Sounds a little counter intuitive doesn’t it but that is the general consensus to come out of the Dalian Iron Ore conference last week. In a note to clients, Credit Suisse used the memorable phrase Goodbye Angst; Hello Harmony when commenting on the China Iron and Steel Association’s (CISA) acknowledgment that the use of spot index-linked pricing structures holds merit for contract volumes. After years of negative rhetoric, particularly against contract changes proposed by the miners and the use of spot prices in particular, this was seen as a sea-change in Chinese strategic thinking setting the scene for improved pricing harmony. The bank went on to report that China is considering the introduction of iron ore futures trading – epitomizing the phrase if you cant beat Ëœem, join Ëœem.
Although Q4 prices are expected to ease on the back of an increase in supply and muted demand, the bank remains bullish on price in the years ahead for a number of reasons. In the short term, China’s domestic miners are facing hefty rates of inflation in their operating costs. The bank estimates 10% per annum, supporting price rises available to the overseas suppliers as China is deprived of lower cost domestic supplies. In addition, the bank sees overseas suppliers as unable to ramp up production as fast as many in the media suggest. New mines of 20mtpa plus will take years to come to fruition. Last, the long term building boom in China is unlikely to end before 2020 according to the bank. While there may be weaker and stronger periods of growth during that time, the long term demands of rising GDP and urbanization will fuel commodity consumption much as it did in Europe and the US over many decades of their industrialization.
In a separate note regarding Japanese steelmaker JFE’s move to more flexible pricing contracts with its major customers, President and CEO Eiji Hayashida warned iron ore miners to not continue to relentlessly increase prices, warning it is in their interests to support steel makers in order to protect their long term market. The attraction of steel is its strength and its cost. If it becomes too expensive, creeping substitution will set in. Mr. Hayashida has a point. Steel does not need to become more expensive than say aluminum or carbon fiber to be substituted, the difference just needs to make the case for change to other products with more attractive features worthwhile.
A study in the IBRC revealed in the latter part of the last century steel cost relative to other metals increased substantially opening the door for greater use of other materials. Since the 1980’s the process reversed and steel costs relative to other materials were back to earlier ratios by the early part of this century. A prolonged period of strong iron ore prices could force steel producers to again move out of line by rising prices and opening the door for rising substitution.The use of aluminum and carbon fiber in automobiles is a prime example in which higher steel costs would accelerate the migration to lower weight materials.