Unfortunately for Rio, even a price cut of this size will not be enough to satisfy Chinese steel markers, with an annual production of about three times the Japanese. According to recent statistics, more companies among the 75 members of the China Iron & Steel Association (CISA) were suffering losses in April, and the losses were becoming heavier.
Sha Gang Group, China's largest private steel company, said if China accepted the Nippon price, it would be almost impossible for them to make profit. The company's production costs are very low compared with other large and medium steel makers in China, so if Sha Gang Group cannot make a profit, neither can most other steel makers in China. Ma Steel also said that the Nippon contract was still far beyond the expectations of Chinese steel makers, and that CISA must continue to negotiate with mining companies for China's interests.
Although this is the first long term iron ore contract price cut in 8 years, the price cut for power ore, most frequently used by Asian steel makers, is still quite far from 35%, the common expectation of the market, let alone China's demand for a cut of 40%.
CISA, in charge of negotiations this year for the first time, has so far remained silent. Analysts say if China were to accept the 32.95% cut, steel makers would see mounting losses, but if it does not, the traditional pricing mechanism, already in danger, may again be broken.
According to the agreement between Rio and Nippon, Pilbara　Blend　Fines and Yandicoogina　Fines will both go for 97 cents/DMT, 32.95% down from contract prices last year, while Pilbara　Blend　Lump will be at $1.12/DMT, down 44.46%.
The annual iron ore negotiations start on April 1 every year, but due to the differences between suppliers and steel makers over this year's iron ore prices, the negotiation hasn't reached a conclusion till now.
The agreement between Rio and Nippon is also the first long-term contract reached this year. Other major iron ore suppliers, including BHP Billiton and Vale, have yet to reach any agreement with steel makers.
Traditionally, once any of the world's major iron ore suppliers reaches the first price contract with any steel maker, other steel makers and iron ore suppliers will fall in line, but this mechanism was partly broken last year. After Vale, of Brazil, agreed to prices with east Asian steelmakers, the two Australian giant miners negotiated a higher price due to the shorter transportation distance. Vale then reneged on its contract with China's steelmakers in order to force a renegotiation.Â
BHP Billiton and Vale have made no comment on the Rio/Nippon deal, but if they follow convention, they will accept the price.
China, however, is adamant. It requires iron ore prices to fall back to at least 2007 levels, according to which prices for Australian ore would fall by 45%, and that from Brazil by 40%.
Now Chinese steel makers are mainly using power ore, and the percentage of lump ore in the total needed is only about 19%. According to the Rio/Nippon contract, FOB price for powder ore is $62.08 per ton, slightly higher even than the current spot price. With the release of the first long-term price contract, spot ore prices will also go up.
If China's steelmakers manage to break the benchmark contract price set between Nippon and Rio, the traditional benchmark pricing mechanism will be further damaged, perhaps destroyed. Chinese companies have long advocated a longer-term pricing mechanism, while BHP Billiton is trying its best to promote a new pricing mechanism according to an iron ore price index, requiring the new contract price to be decided by the index. Seizing the opportunity led by the closure of mining companies in China and the decline in iron ore spot prices, Rio Tinto and Vale are exporting more iron ore to China's spot market.