As anyone following the metals industries knows, producers from around the world in every metal sector and every part of the supply chain have cut or will cut production as a move to help establish a floor to metals prices. But what can the world’s largest mining companies do to shore up the price of say iron ore when they have already made massive production cuts? Part of the challenge has to do with the way iron ore is sourced by steel mills throughout the world. Unlike copper or aluminum which are formally traded on exchanges such as the LME or Comex, iron ore prices are negotiated as part of an annual contracting process. And many steel mills are buying iron ore at $100-120/ton based on those contracts. Yet the spot price is trading at the $60/ton range. And though those contracts were put in place beginning in April, the Big 3 iron ore producers (BHP Billiton, Vale and Rio Tinto) will all be hurting according to this Reuters article.
Despite reducing capacity by 35% for the third quarter, the Big 3 will still produce far in excess of anticipated demand. And according to Vale Chief Executive Roger Agnelli, “steelmaking worldwide is already down 20 percent year-on-year in 2008, and with the International Iron and Steel Institute calculating global output of 1.2 billion tons in 2007, that would imply a further 300-350 million tons of iron ore needs to go to balance the market.” So it’s not just a matter of cutting production but forecasting accurately, as an industry sector, how much production to cut. The degree of industry or market concentration along with the degree of collaboration amongst industry producers will determine how successful each metal industry vertical (e.g. aluminum, copper etc) will be in matching production to demand and shoring up the price.