Recent changes to iron-ore pricing contracts have led to rising raw materials costs. Many steelmakers are protesting the changes, citing unfair market manipulation by the largest ore companies. What will the latest round of pricing disputes mean for manufacturers here and abroad?

In a recent round of contract negotiations, major iron ore mining companies around the world switched from long-term annual pricing contracts to more short-term quarterly pricing methods with many of their customers. This enables iron ore firms to capitalize on a surging market, but will increase raw materials prices for a large number of steel manufacturers, putting many steelmakers in opposition to this latest move by suppliers.

“The ability of the mining companies to impose this change which maximizes their short-run profits, comes from the uncompetitive market for sea-borne iron ore,” Ian Christmas, director general of the World Steel Association, said in a statement a week ago. “Just three companies dominate this business with the major Brazilian supplier having a virtual monopoly in the Atlantic basin and the two major Australian companies having a virtual monopoly in the Pacific basin. The two Australian companies now propose to merge their Western Australian mining operations.”

The three companies mentioned — Brazil’s Vale SA and Australia’s BHP Billiton and Rio Tinto — control more than two-thirds of the world’s iron ore output, according to IndustryWeek. Their decision to move away from the traditional annual benchmarking system to a quarterly pricing model has raised complaints of anti-competitive market manipulation.

“The benchmark system may have imperfections but it has the merit of supporting long-term relationships between the steel industry and raw materials suppliers leading to beneficial medium-term investment decisions,” Christmas said. “The implied move to spot pricing will be volatile and benefit neither side in the medium to long term.”

The new contracting method hinges on a shift from negotiated pricing terms to a system in which future prices are set by the market, based on an index. The major iron-ore mining firms consider this “spot pricing” approach as a better way of obtaining full market value for their materials and more efficient contracts with customers.

“Transparent and regular pricing allows customers to mitigate risks on short, medium and long term contracts,” Ian Ashby, president of BHP Billiton’s iron ore operations, said in a presentation on iron-ore market growth last month.

“The long-term contract worked for 90 years very well for both sides, for both the client and the miner,” Vale CEO Roger Agnelli told Reuters. “I think that model that we are proposing and talking about with clients, of quarterly averages, is helpful for us to be able to complete our investment projects.”

The effects of the pricing pressure are already being felt in global steel production. The price of iron ore is expected to increase by 90 percent in April, and some steelmakers are looking for ways to mitigate rising expenses.

“Facing higher raw-material costs, some steel producers are planning to push through price rises in coming weeks to manufacturers who use steel in their products,” the Wall Street Journal reports. “But they already know that they won’t be able to pass on all the costs — and may see stiff resistance to the ones they are planning.”

Some estimates project “raw-material input costs this year will increase between $125 and $160 a metric ton, with more than half of that coming from iron ore,” according to a separate report from the Journal. “Some steelmakers have indicated that steel prices could rise by $160 a ton to offset higher input costs.”

Although the contract changes are likely to yield general volatility in iron ore pricing, much of the resistance to the new arrangement is coming from European and Asian steelmakers, which rely more heavily on supplier contracts than United States firms. In terms of global competitiveness, domestic manufacturers may, in fact, benefit from the new system.

“The impact the iron ore quarterly pricing will have on the domestic steel industry is not directly related to their costs. Most North American mills either own their own ore (USS) or have long term contracts in place which will minimize their exposure to the price volatility which will be seen in Asia and Europe with the new quarterly contracts,” John Packard, steel expert and founder of Steel Market Update, explains.

“Prices will be higher outside of North America which will provide a base of price support to the domestic steel industry. As international prices rise we can expect a form of ‘push’ to prices here in North America,” Packard adds. “Now we may well be in an environment where international prices help keep North American prices propped up.”

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Resources

Statement on Iron Ore Contracts
World Steel Association (worldsteel), April 1, 2010

Global Steelmakers Alarmed By Iron Ore Price Spike
by Jonathan Katz
IndustryWeek, April 2, 2010

BHP Says Trend to Market-Based Ore Pricing Will Stay
by Jason Scott
Bloomberg News, March 23, 2010

BHP, Vale Shift to Quarterly Iron Ore Prices
by James Regan and Yuko Inoue
Reuters, March 30, 2010

Consumers Not Likely to Feel Commodity Cost Rise
by Robert Guy Matthews
The Wall Street Journal, April 5, 2010

Complaints Rise on Iron-Ore Prices
The Wall Street Journal, March 31, 2010

Joint Statement on Iron Ore Prices by Eurofer and Orgalime
European Confederation of Iron and Steel Industries, March 31, 2010

The Iron Ore Settlements and the Impact on Steel Prices
by John Packard
Steel Market Update, April 7, 2010