In what has been described as a “global iron ore price revolution”, the manner in which iron ore is priced is undergoing a fundamental shift. This has profound implications for the steel industry and those industries — engineering, construction, automotive and more — where steel is a critical input material.
Until recently, iron ore prices were set annually, so the steel industry (and complementary industries such as engineering and construction) had relative certainty about this major cost component. The stability of this approach allowed the focus to be primarily on delivery and adapting operations to meet customer needs.
The world is now in the process of moving to a more frequent approach to iron ore pricing: from annual to quarterly. A move led by BHP Billiton and supported by the world’s other leading iron ore producers; Vale and Rio Tinto. The iron ore producers argue that the annual approach to pricing is outdated which, from an economic perspective, is an argument not without foundation. (Together, the ‘Big Three’ provide about 80% of seaborne traded iron ore, making them an axis of immense influence on global trade.
Major coal suppliers are following the iron ore trend and also moving to a quarterly pricing model.
Of course, the miners are in favour of this new model because it enables prices to be negotiated more frequently and, in a demand-hungry market, this creates more opportunities to increase price.
Quarterly pricing model
The quarterly pricing approach, adopted by Vale, will apply a three month ‘lag’ when setting prices. So the price set on 1 October for the 2nd quarter, for instance, should predominantly reflect the average ‘spot’ (or daily) prices for the months of June, July and August. The prices are therefore not expected to be set in a speculative manner (i.e. anticipating what the spot prices may evolve to during the October-December quarter).
One question that has not been resolved is that even though the new pricing model bases the upcoming quarter’s prices on what is essentially the past quarter’s average spot price, it is unclear what role speculation on imminent changes in spot prices will play. The quarterly price is heavily influenced by the daily — or ‘spot’ — price.
At present, currently China — the world’s biggest buyer of traded iron ore — purchases a significant amount of its iron ore on a spot basis. Given the miners are moving to a quarterly price model, it may drive other major buyers to purchase more on the spot market if that is likely to deliver a more favourable overall cost outcome in terms of raw material feedstock sourcing.
Commodity boom
Off the back of the incredible development in China, the world is in the midst of a massive commodity boom (called a ‘super cycle’ by economists), underpinned by China’s steelmaking capacity. This started in 2003/04.
Will this ‘super cycle’ continue? Well, the answer is most likely yes, but the unknown is for how long.
China is showing no signs of slowing. Even during the recession its GDP was growing at around 7-8%. So whilst it takes a brave economist to tread these waters, it seems for a few years to come at least there will be no slowing of its growth. This means the issues currently impacting on the supply and demand of iron ore and coal, and the volatility of steel pricing, are likely to remain for the foreseeable future.
The increase in demand for steel has led to more iron ore mines being developed along with attendant supporting infrastructure (especially transport such as railways and ports). The development of these mines has not been able to keep up with the boom in demand, further fuelling increased prices for iron ore (the comparative ‘scarcity’ factor being a driver).
In some positive news, however, it was reported relatively recently (20 May 2010), by Goldman Sachs JBWere steel industry analysts, that the 2nd quarter of the 2010 calendar year marked the peak of the current spot iron ore price cycle. The volatility of the pricing of raw materials, however, and the fact that the new raw material pricing model is undergoing a ‘settling in’ period, make it difficult to accurately forecast the prices that will eventuate.
Factors which impact on iron ore pricing include:
• the re-stocking of raw products to pre-empt demand (especially by Chinese mills)
• a lack of high quality domestic Chinese iron ore
• changes in sea freight charges
• the manner in which fluctuating prices may, or may not, bring high cost miners back into production
• weather — this influences the efficacy with which raw materials can be mined, transported and, in particular, loaded onto ships. It also influences the production of mills in northern China.
Steel producers: responding and responsibilities
This ‘revolution’ has reminded steel producers, including BlueScope Steel, of the importance of being transparent and proactive to help customers manage their own costs and operations in the best possible manner.
Raw materials, with iron ore and coal chief amongst them, account for 60% of the cost of steel. Therefore any changes to the pricing structure (and prices) of iron ore and coal will, logically, impact on the cost, and thus price, of steel. One of the major challenges for steel producers is how we can adapt to this change and ensure that steel prices remain competitive and responsive to prevailing market conditions.
BlueScope Steel produces the XLERPLATE steel range of hot rolled steel plate products, as well as a range of other steel products, for the Australian and international markets including: cold rolled, hot rolled and galvanised coil steel; ZINCALUME steel; and pre-painted COLORBOND steel.