Iron ore politics

23 08 2009

You know sometimes governments are so keen on pursuing a specific agenda that no matter how much opposition and obstacles they may face they will push their policies through eventually calling the outcomes a victory, a win-win solution even though they lead to little or no benefits besides face-saving. China’s iron ore quest fits that pattern quite well.

Here’s the grand debacle in a nutshell. Earlier this year China started to negotiate contracts for iron ore seeking to achieve a 40-45% reduction from the previous year’s contracts. As the price of iron ore picked up, the top iron ore suppliers were reluctant to agree to such a cut considering that Japanese mills had set up contracts reducing benchmark prices by 33% from the previous year. As contracts expired, Chinese steel mills had to purchase iron ore at spot prices for more than they would have paid had they settled for a 33% reduction. Some mills even defected the national contract negotiation scheme to secure their own individual contracts. One would think the four Rio Tinto officials jailed on accusations of bribery related to the iron ore negotiations would crown the whole Chinese endeavour as a fiasco. It truly did but I suggest that it is the deal reached this week with Australian miner Fortescue Metal that allows the scenario explained in the first paragraph to materialize.

Fortescue Metal is an up and comer in the field of iron ore. It started mining at its Pilbara project in 2008 and is contemplating expansion activities to compete with bigger Pilbara neighbours Rio Tinto and BHP Billiton. As such, the deal reached between Baosteel and China Iron and Steel Association (CISA) and Fortescue, involves a 35% price cut from the previous year contract prices in exchange of US $6 billion in funding whose terms have yet to be detailed. This deal applies to about 20 million tonnes of iron ore and will allow China to save $35 million according to a Reuters’ calculation which makes it an expensive deal but allows for CISA to save face with a deal that is slightly better than what is offered to mills in South Korea and Japan. MasterCard’s slogan :”There are some things money can’t buy ..” seems to have lost its meaning all of a sudden. Of course China could be attempting to breed a rival to the top iron ore suppliers but the extent to which those may be influenced by this deal is still unclear. According to Macquarie this deal will prevent Fortescue from taking advantage of higher spot prices. Also as a result of this deal, Fortescue will be loaded with debt issued by its only trading partner may become problematic in the longer term.

In sum, this deal is far from being as rosy as China and Fortescue would like to hail it. The deal also comes across as second best to the failed Rio Tinto- Chinalco deal in which Chinalco would have secured stakes in Rio Tinto iron ore assets.




One response

19 11 2009
Iron Ore: It’s in season « Just Digging: a Mining and Metals blog

[…] this month. Thrilled because the last negotiations ended up being a succession of drama and political games. Who needs tv series when iron ore contract negotiations can do just as […]

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