Steeling for more commodities volatility
Remember when Vale and BHP, two of the world’s biggest iron ore miners, changed their pricing contract methods with China and Japan? The move from annual to quarterly contracts came amid resurging Chinese demand for iron ore, which put the miners in a powerful position. By re-setting the prices more frequently in a rising market, profits were predicted to soar, and indeed they did.But the buyers, for their part, were also benefiting as prices rose. Because, as Reuters’ Andy Home points out, the latency of the price calculations meant that steel mills were happy to not pay the most up-to-date price. Home writes:
Prices for each quarter are based on the average of the spot price, most commonly basis Platts’ 62-percent iron content index , over a three-month period starting four months before the relevant quarter.
That works fine with steel mills when spot prices are stable or rising but not when they are falling. As of Monday, for example, the Platts spot price assessment was $152.25 per tonne. The quarterly price based on the same index with the four-month lag is around $175 per tonne.
And now, of course, those same customers are not happy. China in particular still has strong demand, but the country’s steel mills are feeling the pressures of increased uncertainty both at home and abroad. China’s own iron ore production reached record levels last month, writes Homes – notable because of the high cost and poor quality of those resources. BHP Billiton recently confirmed it is pricing the “overwhelming majority” of its iron ore is priced monthly, and Homes says Vale, which followed BHP from annual to quarterly pricing almost two years ago, is set to change to more frequent pricing:
Vale, which has previously said it was comfortable with its quarterly pricing mechanism, seems to be bowing to buyer pressure. Chinese steel mill sources have told Reuters that the company is offering to price Q4 deliveries against OctoberDecember spot rates, in effect removing the historic time lag.
If contract prices continue to move closer to spot pricing — a situation more closely resembling the crude oil market — it will be a challenge for the steel mills, who will have to manage volatility, says Homes. BHP has also indicated that coking coal, the other key ingredient for steel mills, is even more heavily based on spot markets. And China will not be able to rely so much on its domestic supplies of that material either, as Wood Mackenzie coal analyst Prakash Sharma wrote on Wednesday:
China is forging ahead with plans to close all blast furnaces under 1,000 cubic metres and install new blast furnaces with capacities in excess of 2,000 cubic metres. The larger furnaces need coke produced from high-quality coking coal.
It will also be a challenge for the miners, too. As the FT pointed out last year, spot pricing tends to favour Australian exporters over Brazilian, as shipping costs are much lower — something that Brazil-based Vale has been tackling with determination.
Australia, meanwhile, where iron ore and coal (both coking and thermal) account for as much as half of its terms of trade, will have to deal with increased volatility in its tax receipts, argues Macrobusiness — and all without the stabilising benefit of a sovereign wealth fund to smooth things out. Oh, and then there’s Mongolia, already nervous about its soon-to-be-massive dependence on Chinese coal demand.
Prices for each quarter are based on the average of the spot price, most commonly basis Platts’ 62-percent iron content index , over a three-month period starting four months before the relevant quarter.
That works fine with steel mills when spot prices are stable or rising but not when they are falling. As of Monday, for example, the Platts spot price assessment was $152.25 per tonne. The quarterly price based on the same index with the four-month lag is around $175 per tonne.
And now, of course, those same customers are not happy. China in particular still has strong demand, but the country’s steel mills are feeling the pressures of increased uncertainty both at home and abroad. China’s own iron ore production reached record levels last month, writes Homes – notable because of the high cost and poor quality of those resources. BHP Billiton recently confirmed it is pricing the “overwhelming majority” of its iron ore is priced monthly, and Homes says Vale, which followed BHP from annual to quarterly pricing almost two years ago, is set to change to more frequent pricing:
Vale, which has previously said it was comfortable with its quarterly pricing mechanism, seems to be bowing to buyer pressure. Chinese steel mill sources have told Reuters that the company is offering to price Q4 deliveries against OctoberDecember spot rates, in effect removing the historic time lag.
If contract prices continue to move closer to spot pricing — a situation more closely resembling the crude oil market — it will be a challenge for the steel mills, who will have to manage volatility, says Homes. BHP has also indicated that coking coal, the other key ingredient for steel mills, is even more heavily based on spot markets. And China will not be able to rely so much on its domestic supplies of that material either, as Wood Mackenzie coal analyst Prakash Sharma wrote on Wednesday:
China is forging ahead with plans to close all blast furnaces under 1,000 cubic metres and install new blast furnaces with capacities in excess of 2,000 cubic metres. The larger furnaces need coke produced from high-quality coking coal.
It will also be a challenge for the miners, too. As the FT pointed out last year, spot pricing tends to favour Australian exporters over Brazilian, as shipping costs are much lower — something that Brazil-based Vale has been tackling with determination.
Australia, meanwhile, where iron ore and coal (both coking and thermal) account for as much as half of its terms of trade, will have to deal with increased volatility in its tax receipts, argues Macrobusiness — and all without the stabilising benefit of a sovereign wealth fund to smooth things out. Oh, and then there’s Mongolia, already nervous about its soon-to-be-massive dependence on Chinese coal demand.
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