End of the Quarterly Iron Ore Contracts(?) That Was Easy!

That may be a bit presumptuous of a statement but Tom Albanese, CEO of Rio Tinto, one of the “Big 3 iron ore producers has stated, according to SteelOrbis, that the “Quarterly pricing system applied in the global iron ore market could be rescinded since current iron ore prices in the spot market are lower than the main iron ore miners’ contract prices for the third quarter. Well folks are we at all surprised that the Chinese would decide to not play ball with the current schema as spot prices for iron ore decline against the quarterly contract price? Truth be told, the Chinese are not the only ones unsatisfied with the current quarterly iron ore contracts. But by wiggling out of the quarterly contracts, where does that leave the state of iron ore price negotiations?

We have long reported on the validity of certain types of contracting mechanisms, in particular, we have written about how when a company is in a long term buying agreement and prices drop, buying organizations tend to want to try and re-negotiate (we actually tried to coin a term to cover that practice Ëœweaseling’) and when prices rise, they tend to thank their lucky stars that they called the market correctly. We all know that the Chinese have a history of wiggling out of contracts that don’t work in their favor (they did that the last time iron ore spot prices plummeted during 2008). So the questions we really need to ask ourselves are as follows:

  1. If the Chinese are working on a quarterly contract such that volumes are established annually and only the pricing mechanism is left to the quarterly contract AND the Chinese fail to place orders under that contract, then we can say that the Chinese have reneged on their contracts.
  2. But if the quarterly contract also involves a quarterly volume commitment (in other words there are no base load volume commitments set annually) and the Chinese opt to buy on the spot market, have they broken any contract? The answer would be no.

So, which of these two scenarios actually shows the reality of the situation? Friends, if you picked Scenario 1, you would be correct. But in all fairness to the Chinese, we’d like to reiterate that the Japanese and South Koreans (though in a more delicate approach and tone) also reneged on the quarterly contracts. We have even heard from industry sources that European mills also reneged and specifically, ArcelorMittal also attempted to re-negotiate their iron ore contracts. We can’t blame them. Again, it’s natural to do what we described in the second paragraph of this post.

There is one mis-perception (that we were guilty of) that we will share with you now. First, we (MetalMiner) interpreted the move from annual iron ore contracts to quarterly contracts as instigated by the Big 3 iron ore producers to capture price rises more effectively and frequently (we assumed the producers see a long term bull market for these types of commodities). That assumption turns out to be erroneous based on our discussions with firms close to the process. The reality is that yes, the Big 3 did switch to quarterly contracts but not for greed, rather, to try and limit the amount of contract reneging by the Chinese! (So much for their efforts)

We also reached out to Tim Cummins, who runs IACCM (International Association for Contract and Commercial Management) for what recourse, if any do the miners have if indeed the buyers failed to honor their contracts, “The question is whether the ‘consideration’ that accompanies a firm commitment is sufficient to merit any sort of compensation for de-commitment. Some supply contracts handle this by allowing a certain percentage increase or decrease at specified times in the contract period. Whether these contracts are written in this manner remains unclear.

That brings us to the last big question of the day if the iron ore quarterly contract dies, what will take its place? Well, certainly trust no longer factors into the equation. With essentially everyone breaking contracts when things don’t go their way, maybe the industry will move toward a spot market and steel buying organizations will need to bone up on their hedging skills to take advantage of iron ore swaps contracts.

–Lisa Reisman

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