Chinese steel mills have given in and agreed to pay Rio Tinto an average 85% more for its iron ore shipments from next Tuesday.
The deal will be announced today but will see Rio receiving an increase of 79.86% for its iron ore fines and a huge 96.5% increase for the premium quality lump ore.
Combined, the two increases make for an overall rise of 85%. BHP and the Chinese mills are expected to wrap up an agreement shortly, though some of its contracts don’t start the new shipping year until September.
The price increase is more than estimated by The Australian Bureau of Agricultural and Resource Economics in its latest forecast for a 40% surge in commodity export income in 2008-09.(See below).
The rise will be warmly greeted by the market: hints of a settlement helped steady the market yesterday after a sharp fall in the morning.
The high prices follow a campaign by Rio and BHP to get prices from Asian mills to reflect the proximity of Australia to them, compared to the world’s biggest exporter, Vale of Brazil (formerly CVRD) which won price rises of 65% to 71% from mills in China, Japan, Taiwan and South Korea.
The increases are around nine times the 9.5% increase won for the 2007-08 shipping year.
Analysts at Macquarie Bank yesterday suggested the price rises could rise to around 85% and within hours of that being published, Rio told the industry of the outcome of the talks.
It means all the bluff and bluster from Chinese mills to try and deflect the Australian companies to settle early has failed. China banned its mills from buying iron ore from both companies on the spot market to punish the two Australian companies, and to try and keep a lid on prices.
The rise suggests that the commodity boom is still running hot, in spite of the slowdown in the US and Europe.
The iron ore deal will introduce a competitive note into BHP’s 3.4 share bid for Rio: Rio will argue the benefits of its price negotiations will be lost if BHP wins. Rio shares closed at $137.58 yesterday and BHP at $44.60. At the closing BHP price the bid was worth more than $151. The market says it’s a no go.
The average 85% price rise exceeds the record increase of 71.5% won in 2005 and which alerted the investment world to the gathering resources surge from China in Australia, Canada, Brazil and other minerals rich countries.
Rio’s agreement marks an unprecedented divergence in the annual pricing mechanisms for Australian and Brazilian ore exports. Traditionally, Vale would negotiate a price and Rio and BHP Billiton would agree later to a similar rise.
But this year Vale’s agreement for a price increase of between 65% and 71% was ignored by the Australian companies who argued for higher prices based on Australia’s proximity to China meant lower shipping costs for the mills.
The mills need one fewer carrier to ship the same amount of iron ore from Australia than they need from Brazil: usually the ratio is four carriers needed for Brazil and three for Australia (One loading in Brazil, two on the water and one discharging in China: for Australia it is one loading, one on the water and one discharging. The closeness of the WA iron ore ports to China allows for the reduction, which is a big cost saving for the Chinese mills.
BHP and Rio have wanted higher prices to reflect that cost advantage and have finally won after a year or more of pressure. BHP reckons that the price premium won by Rio is equal to only 10% of the shipping savings generated by supplying iron ore from Australia compared to shipping from Brazil
BHP last night declined to comment on whether it would take Rio’s price as a benchmark, but indicated it would decide shortly.
The increase will be inflationary: the cost of a host of products made with steel will rise, both for the Chinese domestic and export markets. Steelmakers in Japan and South Korea and India are already feeling the pressure.
What Rio and BHP win for their raw materials, we will pay in higher prices for some imports and other products.
