Iron Ore Prices Wreaking Havoc – Go China Go!

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Several big iron ore contracts are set to expire at the end of this month. According to a recent Financial Times article, “Macquarie, the Australian bank, said Rio was committed to securing a price in excess of the 85-95 per cent the market is expecting. That stance suggests investors should be prepared for an extended and potentially hostile conclusion to the negotiations, it said in a report.” To add salt to the wound, according to this Forbes article, BHP Billiton has also been looking for a “freight premium to reflect the lower cost of shipping ore to China from their mines in Australia than from Brazilian mines.” I had to re-read that last sentence a couple of times. In short, BHP Billiton because it is closer to China (Australia vs. Brazil) wants to make sure that any potential savings the Chinese receive in freight is lost in material (resulting in more profits for BHP Billiton). But Vale, the Brazilian producer only received a 65% increase, according to the same article.

This news should come as no surprise. In fact, we covered it back in early April. Secretly I’m pleased to learn the Chinese aren’t just going to take this and instead, will likely postpone orders for as long as possible in retaliation against the iron ore producers who would then force the Chinese to buy off the [much more] expensive spot markets. The Forbes article quotes Lehman Brothers, “each 10 percent change in the iron ore contract price should result in a 9 percent change in Rio Tinto’s earnings and a 3.5 percent change in BHP Billiton’s earnings.”

I wonder what Lehman’s earnings analysis for Rio Tinto and BHP Billiton looks like when Chinese orders drop off for a  quarter or more? Now that would be fun to watch!

–Lisa Reisman

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