Iron Ore — China creates a new national champion to counter the big miners.
The establishment of China Mineral Resources Group is no small event and could have a major influence on how iron ore contracts are negotiated in the near future.
What’s in store for Iron Ore pricing?
Anyone with some history in the metals business will know that for a long time Iron Ore prices were negotiated on annual contracts at a fixed price. This shifted around 2010 when BHP decided it wanted to change this methodology by way of moving to floating prices (indexes) based on the prevailing spot price of Iron Ore. The other big miners quickly followed suit.This made a lot of sense for them - Firstly, they could focus on operational excellence and cost reduction and secondly, their shareholders could be certain they were getting direct exposure to commodity prices.
This seems to have worked out very well for BHP, Rio Tinto and Vale. With average spot prices trading well in excess of the cost of production, miners have reaped bumper profits. But what about consumers? How has index pricing suited them? On the one hand, by using spot pricing you could argue that steel mills are better placed to pass on the input costs to the end-user (the buyer of steel products) on the other hand, the steel mills have been subject to extreme price volatility and prices that have generally been in favor of the miners.
China attempted to bring pricing closer to shore with the launch of the Dalian futures contract. However, sales prices are still dominated by off-shore indexes collated by the likes of Fastmarkets, MySteel and Platts. In the past 2 years not only have we experienced large volatility in the Iron Ore price, but also there have been some significant disconnects between the Dalian price and the Iron Ore indexes.
Time for Change?
China Mineral Resources Group (CMRG) has been established with a registered capital of 20 billion Yuan (US$3 billion) and is headed up by some big hitters from Chinalco, China Baowu Steel Group, Ansteel, MMG and the NDRC (the National Development & Reform Commission — a major state policy and planning agency). As we understand there are two main missions for this company 1.) To manage investment in overseas Iron Ore mining activity (particularly the giant Simandou project in Guinea) 2.) To coordinate the buying activity of Iron Ore.
Let’s put things in perspective.
China imports around 1.1 billion mts of iron ore a year. That accounted for around $190 billion of traded value in 2021. There are approximately 500 steel mills in China. Today most of these mills buy on their own behalf (either directly from producers or through traders). Given the executives of CMRG are coming from some of the largest producers, when you calculate it out this means CMRG could be responsible for buying close to 500 million mts of Iron Ore per year. Simandou is also expected to produce 100 million mts per year at some point in the future. It would also be safe to assume that coking coal will also fall under their mandate. So CMRG could have some very big clout.
What is the likely outcome?
Skeptics would say that we have seen this all before and that attempting to centralise buying in China just does not work. However, if we look at other commodities this is not really the case. For oil and gas we see an increasing tendency towards Government to Government arrangements. In copper the CSPT has had considerable influence on coordinating the buying activity of copper concentrates for Chinese copper smelters. China itself looks increasingly like a command economy with Beijing asserting a growing influence on strategic assets and planning. The miners would be making a mistake if they do not prepare for the changes ahead. The CMRG will be doing everything they can to bring negotiating power to their side of the table. This could see the end of index prices as we know it. What could be in its place? We will have to see, but a probable outcome will be longer term contracts directly with the CMRG. Under these contracts pricing could be based closer to the cost of production than the spot market price.
