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May 1, 2010

CHANGE AHEAD

The new market for iron ore will have a strong ripple effect on steelmakers worldwide.

Ongoing talks among the largest iron ore miners and their customers have led to unprecedented changes in the industry that will have strong implications for steelmakers worldwide. One likely beneficiary: North America’s steel producers.

A near 90% increase in the contract price for Australian and Brazilian iron ore from $60 per metric ton in the year ended March 1, to between $110 and $120 per metric ton this year, combined with a shift to quarterly pricing, will have a ripple effect on companies around the globe, especially in Asia and other regions that lack local supplies of iron-rich ore. In contrast, North American steelmakers rarely need to buy iron ore from outside the continent. “U.S. steel producers that are integrated with their own ore supplies will benefit by moving down the cost curve and will be more competitive globally,” says James Lennon, executive director, commodities research, at the securities arm of Australia’s MacQuarie Bank. “Main beneficiaries of higher prices are integrated producers in North America, Eastern Europe, Brazil, China and India who move down the cost curve.”

The European Confederation of Iron and Steel Industries (EUROFER) expressed “outrage” at the price increase announcement in a formal statement in March. Chinese steel mills, similarly, have publicly resisted the new pricing, including an April boycott of Australian iron ore imports by the China Iron and Steel Association (CISA) to protest the “monopolistic behavior” of the three largest iron ore companies: Brazil’s Vale SA, Australia’s BHP Billiton Ltd. and United Kingdom-based Rio Tinto.

In March, Vale and BHP Billiton signed quarterly price contracts with what they called “a significant number of” Asian steel companies. Among the first were Japan’s Nippon Steel and South Korea’s POSCO, locking those steel mills into the steep price increase for iron ore. Rio Tinto agreed to quarterly pricing in early April. The move away from annual benchmark pricing ends a system that was in effect for 40 years.

“I’ve been covering steel markets for 30 years, and cannot recall anything this far-reaching in the way of marketing, pricing, trading impact,” says Joseph J. Innace, U.S. managing editor for Steel Markets Daily, a Platts publication.

Meanwhile, regulators globally are investigating the potential oligopoly that results from the proposed joint venture between BHP Billiton and Rio Tinto to combine their iron ore holdings in Western Australia. With Vale, the three companies control nearly 70% of the ocean-borne iron ore market.

DOMESTIC ADVANTAGE

North American steelmakers own or have access to iron mines concentrated in Michigan and Minnesota. The U.S. Geological Survey estimates U.S. iron ore reserves to be about 110 billion tons of iron ore, containing 27 billion tons of iron.

North American iron ore has become a very hot commodity. “They’re able to control their own costs because of owning these facilities and in some cases the mineral rights,” says Duluth, Minnesota-based Craig Pagel, president of the Iron Mining Association of Minnesota, of domestic steelmakers. In 2009, mines in Michigan and Minnesota shipped 99% of the usable ore produced in the United States, with an estimated value of $2 billion, says the Geological Survey. Additionally, eight of the mines operated by three companies—U.S. Steel, Cliffs Natural Resources and ArcelorMittal—accounted for virtually all of the production.

In March and April, Pagel says he received numerous calls from those looking to broker iron ore in China, despite complicated and restrictive shipping routes from the main port in Duluth. With competitive advantage lost in countries across the globe, some may be willing to go that new distance—but not without new costs.

“Negotiations will revolve around accounting for freight,” says Lennon.