The recent change from the 40 year-old annual price benchmark system for the pricing of iron ore to a quarterly price fix is having ramifications beyond the steel industry. The change has come from the suppliers’ desire to see prices more closely mirror the spot market for these products following several years in which spot prices have exceeded long-term contract prices. The same iron ore suppliers are also major players in the mining and sea-borne trade of other commodities such as coking coal that has also moved from an annual to a quarterly price fixing. Now BHP Billiton is pushing the market to consider a quarterly price fixing for alumina, the bauxite ore to aluminum intermediary, pre-cursor for aluminum smelting. Like iron ore, alumina has traditionally been fixed via annual or even longer term contracts of up to five years and generally at a fixed percentage of the average finished price of the aluminum as reported on the LME. Recently this has been around 13.0 to 13.5% of the three-month forward price of aluminum on the London Metal Exchange. The LME average for March was $2236.50 per ton giving an alumina price of $300 per ton. April’s will be higher, probably closer to $350 per ton due to higher recent aluminum prices, but still some way below spot prices. In fact the benchmark price for alumina has been below the spot price for the last five years and therein lies the problem for the major suppliers like BHP. Every month that spot sales outperform contract sales represents in their eyes a loss of profit running into hundreds of millions of dollars in the $25bn a year alumina market.
In a Financial Times article it goes on to say that it is not just BHP that is suggesting a change to the pricing formula. Major aluminum producers like Alcoa are also getting behind the move. “It is time for the industry to develop a pricing methodology that is reflective of alumina fundamentals,” says Timothy Reyes, president of Alcoa Materials and head of commercial activities for aluminum, alumina and bauxite at the company. He suggests replacing the current system with an index based on spot transactions, similar to the new pricing system for iron ore. “We have had discussions with parties interested in developing this index, and we believe that the number of transactions in the spot market allow a reliable index to be created,” he said. Not everyone agrees however, not surprisingly most of the smelters are strongly against a change seeing it as increasing their risk and almost certainly their costs.
The smelters may have a hard time preventing a change, at least in the longer term. Historically most aluminum producers were vertically integrated from bauxite mine through to finished aluminum products like foil, forged car wheels, window sections and building systems but with the rise of Asian and Middle Eastern producers focused purely on the smelting of alumina to aluminum many producers are sourcing their alumina from third party suppliers. According to the FT, this has grown from 7m tons in 1980 to 35m tons today, and alongside that third party market has developed a spot price for alumina and a sufficiently liquid market for an index. As with iron ore’s development of a spot price being the precursor for change, the article concludes with the observation that the same may be happening for aluminum.