Rio's fate aside, China braces for costly iron ore

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By Lucy Hornby and Nao Nakanishi
February 6, 2008

BEIJING/HONG KONG, Feb 6 (Reuters) - China may yet seek to spoil the merger of two of its biggest iron ore suppliers, but that won't help its steelmakers stave off another big rise in annual prices when negotiations resume later this month.

Chinese steel industry officials are starting to suggest they could accept an increase of 30 percent for the year beginning in April, but even that could be hard to win with spot market prices now nearly double what they were last summer.

"I think a 50-70 percent increase is still possible. It would still be lower than spot ore prices," said a trader in Beijing who sells spot iron ore to China. Analysts who expected a modest increase months ago now see a rise of over 50 percent as likely.

Top miners BHP Billiton (BHP.AX: Quote, Profile, Research) (BLT.L: Quote, Profile, Research) and Rio Tinto (RIO.AX: Quote, Profile, Research) (RIO.L: Quote, Profile, Research) -- which together supply around 40 percent of China's iron ore imports -- are believed to be aiming at a 70 percent price hike.

BHP on Wednesday launched a formal $147 billion bid for Rio, but China's Chinalco could block the takeover after it teamed up with Canada's Alcoa (AA.N: Quote, Profile, Research) to snap up a 9 percent stake in Rio.

Chinese steel mills, led by top producer Baosteel, are expected to resume 2008 price negotiations later this month after the Lunar New Year holidays that began on Wednesday.

Mills are under increasing pressure from rising raw materials costs, including iron ore, coal and coke. A 35 percent rise in term prices would increase the cost of making steel by 10.6 percent, according to Helen Lau, metals analyst for Daiwa.

Officials with the iron ore miners have denied that any firm price is on the table for discussion yet.

Contract iron ore prices have nearly trebled over the past five years, rising 9.5 percent for the current year to between $55 and $63 a tonne, free on board, for Australian ore.

Despite a likely U.S. recession and winter transport problems in China, which cut coal supply to mills and forced many metal smelters to shut, Australia's Goldman Sachs JBWere Investment Research said contract prices would probably rise by 60 percent, double its earlier forecast.

"We estimate that the gap between supply and demand in seaborne iron ore trade will widen to about 40 million tonnes this year," Goldman said in a report, adding China's iron ore import requirement would rise despite slowing steel growth.

"Tightness in the iron ore market is clearly manifest in spot prices with Indian sinter feed trading at an approximate 90 percent premium to contract ore from Brazil and a massive 160 percent premium to Australia," Goldman said.

Iron ore traders in China said the benchmark mid-grade spot Indian iron ore prices fell to about $180 a tonne, including costs and freight, down from a record of nearly $200 in December but still well above $100 reached in mid-2007.

The traders ascribed the softer Indian prices to Beijing's credit tightening, power shortages and soaring prices for raw materials, including coke, which had led to closures of about 10 percent of China's total steel capacity of about 500 million.

Chinese steel mills rely on long-term contracts for just over half of their iron ore, the price of which is set at the start of the year through often acrimonious negotiations.

Two rounds of talks in January failed to reach a deal, with some consumers reluctant to agree to any big increase for fear of incurring the wrath of their peers.

"Several years ago (in 2005) Japanese buyers were blamed for accepting a high price and Chinese buyers were blamed when they sealed a deal last year, so nobody wants to be first to settle the price," said an analyst at a Japanese brokerage.

China's iron ore imports rose 17.4 percent to 383 million tonnes last year, meeting about half of demand. Brazil, whose flagship Vale (VALE5.SA: Quote, Profile, Research)(RIO.N: Quote, Profile, Research) is the world's biggest producer, supplied 25 percent.

(Additional reporting by Chikafumi Hodo in Tokyo and Fayen Wong in Sydney; Editing by Jonathan Leff)

Rio's fate aside, China braces for costly iron ore | Reuters