Steelmakers in India are expected to hike prices by Rs 4,000 a tonne in the next two months. The companies fear that a historic change in the method of pricing iron ore will increase their raw material costs. For close to four decades, iron ore miners and steel manufacturers used to negotiate the contract price of iron ore on an annual basis. However, on Tuesday, mining giants BHP Billiton and Vale struck deals with Japanese steelmakers to negotiate ore price every three months. The move helps miners get better price for their ore while it increases costs for steel companies which purchase ore from them.
The new pricing model has alarmed steelmakers across the globe, as it will permit miners to rework prices every quarter and make upward revisions, in line with spot market trends. Steelmakers now plan to increase prices to make up for the increase in raw material costs. Some have already raised their prices in anticipation of the rise in iron ore prices.
Seshagiri Rao, joint MD, JSW Steel, and group CFO, JSW, said: ?The new pricing policy brings a lot of uncertainty in the area of cost of steel production. Steel companies are not comfortable with quarterly pricing because the cycle is too short, and the hedging opportunities available to steel companies by way of long-term contracts with their customers is taken away by quarterly pricing.?
Steel sector experts believe the quarterly contract pricing system is highly negative for the industry. So far, the spot price for ore used to be 60-70% higher than the contract price. With the new three-month pricing model, the contract price will be closer to the spot price. Moreover, quarterly pricing will take away the pricing flexibility available with steel companies. So far, they could quote a long-term price to steel buyers, especially in the automotive industry; this flexibility won?t be available from now.
?Quarterly contracts will result in higher cost of production, sharp price fluctuations and less security in planning,? said a steel manufacturer requesting anonymity. According to reports, ore prices are currently trading at 100% premium to their 2009 contract rates.
On Tuesday, BHP Billiton and Japan?s JFE Holdings entered into a quarterly agreement, where Billiton would supply coking coal for three months at $200 per tonne, a 55% increase over the last year?s annual contract price of $128 per tonne. Japanese steelmakers Nippon Steel and Sumitomo Metal have reportedly agreed to buy iron ore from Vale on a quarterly basis at a price close to 90% higher than the 2009-10 annual contract price. Nippon Steel had provisionally agreed to buy Vale?s iron ore for a price of $100-110 a tonne for the three months till June.
According to Rao, the cost of production for steel manufacturing is expected to increase by $165 per tonne due to rise in iron ore and coking coal prices. And the increase in cost will have to be passed on.
Industry sources say steel sector?s Ebitda per tonne could come under pressure during April-June 2010 once higher input prices kick in as there is still a considerable level of oversupply in the western world.