Last Updated : 31 July 2009 at 15:20 IST

Steel sector and delayed iron ore price negotiations

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By Julian Murdoch
Iron ore price negotiations, usually wrapped up by a June 30 deadline, have instead gone on for months this year, with the big three - Rio Tinto, Vale and BHP - still at the bargaining table with China.

China has been pushing for cuts as high as 45% off last year's record prices. Needless to say, the miners have been resistant.

But now there's light at the end of the tunnel: BHP just agreed to a 33% cut in benchmark price for Chinese iron ore, although the price doesn't apply for all its ore. BHP CEO Marius Kloppers, long a proponent of changing the way iron ore is priced, has made no secret of his desire to move away from the traditional benchmark pricing and more toward spot market sales. This new agreement gets them one step closer to that.

According to a company press release, 23% of BHP's iron ore will be sold at the lower annual contract price just agreed upon. A full 30% of BHP's iron ore will be sold "on a mix of quarterly negotiated pricing, market clearing price (spot market) and index-based pricing." And the remaining 47% of BHP's ore? Those negotiations are "ongoing."

Now we just have to see what plays out between Vale, Rio Tinto and China - negotiations that Rio Tinto is currently not a part of, as the country continues to investigate the company's employees on charges of espionage.

But iron ore still needs to flow into China, and without an official benchmark price, some, but not all, steel mills have started to turn to the spot market. Bloomberg reports that about half of Vale's shipments are selling at the same benchmark prices the company agreed to with Japan and Korea, a 28% decrease from last year's benchmark.

Whether or not an official agreement is reached at this level may depend on how soon it could be made, as steel demand is ever rising.

Money to be made in China
The $585 billion Chinese stimulus package is showing results; in June, steelmakers in China managed to post around $520 million worth of profits. As Bloomberg reported Wednesday:

"For the first five months of 2009, the mills had a combined profit of 17.9 billion yuan, down 87 percent from a year ago, the Ministry of Industry and Information Technology said today in a statement on its Web site, without giving details."

Lakshmi Mittal, CEO of ArcelorMittal, said in a conference call Wednesday that the country's steel mills are almost back to full capacity, and he expects Chinese steel demand to rise 10% this year. He contrasted that with dropping demand elsewhere in the world - to the tune of 20% or more in Europe and the United States.

Where's Our Recovery?
China is the industry's bright spot; steel companies based elsewhere just aren't feeling the love. On Tuesday, United States Steel [NYSE: X] reported a second-quarter loss of $2.92 per share, or $392 million. While it beat analysts' expectations of a loss of $3.32 per share, United States Steel also had lower sales than expected, reporting net sales of $2.13 billion rather than the hoped-for $2.3 billion.

And the future doesn't look much better. CEO John Surma expects the losses will continue into the third quarter, with continued low demand translating into idle facilities and low operating rates.

On Wednesday, both ArcelorMittal [NYSE: MT] and Nippon Steel [TYO:5401] followed with more bad news. ArcelorMittal experienced its third consecutive quarter of losses, losing $792 million, or 57 cents per share. The same day, Nippon warned that it would see worse-than-expected results for the six-month period starting last September, just after posting a second-quarter loss of $600 million.

What makes matters worse is that over the past few months, steel companies have been the rare shining light in the equity markets - a light that got pretty dim this week with all the bad news

When will the bleeding stop?
Remember when analysts were forecasting the recovery to occur in the second half of this year - only to then push it into 2010? It looks like things might even take longer than that, despite both ArcelorMittal and Nippon Steel Corp ramping their production back up. For a full recovery back to "precrisis" levels, we should be thinking 2011, according to Lakshmi Mittal's remarks during the conference call. Is it pessimistic to say "don't hold your breath"? (Courtesy: Hardassetsinvestor.com)