BHP, the world’s largest supplier of coking coal used in steel making is pushing for annual contract pricing to be based on spot prices rather than the traditional annual fixed price contracts. If successful, costs for steel makers are likely to rise as spot prices are predicted to be higher in 2010/11 than now.
BHP is successfully moving iron ore pricing to the spot market and although it took some five years has also migrated thermal coal, used in power stations, onto spot pricing so the tide of history is running against steel producers clinging to the annual fixed price mechanism.
According to an FT article, coking coal spot prices have rallied in the past six months as China becomes a large importer owing to strong local demand and domestic mine closures. Traders said that prices had surged to about $175 per metric ton, the highest so far this year and more than 30% above the level at which annual contracts were settled for 2009-10. Moving to contracts linked to spot prices would enable BHP to obtain higher prices for its coking coal the firm believes as prices could reach $200 per metric ton in the first quarter of 2010. Prices reached a record of $300 per metric ton in 2008.
Demand from China has remained strong despite the industry reportedly running at only 72% capacity utilization and the Ministry of Industry and Information Technology’s announcement last August of a ban on all new capacity projects for the next three years. Since then, 32 new expansion projects have been announced at 27 different steel mills. Clearly economic priorities take precedence over government directives. In fact the scale of excess capacity in China is positively scary, at the end of 2008, China’s steel capacity was 660m tons against demand of 470m tons. This difference is much the same as the European Union’s total output. Yet, there are currently 58m tons of new capacity under construction in China further exacerbating the problem.
With demand running at these levels BHP is playing with a strong hand even if other Asian buyers are still struggling. Nevertheless it could be a year or two before the producer manages to move the whole market over to spot but as it does, providers of OTC coking coal contracts are likely to be the other major beneficiary to BHP.