The Rising Influence of Rising Affluence

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Chinese Steelmakers Outsmart Themselves and Now Have No Contract for Iron Ore

http://online.wsj.com/article/SB124638501713674455.html

›Big Miners, Flexing Muscle, Balk at Beijing Trade Group's Request to Shave 40% Off the Cost of Last Year's Contract

JULY 1, 2009
By ANDREW BATSON and SHAI OSTER

BEIJING -- China's steel industry failed to reach a supply deal with the world's major iron-ore producers by Tuesday's informal deadline, highlighting the challenges the resource-hungry nation faces in trying to shift the balance of power in global commodities markets.

The world's largest steel-producing country started annual talks on the key raw material during the depths of the financial crisis, as commodity prices collapsed and prospects for the world economy turned bleak. The China Iron & Steel Association, a government-backed body that coordinates the industry, argued for cutting contract iron-ore prices nearly in half from last year.

Its position never changed -- but market conditions did, with most Chinese steelmakers ramping up output since early this year on signs that government stimulus is boosting demand for their products.

The steel association found itself isolated in its insistence on a cut of at least 40% from last year's contract price. Major Japanese and Korean steelmakers have already reached separate iron-ore supply contracts based on price cuts of 28% to 33%, which the mining companies say should be the global benchmark.

ArcelorMittal, the world's single largest steel producer, negotiated a 28% cut in its contract with Brazilian miner Vale SA. Few expect China can get a lower price -- especially since many smaller Chinese steel mills have ignored the association and also done separate deals.

"Being a large consumer of commodities has not given China a lot of pricing power," said Scott Kennedy, an Indiana University political scientist who studies China's negotiating strategy. "The failure is a signal that the Chinese industrial-policy machine has problems."

The China Iron & Steel Association declined to comment Tuesday, when many of the supply contracts China negotiated last year expire. Global miners BHP Billiton and Rio Tinto Ltd. also declined to comment on the talks, but said they expect to continue supplying China even without long-term contracts. "If customers opt to buy on the spot market instead, they will," said Rio Tinto spokesman Gervase Greene.

With China's steel output already back to last year's record levels, steelmakers have been buying more iron ore on the spot market, pushing imports to new highs. That undermined the association's position that China's market is so weak that it can't accept less than a 40% cut. And prices for iron ore imported into China are now up about 12% since April's lows. They are even higher than the long-term contracts others have negotiated, so letting the contracts lapse looks like less of a good deal.

"It's hard to have a united front. The small- and medium-sized steel companies in particular cannot just stop production to wait for the final result of the negotiation," said Zhu Fengliang, who heads a steel industry group in the western province of Shanxi.

…"The Chinese have an unenviable negotiating position in iron ore. If anything they need more of it than they did before," said Michael Komesaroff, a mining consultant with Urandaline Investments.

Lower global prices for iron ore have made supplies from China's own high-cost mines less competitive, he said. The result is that China's steelmakers have this year become more dependent on imports, not less. Domestic iron-ore output, as of May, was down 6% this year.

Few Chinese steel companies now want to stay in the association's framework for iron-ore purchases, said Jia Junyan, a private iron-ore trader in Shanxi province. "No one wants to wait and end up with what will probably be a bad deal," he said. "The steel companies have lost faith in the China Iron & Steel Association. It's embarrassing. No one wants to listen to them," he said.‹