodities research at Australia and New Zealand Banking Group in Melbourne told Reuters.
For their part, the Chinese are withholding comment.

"I can't comment because we need to study" the agreement, Ding Shouhu the iron ore price negotiator for Baosteel, China's largest steelmaker, told Bloomberg. "We haven't got in touch with Rio for two weeks. Rio hasn't set a time for the next round of negotiations with us."

The negotiations will be closely watched by Vale SA (NYSE ADR: VALE), the world's biggest iron-ore producer, and BHP Billiton Ltd. (NYSE ADR: BHP), the third- biggest exporter. 

Vale prematurely signed contracts last year, settling for a 71% price increase. This year it is waiting for Rio to reach pricing accords before deciding what to charge.

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