Battle Lines Being Drawn For Iron Ore Negotiations

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This story features BHP GROUP LIMITED, and other companies.
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By Rudi Filapek-Vandyck

Negotiations between the Big Three producers of iron ore and their major customers in Asia are due to commence soon and the battle lines are already being drawn.

A reporter from China based Xinhua news picked up the highly suggestive quote from Luo Bingsheng, executive vice chairman of China Iron and Steel Association, that China, Japan and other steel producing nations have “common interests” in negotiating this year’s iron ore contract prices.

Remember how two years ago Brazil’s Companhia Vale do Rio Doce (CVRD) circumvented Chinese opposition to a fierce price increase by signing agreements with customers throughout Europe?

Xinhua further quotes Bingsheng as “We’re in this together, China and Japan… the two countries both have common interests in the negotiations’ with the three major ore suppliers, the Anglo-Australian groups BHP Billiton ((BHP)) and Rio Tinto ((RIO)) and Brazil’s CVRD.”

Over in Australia, BHP Billiton has been organising a tour for securities analysts plus a briefing by management on its West Australian iron ore assets and as one would have expected the underlying tone proved to be very, very positive.

UBS analysts picked up that current spot prices in excess of US$100/t free-on-board (FOB) suggest pricing expectations in the market of plus 50% may possibly be exceeded. The analysts estimate a 10% increase in iron ore prices adds around US$300m or circa 2% to BHP’s earnings per share (EPS).

On the other hand, BHP management seems to have shelved the ambition of achieving an extra bonus through attacking the freight differentials with deliveries from other countries to Asia, most notably Brazil. (So there goes the option of a 100% price increase from April next year onwards).

Instead management seems to have come up with the plan of introducing an index assisted pricing mechanism to determine benchmark prices. This new mechanism could see freight equalisation achieved in five years, management believes.

In the meantime, BHP will simply look to maximise its benefits from the extremely tight market by selling part of future production via the spot market.

Some analysts who attended the events also picked up that BHP management is far more positive than the market in general about the outlook for iron ore in the years ahead. Most analysts will tell you the market will likely return to balance, or even a small supply surplus, by 2009 or 2010. BHP management forecasts a market in deficit until 2015.

This forecast is based upon 7% per annum crude steel production growth while also taking into account production plans by Fortescue ((FMG)).

Within this framework we note that some analysts recently noted how expectations for iron ore prices always seem to lift as each calendar year progresses. Some of them asked the question: what if history repeats itself in 2008?

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