Commodities | Jun 14 2006
By Rudi Filapek-Vandyck
It doesn’t take a genius to figure out the Chinese steel mills are not happy with how this year’s annual contract negotiations have developed with the world’s three dominant suppliers of iron ore.
After watching the world agree to a massive 71.5% price hike last year, the Chinese thought it would have been better if they’d taken the lead in this year’s negotiations, but somehow somewhere things failed to go their way.
Now steel mills from Europe to Japan to South Korea have agreed to another 19% price rise, again leaving the Chinese with little option but to accept similar terms or face the uncertainty of having to buy iron ore on the open spot market while the short term outlook is for a very tight market.
For the Chinese negotiators, this is a hard pill to swallow.
Anyone who deals with the Chinese will tell you Chinese business relationships are all about power and exerting that power. And about saving face.
This may be the last time the Chinese have to accept public defeat. From next year onwards, the Chinese will likely be the price setters for the rest of the world instead of having to accept another fait accompli, Jose Carlos Martins, executive director at Companhia Vale do Rio Doce flagged this week.
Martins is probably very much aware of the principles and the determination that dominate his customer base in the world’s largest industrialising nation. According to our sources in Australia with business contacts in China, the Chinese are determined not to face defeat again on such a large scale – ever! Prepare for the revenge of the Chinese steel mills.
China is currently the world’s largest steel producer, accounting for circa 30% of global production, and still growing. This year’s capacity growth is likely to be around 19%. Most steel mills in Europe and the US are applying the brakes to stop the markets from being flooded with steel products, but China has thus far shown no such inhibitions.
As a result, China’s hunger for coking coal, iron ore and nickel, key ingredients for the production of basic carbon steel and/or stainless steel, requires increasing imports. China has learnt the lesson it cannot rely solely on its market size to gain more control over the pricing and availability of key supplies. The lesson learnt is being put in practice already.
FN Arena News has been repeatedly informed over the past few months that delegations of top tier Chinese steel manufacturers are traveling across Asia with the specific aim of securing access to iron ore and coking coal supplies. If our information is correct, another delegation should visit Perth over the next week or so.
The past few months have seen some negotiations result in contracts being signed. No doubt, the one that received the most attention so far involved Fortescue Metals (FMG). It is probably no coincidence that the largest "independent" (as in without any involvement with the major three) iron ore projects in the world found initial support in China, but soon saw controversy come to the fore as the Chinese partners appeared to be exerting their perceived market power.
It’s probably a fair assumption that if you are a miner of an industrial metal or mineral in Australia you will have been contacted by Chinese investors or importers by now. (If not, you are definitely doing something wrong).
So will the Chinese steel mills succeed in their quest to break the market power of triopolies such as the one currently ruling the iron ore market?
The Chinese have a few disadvantages, FN Arena News was told by an industry insider familiar with negotiating deals with them. They are too confident and arrogant, relying heavily on their assumption they are the preferred party to deal with (giving them the balance of power during negotiations). At the same time the Chinese tend to be rather slow in signing off on a binding contract.
According to our industry source, it is more than likely the Chinese will be unpleasantly surprised by deals going to competitors from India or the Middle East as they seem to be similarly eager while acting faster when it comes to signing off on contracts.
Chinese also tend to have a different attitude towards contracts and contractual obligations than their partners in the West. The confusion that surrounded Fortescue Metal’s agreements with Chinese customers last year may only be the first among many more to hit the country’s news headlines.
Many resources companies have little choice but to deal with the Chinese, our industry insider believes. In the end, they will have to find the necessary funds to mine their reserves and striking a deal with Chinese investors often seems the easiest and quickest way.
Just how eager the Chinese are can be deduced from the deals that have come to light over the recent months.
Deals vary from buying an iron ore producer out of Chapter 11 (bankruptcy protection status) in the US, to negotiating long term iron ore supply contracts in India (not an easy feat considering India has similar ambitions for its own steel sector), to securing exclusivity to exploit huge untapped iron ore reserves in Gabon (Africa) for which the Chinese will have to build costly rail links needed to reach the site inside the tropical forest.
Last week a Chinese steel company agreed to purchase a 73% stake in Asia Iron Holdings’ yet to be approved iron ore project from Mount Gibson Iron Ltd (MGX) for $52.5m.
Three months ago, four Chinese steel mills even signed off on a multi billion dollar deal with BHP Billiton (BHP), one of the three iron ore "devils", agreeing to take a 10% stake each in a joint venture to secure 25 years of iron ore supply from Australia’s Pilbara region.
A few months ago, Hong Kong listed CITIC Pacific bought the mining rights and two Australian iron ore companies from Mineralogy Ltd for $415m.
Expect more deals. Many of them will involve small to medium sized Australian miners. Look for hard coking coal as much as for iron ore and nickel.