Global sourcing of raw materials is one of the reasons why the steel industry is passing through a great deal of volatility and uncertainty. The world prices of iron ore, coal, nickel, manganese – whatever one takes, have exhibited huge turmoil in the spot market. Even the contract market is no differently placed in this respect.
For example, coking coal prices moved down from about $120 to $98 in 2007 and then jumped to about $300 per tonne. They are usually not in sync with the steel prices through the year. For example, when the coking coal prices dropped to $98 from $120 or so, the steel prices were expected to fall during the year. It happened the other way. In the subsequent year, the prices of coking coal contracts rested at $300 on strong price expectations of rising steel prices. On the contrary, the steel prices crashed and this year the contracts are down to anything between $110-129 per tonne.
The story is not much different for iron ore.
The contract prices are to provide stability to the costs of production of steel and help the steel makers plan their business better. What is happening now is that they are taken out of the day to day concerns of change and put into the anxiety of an annual ritual that they know they will have to live with irrespective of whatever happens in the steel mart.
This year, several steel mills forced the coal and iron ore producers to renegotiate existing contracts. This was not an easy thing to do. Once a contract is signed, each party would like that to be honoured irrespective of whatever happens to the ground – rise or a fall in the spot market or a rise or fall in the steel market. On a normal day, one would not like the conditions to change so drastically and the contracts are therefore likely to sail through for the year without any significant hardship to any of the parties involved, especially when the year to year changes in the prices is not much. Contracts of the present day are good only for a normal period. The problem is that the price changes, year-on-year, are so drastic that whoever is signing the contract is taking a big risk, if the market remains uncertain and the business environment unpredictable. It is very likely that such contracts will be sought to be violated in the slightest pretext. If so, what is the sanctity of these annual contracts?
Annual contracts are meant to serve one basic purpose. They provide assurance of supply. The buyer actually pays for it. They help the miners plan better their logistics and thus reduce costs. The benefits do not necessarily come to be buyer.
What happens when the steel demand is low and production is cut in response? Demand for coal or iron ore falls. The buyers should become kings then. However, the mineral assets are not under widespread ownership and the market is far from being competitive. The mining oligopolists still hold sway.
Annual contract negotiations have lost significance when it comes to prices. It has a meaning only when supply volumes are considered. There is a need for a new arrangement for interdependence.
?The author is a strategy consultant and the views expressed are personal