Chinese not Alone in Feeling the Heat of Rising Iron Ore Prices

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Commodities, Ferrous Metals

The trials and tribulations surrounding the annual iron ore price negotiations are not an event reserved purely for the Asian markets. China and other SE Asian steel producers may be the consumers in the media spotlight but prices set there impact iron ore sales the world over. In Europe, there is a growing clamor for price restraint fronted by Eurofer   (an industry group representing ArcelorMittal SA, ThyssenKrupp AG and Corus Group PLC) who say price hikes of between 80 and 90% for steel’s main raw ingredient would have a significant impact on steel prices according to an article in Forbes.

It claimed the higher prices would reduce demand for many price-sensitive products and slow down Europe’s economic recovery – or even push economies back into recession. Putting the headline grabbing hype to one side, it is true to say the consumer market is not in the strong position it was in 2006-2008 when rapid iron ore price increases were absorbed by consumers in rising steel prices. The steel producers although complaining about the cost increases actually did very well in that period as they were able to pass through cost pressures and still maintain high capacity utilization. That is not the case today. Mills are struggling to pass through previous increases in scrap costs and the effect of higher spot purchases. If the contract prices for iron ore and coking coal rise as expected, the mills will share in the pain this time with margins being squeezed.

As an example of how seriously this possibility is taken, ING recently  down-graded ArcelorMittal’s stock from a buy to a hold recommendation on the grounds that the firm will face serious margin pressure from rising raw material costs.

Eurofer has also complained about the plans to combine Rio Tinto and BHP Billiton’s iron ore resources into a merged venture. It was in part European Union anti trust regulators objection to BHP’s hostile takeover bid for Rio back in 2008 that forced BHP to drop the plan to buy Rio. Their intervention this time could equally impede the two miners plans.

And it is not just Rio-BHP-Vale who are looking to take advantage of rising iron ore demand to secure better pricing. ArcelorMittal’s largest South African supplier Kumba Iron Ore announced this week that it’s subsidiary Sishen Iron Ore was ceasing further deliveries under it’s cost +3% long term contract, citing some failure of AM to adhere to conditions of South Africa’s Mineral and Petroleum Resources Development Act. But Kumba had offered the steelmaker material on “commercial terms for which read world market prices. A Bloomberg article says ArcelorMittal South Africa, which is 47% owned by Luxembourg-based ArcelorMittal, produced 8 million metric tons of steel in 2009. It sourced 5.5 million tons of ore from Kumba under the terms of the disputed agreement and the consequences could be so dire it has asked for its shares to be temporarily suspended on the Johannesburg stock exchange until the problem can be resolved.

North American steel producers tend on the whole to be more vertically integrated with captive iron ore and coking coal mines. For them and the scrap based mini mills like Nucor and Steel Dynamics the actions of iron ore producers are on balance favorable as it will add upward pressure to finished steel prices but not unduly impact their raw material costs. Vertically integrated or not we can still expect the US mills to use rising raw material costs as an excuse for prices increases in 2010.

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