Iron ore prices: how far will they go

Written by AS Firoz | Updated: Oct 29 2007, 08:09am hrs
Iron ore is hot. A reported price of $210 per tonne landed in China, presumably for fines from India a week ago, is an indication of the shape of things in the market. With shortages of ships and oil prices hitting $92 a barrel, the freight costs have turned frightening, with worse to be expected in the days to come.

One expects the negotiations for iron ore contracts to end with a higher price for it. But, how high will that be While most analysts have pitched for the 25-30% range, there are views that the price rise can be a higher by 50% or so. Nothing is impossible and if one goes by the current contract and spot price differential, a 50% hike will not be out of place to expect. Fair enough from the point of view of iron ore miners. But, will steel makers give in so easily

Much will depend on whether steel makers are in a position to pay this much on Chinas steel production growth and the resultant iron ore hunger for them. Reports have forecast some slowdown in steel production growth in China in 2008. The point is that even if the production growth rate slows down, the country will still add significant absolute volumes. Chinese steel makers despite being put to a government-intervened discipline, will chase iron ore, compete among themselves, and strengthen the bargaining position of sellers in the process. Their own iron ore concentrates are not cheap and reach the steel plants with fairly high price tags.

Domestic demand for iron ore in India is set to rise with higher steel production expected in the coming year. While those with captive mines will rejoice at the sight of iron ore prices hitting the roof, the increased market demand for merchant products and the consequent higher prices, will prevent a lot of iron ore from going out of the country. Further, exporting in increased volumes will not be easy. With infrastructure constraints all around, iron ore miners will be happy selling within the country as much as they can. The sponge iron industry is ready to pick them up at any cost. It is also a fact that the merchant mining capacity in private hands is not as large and they may not be able to immediately raise the capacity either from their existing mines or from new ones (they have not had too many significant leases in any case in the recent times!).

With reduced exports expected from India and higher freight from Brazil, Australian miners will be in great shape. But, they are also not in a position to raise production sufficiently and move them efficiently and reliably (due to infrastructure constraints).

Steel makers in China, Korea, and Japan will take note of all the points discussed above. They will be well prepared to accept a significantly higher price as they see very little space today to bargain. The question for them is whether they will be in a position to pass the increased costs on account of iron ore on to the price of steel. Unable to export at will, Chinese steel makers can find their domestic prices not increasing sufficiently in a sort of non-market situation to absorb all the cost hikes on account of both iron ore and coal.

The prices of flat steel are lower today than one expected the same to be a month or so ago. The picture for 2008 has been hazy from today. Accepting a higher price based on the reality today can be terribly risky.

How far will the Chinese go, will depend on this.

The author is Strategy Consultant: Steel, Minerals, and Coal