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BHP to Renew Iron-Ore Price Push in Threat to Mills

A sign marks the entrance to the BHP Billiton Ltd. headquarters in Melbourne. Photographer: Carla Gottgens/Bloomberg
A sign marks the entrance to the BHP Billiton Ltd. headquarters in Melbourne. Photographer: Carla Gottgens/Bloomberg

BHP Billiton Ltd., the world’s largest mining company, may use last month’s 16 percent decline in iron-ore prices to persuade steelmaking clients to pay cash instead of contract-based prices from next quarter.

Vale SA, Rio Tinto Group and BHP, the world’s biggest exporters of the ore used to make steel, scrapped a 40-year custom this year of pricing supplies in 12-month periods, replacing it with quarterly contracts based on the average cash or spot price over three months. Ending fixed-term contracts altogether would be the next step.

“There has been a drive from the large players in the iron ore market to spot prices for some time,” Alex Tonks, a commodity strategist at Bank of America Merrill Lynch in Sydney, said by telephone. “It really should occur this half; I would be thinking the next quarter.”

The slump in prices in May could help BHP negotiate a move to spot-based sales, offering clients a lower rate than quarterly contracts in anticipation of future gains. Yet supplies based on the fluctuating prices may squeeze profit margins at steelmakers and create price volatility for end users such as Toyota Motor Corp. and Volkswagen AG.

Goldman Sachs JBWere Pty estimated in March that Rio, BHP and Fortescue Metals Group Ltd., Australia’s biggest exporters of the ore, may be missing out on $20 billion of sales a year by not selling ore at cash prices.

Testing Point

“BHP are all about expediting the process, about moving to shorter-duration contracts,” Olivia Ker, a London-based mining analyst at UBS AG, said by phone. The next couple of quarters will be the testing point, she said.

The cost of ore, the largest raw-material expense in steel production, is about $170 per ton of steel, based on current prices, according to Bank of America Merrill Lynch. Steelmakers use 1.6 tons of iron ore and 0.5 tons of coking coal to make 1 ton of steel. Raw materials account for as much as 75 percent of production costs for mills, according to JPMorgan Cazenove.

The quarterly price for BHP’s and Rio’s Australian ore is likely to rise about 23 percent to about $148 a metric ton starting July 1, Colin Hamilton, an analyst at Macquarie Group Ltd. in London, said by phone. That’s a premium of about 6 percent to his forecast spot price at the same time of about $140 a ton, he said.

Lower spot prices may prompt some mills to default on quarterly contracts, according to Macquarie.

Contract Doubles

Until mid-April, iron ore prices had been rising over the past year as demand surged in China, the world’s biggest steel producer. BHP’s contract price doubled to $120 a ton in the quarter beginning April 1 from about $60 a ton for the year ended March 31, Macquarie data show.

The price for ore delivered in 24 months traded at $122 a ton today, according to SGX AsiaClear. Ore for immediate delivery to China fell 1 percent yesterday to $143.20 a ton, according to The Steel Index. The spot price has dropped 23 percent from its high this quarter of $186.50 a ton on April 21.

“Market-based pricing offers the industry an improved outcome,” Ian Ashby, BHP’s president of iron ore, said March 23. “This is especially so because of the dynamic nature of market-based pricing, which is much more responsive to changes in the underlying market fundamentals.”

Ruban Yogarajah, BHP’s London-based spokesman, declined to comment on the company’s current pricing plans.

Vale Price Jump

Brazil’s Vale said June 1 that quarterly prices for its sales starting next month will be based on the average spot-market price for ore sold in China in March, April and June. That’s a jump of about 50 percent from the previous quarter to about $128 a ton, said UBS commodity analyst Tom Price.

A move to spot prices may hamper efforts by steelmakers to predict costs at a time when steel prices in China are falling. Steel producers have urged authorities globally to examine the market after annual contracts were abandoned, saying the change served only to boost miners’ profits and uncertainty for buyers.

“The bad news for steelmakers is that we have lost visibility on their cost base,” said Christian Georges, an analyst at Olivetree Securities Ltd. in London. “The likelihood that margins will have been decimated through the summer has never been so high.”

Steelmakers including ThyssenKrupp AG, Germany’s largest, are studying using iron-ore swaps contracts to fix future costs, hedging their exposure to price fluctuations. Trading in the swaps may grow 10-fold to 1 million tons a day in two years, according to a February statement from Credit Suisse Group AG, which introduced the swaps two years ago with Deutsche Bank AG.

Index System

Steelmakers need visibility on future costs because they must configure their mills to process different iron-ore grades. Ore suppliers have yet to propose an index pricing system that reflects the volumes and qualities of ore sold on contract and allows a move to a spot-based market, according to Eurofer, which represents steelmakers in Europe.

In China, declining steel prices may force mills to curtail output and default on quarterly contracts, Baosteel Group Corp. said June 8. Vale, Rio and BHP may demand a 30 percent price increase next quarter, China Steel Corp. said last month.

Chinese mills will struggle to make a profit in the third quarter should steel prices continue to fall and iron ore contracts remain at about $150 a ton, Arctic Securities ASA said today in a report. “That could have been avoided if prices were traded on a spot price,” the broker said.

Steelmakers Follow Suit

Following the establishment of quarterly iron-ore accords, ArcelorMittal, the world’s largest steelmaker, and Tata Steel Ltd., India’s biggest producer, have said they may end annual steel sales contracts in favor of quarterly deals. Japanese producers may also shorten contracts, Tadashi Usui, a senior analyst at Moody’s Investors Service, said May 25.

“We never think the quarterly pricing is good for the industry,” Eiji Hayashida, president of Tokyo-based JFE Holdings Inc.’s steel unit, said May 28. “In reality we have no choice but to accept it.”

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