They tell us some things of course because iron ore prices as a component of integrated steel making do have some impact on prices. See our earlier post on integrated steel mill cost build-up models. But we don’t think the correlation is as tight as one might suspect. Instead, we hypothesize (and we are running some regression models now on this) iron ore prices tell us more about steel production levels (and where they are headed) than actual steel prices.
But what rising spot iron ore prices in China tell us (and those spot prices have reached $100/ton), is that China has effectively lost control over their own price negotiations for having insisted upon a lower contracted price with the Big 3 (Vale, Rio and BHP) than other steel producers in Japan or Korea. Having created an intractable position, China arrested Rio Tinto employees on charges of spying and bribing likely as a last ditch effort to save face. And today, Reuters said that CISA (China Iron and Steel Association, the negotiators) has asked Beijing to limit the number of iron ore producers within China from 112 to 5-10 because firms (and the small to medium sized steel producers they represent) have undermined the negotiations causing spot prices to skyrocket.
Does this mean that steel prices will skyrocket? We don’t think so. Rather, spot prices in China have jumped because no long-term contracts had signed. And as we predicted back a few weeks, the lack of long term contracts will create heavy financial exposure to steel mills that rely on [rising] spot prices. This places Japanese and Korean firms at a competitive advantage to China because they locked iron ore contracts in the $60/ton range, despite the fact that China has the largest steel making capability on earth.
This should put US producers at ease, as some Chinese exports will remain unattractive from a price perspective for the US market. On a related note, domestic iron ore producer Cliffs Natural Resource also plans to notch up production, even if on a limited basis.