The war of words—and sometimes deeds—continues between China and the world’s biggest iron ore producers, BHP Billiton (BHP), Rio Tinto (RTP), Vale (VALE).
The producers seem intent on freezing China out of the annual negotiations that set iron ore prices for the year ahead. The companies are instead talking to Japanese steel makers in an effort to reach a benchmark deal that will then be presented to Chinese steel makers on a take it or leave it basis, according to the Financial Times.
China is the world’s largest iron ore importer, accounting for 50% of the world’s seaborne iron ore market.
But China’s steel industry, led by the government owned giant Baosteel, has been hamstrung by internal disagreements about how to negotiate and what price target to aim for.
Australian producers aren’t in a mood to talk after the detention last year of Stern Hu, Rio Tinto’s former iron ore executive in China and three other employees. Recently Hu’s case has been referred to Chinese prosecutors who have 45 days to decide whether to bring him to trial.
I think this quote from an Australian iron ore executive pretty much sums up the attitude at producers this year: “As far as I am concerned, they [the Chinese] could come over to Australia if they want to talk.”
The likely result?
China wouldn’t have to accept any deal negotiated by the Japanese or other Asian steelmakers as the basis for an annual contract. Instead Chinese steel companies could buy iron ore on the spot market.
But that would be very expensive. The current spot price is about $129 a metric ton. That’s about 50% higher than the negotiated annual price for 2009. Goldman Sachs recently projected a negotiated price of $69.60 for 2010.
That may be low. The China Iron and Steel Association, China’s representative in any annual talks, recently said it expected iron ore producers to look for a 20% to 30% increase in 2010.
In addition iron ore has been tough to find on the spot market in the last two months, Chinese steel industry officials say, as iron ore producers have reduced supply to strengthen their hand during negotiations. China has set a target to increase steel production by almost 9% this year in response to increased demand for steel created by the country’s economic stimulus package
The long-term effect of this war, of course, will be to reinforce Chinese fears about a conspiracy to stunt the country’s economic development by cutting access to critical raw materials. If I were in power in Beijing, the iron ore wars would certain have me ordering China’s companies to be even more active in buying overseas sources of raw materials.
NB,
Add in the fact that Apple is changing the way they’re accounting for sales on the iPhone (profits in the quarter it’s sold, rather than spread out over the life of the contract), and Apple is due for a big earnings surprise very soon!
Mind you, I’m not the biggest Cramer fan, although I do watch him for entertainment value (I enjoy loony people who talk about stocks). But he’s been plugging Apple for months. In this specific case, Cramer is right.
Just based on history, Apple has the growth record to justify buying it, and they keep putting themselves in the right position to keep growing.
But the thing that amazes me about Apple is their long term debt: 0. For a major growth stock, that’s unusual.
@EdMcGon – Cramer talked about the benefits to apple on his show yesterday as google decides to pull out (impact could be in the Androids as well as search rev).
Good! This is more FAIR trade. If China can produce it then they subsidize it–locking out “free trade”. If they cannot then they force the lowest possible price–locking out “free trade”. Campotex should do the same with fertilizers. Make China pay more and let loose some of that fancy dollar collection they’re hording. Rant over.
Jademan,
I have been watching CTRP also and looking for and entry point. the 50MA sits at $70.52 as I write this post. I want to see if I can enter around $65 or less?
Jim,
Speaking of China, any comments on the potential Google pullout? Obviously, Baidu stands to gain from it, but what about Apple? I’m surprised nobody has mentioned that possibility.
post script:
As Jim once said Actually he said it several times, This is a very risky stock and “I wouldn’t put my kids retirement money here”
And Jim did sell this out of the picks portfolio some time ago (He still retains it in his Jubak picks 50 portfolio)
Down sides?
Andrew Forest is notorious in the industry, he was removed from a director position at the last mine that he ran for impropriety.
What we see happening in China right now may very well put a damper on Commodities.
Rising interest rates may put a damper on commodities.
Rising dollar may put a damper on commodities.
Double dip will put a damper on commodities.
Exploding bubbles in China will put a damper on commodities.
China is very new to this “fiscal policy” thing, raising rates to balance or deflate bubbles, or to prevent over heating or inflation etc… Just look at the job that the US does (And they have 100+ years of expierence!)
A Misstep by China could bring a lot of pain for the whole world economy… Iron ore included…..
EdMcGon is correct.
The last round of negotiations saw FSUMF going to the Chinese with a slightly lower price point then the Japanese got, they were hoping to force China into a long term commitment via a loan to expand infrastructure.
The loan never happened, and FSUMF stopped selling ore at the negotiated price back in December, and presumably, sold whatever ore was not contracted elsewhere, on the spot market.
Fortescue can now do three things.
1.) Revisit last year’s plan to squeeze a loan or investment (That does not include any language that would dilute the number of shares outstanding) out of china by promising a lower price for the ore then the Japanese get. This is what they tried to do last time round, and if you remember when the deal didn’t go through, the shares of FSIMF went up. I think investors believed that any deal with China was likely to add so much debt to FSUMF that it would be a killer repaying in the long term (They already have a massive debt ratio.)
This time around, with spot prices up $60 (US), they may be able to get what they want, if the Chinese believe they missed the boat on lower prices, and the only direction for ore is up, they may decide that they now need to make any concessions necessary to build a reliable source for ore, before it moves even more out of reach. It would also make them very happy to smack RIO and BHP, whom they see as “not nice” partners.
2.) Wait until a contract price is set, and use that as the basis for FSUMF ore, and expand using free cash flow.
3.) Wait until a contract price is set, and offer the Chinese a long term discount if they contract to buy 100 – 200 million tons of ore from FSUMF with and upfront payment that would put FSUMF on the road to immediately start the 2nd and 3rd phase of the port, rail and infrastructure (De sanding, earth moving , dump trucks, additional locomotives etc) that will get them to 95 million tons per year ahead of the current time table. If they could get an upfront payment of 2 billion dollars in return for a long term contract of 50 million tons a year ( 50 million tons times $100 per ton (Which is a significant discount to spot price would bring in about 5 billion a year for FSUMF) That would be more than enough to put FSUMF on the fast track to expanding the mines and facilities, and possible becoming the “New force in Iron Ore”
This should play out well for FSUMF, I believe in the not too distant future, with everybody and his uncle expanding ore production, we may run into some of the same problems we see with Aluminum, that only the lowest cost producers will have enough pricing power to live long and prosper. Luckily, the ore from the Pilbara is some of the cheapest produced on earth.
In an earlier column about China you mentioned CTRP hitting its 50 day MA as a test for China stocks in general. It just hit the 50 day MA.
Marcus, first, my disclaimer: I am not that familiar with Fortescue. That said, unless Fortescue can supply all of China’s needs, all they can do is make a deal, and if they do that by giving China what China wants, they run the risk of locking themselves into a lower margin deal than the big three will be getting from other buyers.
Just my opinion, but if I’m running Fortescue, and I have the production capacity, I sit back and see what kind of price the big three get, THEN go to China and undercut the big three. By then, China will be willing to play ball at a higher price, while allowing Fortescue to increase their business AND still make greater profits. Win-win.
Jim/Ed,
I’m more interested in the implications for Fortescue. They’ve typically been outside the price negotiations of the big 3 (Rio Tinto, Vale, and BHP), so maybe this opens the door for them to step in and negotiate their own more profitable or higher volume deals.
Thoughts?
Jim,
Do you think this could push China to play hardball with their rare earth metals?