China’s steel industry faces a historic moment of truth as it threatens to abandon the traditional “benchmark” for annual iron ore pricing in an apparent fit of pique at the refusal of the miners to share their profits.
The anger is palpable in the voice of China’s chief iron ore negotiator, Shan Shanghua of the China Iron and Steel Association, and from the mills: miners are making big profits but China’s steel industry loses money.
It is only common sense, says Mr Shan, that this situation cannot persist.
The conflict has arisen out of a peculiarity of the iron ore market – for the past 40 years, prices had been settled annually in secretive talks between steelmakers and miners, rather than in the open market, as in other commodities such as crude oil or copper.
The first agreement creates a benchmark price that is followed by the rest of the industry.
The peculiarities do not end there. China’s steel industry is also different: production has remained high even if final demand has slumped, supporting input prices such as iron ore but depressing steel prices and, therefore, margins.
This is explained by Beijing’s desire to avoid job losses in the industry.
Mining executives invol-ved in the talks view Cisa’s argument as an attempt to force them to share the cost of Beijing’s social policies.
But Chinese officials see things differently. The country, the world’s largest iron ore consumer, has led the negotiations since 2005.
Its leadership started as its voracious appetite for ore triggered large price increases, including a record 85 per cent last year.
It was on the back of that increase – seen in China as a humiliation – that Beijing was adamant that, this year, with demand so much lower because of the global financial crisis, it would hold the balance of power. The Chinese side has become increasingly angry as the miners have refused their demands for a 40-50 per cent price cut, which would return prices to the level of 2007, say executives familiar with the talks.
Cisa is not alone in its fight to achieve a large cut. Chinese mills are in a defiant mood, saying they would rather buy cheaper ore on the spot market than accept a benchmark deal with a 30-35 per cent price cut.
The mills dismiss arguments that this is a short- term strategy that leaves them hostage to price rises once ore demand recovers.
But will China abandon the benchmark system, with its advantages of price stability, for an extra 10 percentage points price cut?
The answer, which mixes businesses, economics and politics – and some personal prestige – would influence the global economy as iron ore prices filter into steel costs and ultimately in the prices of goods such as cars and washing machines.
Mr Shan, who is leading the negotiations for the first time, is under heavy pressure and risks losing face if he cannot deliver the price cut he has promised since December, says Xu Zhongbo, a veteran steel analyst at Beijing Metal Consulting. “And Mr Shan has no steel mill,” he adds.
This echoes an argument also used by mining executives involved in the talks when they described Mr Shan as a “politician, not a businessman”.
But at least for this year, the benchmark may survive.
“Mr Shan risks losing face but we are only talking about a 5-10 per cent loss of face,” says a mill executive.
Baosteel, China’s largest steelmaker, which led the talks until rEcently, is also likely to put pressure on Cisa to keep the benchmark.
But even Baosteel seems to be losing its cool. Xu Lejiang, chairman, said last weekend that commodities traders were “possessed by evil” and were pushing up costs for companies such as Baosteel.
Cisa, for its part, continues to play its “bad cop” role, saying yesterday it would not settle at a 30-35 per cent cut, the level at which South Korean and Japanese mills appear close to an agreement with the miners.
