Overhang for Steel Stocks

UOB KayHian: The failure of Chinese steel mills to reach an agreement on the price for their 2008/2009 iron ore imports with the Australian ore suppliers – Rio Tinto and BHP BIlliton – will likely create an overhang for steel stocks dependent on imports until the talks are wrapped up.

Given the chasm between the two countries, an agreement is unlikely any time soon and could drag until June.The Chinese mills expect the two Australian suppliers to accept the 65% price rise that Brazil’s CVRC - had earlier agreed with the Chinese and Japanese steel mills about two weeks ago.

Australian mines want higher ore price rise. However, the Australian miners want much more – they want to equalise the price of ores imported from Brazil and Australia. In general, the port price of ores of similar grades imported from Australia is at least US$30/tonne cheaper than that of Brazilian imports because of the lower shipping cost arising from the shorter distance from Australia to China. The Australian miners want a share of the cost savings in freight and so are demanding ore price increases of well over 70% - or else one of them, Rio Tinto, has openly threatened to sell more of its ores on the spot market. Spot ores now fetch about US$210/tonne compared to the US$108/tonne that CVRD has agreed with the miners. (The new contract rates agreed with CVRD will be effective from Apr 08 to Mar 09, which ties in with Japan's new
fiscal year.)

Global ore trade are in hands of three miners. About 90% of the marginal increase in the global iron ore trade comes from China as its steel sector produces about one-third of the world’s steel output. Almost 80% of the world’s trade in seaborne iron ores are in the hands of three miners – CVRD, Rio Tinto and BHP Billiton - allowing them to extract huge increases for their ores. The Chinese are handicapped by a fragmented steel market, so it is hard to gain any leverage from being the world’s biggest importer of iron ores.

Higher China ore output not enough. China has been trying to raise its output of ores, but it is still not enough to meet demand. In general, they are low-grade ores of 35% iron content compared to the average grade of 65% for imported ores.

My Take: I believe the Chinese will have no choice but to subscribe to the Aussie's demand as the latter can sell the ores at a much higher price at the spot market and will be quickly taken up by international buyers. (The other main exporters of iron ore are India, Russia and Iraq but they are of lesser quality and output). The Chinese will buy because there is a sustainable demand in China for steel products. Furthermore, the fact that the 10 ten millers in China only has 33% market share in the country's steel industry compared to Japan's top five millers who have at least 70% of market share, only show Chinese millers have little leverage in negotiation of iron ore pricing. The increase in the primary cost of production(iron ore, coal and freight charges) by the millers will be passed on to the consumers but if the price is too high, consumers may take on the lower quality steel. Millers in China are pressured to have a modern, efficient and environmentally friendly blast furnace plant and they do not come cheap. This industry is facing massive challenges ahead.