For several years during the 2007-2010 period I was a lone voice questioning the long term wisdom of the Australian miner’s crusade to destroy the iron ore contract pricing system. In the end the demise of the system was probably inevitable owing to its internal pressures. Negotiations over so much money, in such nationally strategic industries, conducted by so few individuals, was bound ultimately to generate explosive frictions.
The original annual contract system provided suppliers with higher prices than they would have otherwise achieved given they traded on security of supply. But when China entered the iron ore market en masse and prices began to rocket pre-GFC, miners became impatient that they were missing out on the gains and, as the post-GFC boom took off, they used their market power to break the system.
Some argue that it was the Chinese that drew first blood by defaulting on contracts during the GFC, and it’s true. But it was also an environment in which BHP and RIO planned the most egregious monopoly merger of any that I can remember so the environment was already poisoned and everyone’s actions frenzied.
Anyway, spot prices and shorter term contracts arrived, prices soared and so did profits.
But even back then it was obvious that the time would come relatively quickly when iron ore expansion plans and slowing Chinese growth would mean that the lost contract system would become an advantage to buyers. That time has now come, seemingly. From the SMH blog:
Chinese steel mills are cutting back on long-term iron ore contracts in favour of cheaper spot cargoes, confident that beaten-down prices are unlikely to rebound amid the first global ore surplus in 10 years.
…Market talk is swirling that some Chinese mills have cancelled iron ore cargoes, with several traders saying up to four million tonnes have been rejected, although this could not be verified by Reuters.
…WA miner BC Iron said some of its customers have asked for small discounts or more flexible pricing periods, but it has not seen any cancellations.
…A senior executive at a leading Chinese steelmaker told Reuters the firm has cut the volume of iron ore it buys via long-term contracts by about 10 per cent this year, noting that some of its contracts with miners gave it an option to reduce volumes.
A second official who buys iron ore for a mid-size steel mill in northern China said the company was now relying totally on the spot market.
“We used to go with annual term supply but we have stopped doing it from this year as the market outlook remains weak,” the official said.
Lowest marginal cost of production determines prices is the iron ore law of commodity markets long term and producers are price takers. Like so much of this boom, it was pissed up against the wall long before it ended.
