Commodities | May 23 2006
By Rudi Filapek-Vandyck
It would appear the Chinese are being taught a hard lesson not so much in global capitalism, but in basic economics. The rapid expansion of the Chinese steel sector has turned the country into a steel exporter and into the world’s largest consumer of key ingredients for the production of steel, such as iron ore.
No doubt, the Chinese thought they could use their market weight to negotiate things in a direction that would suit their perceived leading market position, but things seem to be turning out differently.
Rio Tinto’s (RIO) latest contract with South Korea’s POSCO is the first contract renewal for premium iron ore lumps. Despite doubt creeping into some market analysts’ expectations about whether Rio Tinto and BHP Billiton (BHP) could achieve a similar price increase as done for the cheaper iron ore fines, the latest supply agreement has proven these doubts to be unwarranted.
But the Chinese are still holding off, their latest strategy being a push to diversify pricing across different regions, which would allow Chinese prices to be lower than in the rest of the world.
It seems unlikely that negotiators for Rio, BHP and Brazil’s Companhia Vale do Rio Doce (CVRD) will allow for the creation of such a precedent. This leaves the Chinese steel sector with two options: either satisfy its needs via the open spot market (dangerous strategy) or succumb to the 19% price rise proposal that is on the table.
Market commentators at Credit Suisse suggest this morning that if anyone should be unhappy it should be global steel manufacturers instead of the Chinese. "Perhaps if the Chinese ceased producing more and more steel each year and therefore did not account for almost the entire growth in global steel production, the market for iron ore wouldn’t be quite so tight", Credit Suisse points out. And to be honest, it is difficult to argue otherwise.
It seems but logical that if China continues expanding its steel production next year’s contracts for iron ore deliveries might again go further up in price.
Maybe somebody should tell the Chinese.