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Iron ore price negotiations - Steel makers weighing options

Reuters reported that Europe's steel makers are in tough negotiations with powerful iron ore miners who are pushing to end a decades old annual benchmark pricing system for the steel making ingredient in favor of a more flexible mechanism.

It may be noted that the world's top three iron ore miners namely Vale, BHP Billiton and Rio Tinto are either in talks with their customers or have reached an agreement to supply ore priced on a quarterly basis.

But major steel makers including ArcelorMittal as well as ThyssenKrupp said that they still prefer the annual system as a fluctuating pricing scheme will force them to renegotiate regularly with their own customers.

Miners have not disclosed the price hike they obtained so far in this year’s talks but analysts estimate a rise of around 80% to 90% in iron ore, which has more than doubled since September in the spot market. Below are some possible moves by steel makers to adjust their business model in a changing environment:

1. Convince steel customers to adopt flexible pricing

Flat steel users such as engineering companies as well as automakers are expected to fight to maintain the current annual pricing system that would allow fixed costs.

Analysts say steel makers do not have the same bargaining power as miners due to the industry’s fragmented structure, compared with the three big miners controlling around 70% of total sea borne iron ore trade.

Mr Frederic Gits head of EMEA Industrials at Fitch Ratings said that "If you look at the balance of power between the various levels of value chain, then it looks like steel makers will have to absorb more volatility, brought by the quarterly pricing."

Austrian steelmaker Voestalpine said last week that its customers were extremely reluctant to adopt quarterly contracts as negotiating a price so often would make it very difficult to keep project costs within their original budgets.

Analysts say life could be particularly difficult for Germany’s largest steelmaker ThyssenKrupp, whose contracts are primarily on a long term basis.

However, ThyssenKrupp produces high value added, specialty products, some of which it develops jointly with its automaker customers, who may not be able to switch to another supplier and that could give Thyssen more bargaining power.

2. Vertical integration

Self sufficiency in key steelmaking raw materials iron ore and coking coal is set to be a top priority for steel makers globally with sky rocketing prices for both resources.

ArcelorMittal is thought to be the best positioned with 50% self sufficiency in iron ore and a strategy to boost this to 75% by 2014. In Europe, ThyssenKrupp looks vulnerable as it does not own any mines and has traditionally focused on investing in downstream such as production of high tech steel.

voestalpine has 25% integration in iron ore, which it aims to raise to one third of its total needs in the medium term. The company purchases its iron ore from various miners and is not dependant on one big supplier.

3. Start using hedging tools to mitigate price risk

The conservative steel industry has traditionally been critical of hedging instruments, saying the involvement of financial markets distort prices an argument reflected in industry leader ArcelorMittal’s opposition to steel futures.
But analysts say with their raw material purchases based on a fluctuating period while their sales are tied up under annual contracts, the USD 500 billion industry may have to dive into hedging whether they like it or not.

Mr Gavin Wood analyst at Nomura said that "Essentially somebody will need some sort of hedging mechanisms, whether it’s the automakers hedging their steel prices or whether it's the steel producers hedging their input raw material prices that's not completely clear."

 

Apr 19, 2010 09:23
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