BHP Billiton Plc and Vale SA have signed iron ore contracts with Japanese steel producers Sumitomo Metal Industries Ltd and Nippon Steel Corp. The revised contract prices now stand at $100-110/tonne. These prices are 80% higher than the FY10 annual contract prices of $61/tonne FOB (freight on board).
The Chinese steel producers are still negotiating the contracts. However, considering the strong Chinese demand for iron ore, Chinese steel producers are expected to follow suit. Last year, Chinese producers did not agree to the annual contracts signed by Japanese steel producers. However, the demand for iron ore kept increasing significantly from the Chinese steel producers.
This has led to a significant jump in the spot prices of iron ore which moved up from the lows of $50/tonne FOB to the current around $135/tonne FOB. This hike in prices is significantly ahead of our estimates. For Sesa Goa Ltd, we have factored in 25% hike in iron ore prices for FY11E. The new contract prices are around 18% lower than the spot prices of $130-135/tonne FOB.
BHP and Vale have been successful in breaking the 40-year-old traditional annual contract system for iron ore by signing quarterly contracts with Japanese steel producers. This has increased the importance of spot prices as contract prices will now be driven by spot prices more frequently than what it used to be historically. BHP has been pitching since long to do away with the annual contract system. It also tried to introduce quarterly contract but did not receive proper support from other miners and steel producers.
However, this year looking at the strong demand in the spot market, BHP got another incentive to pitch for quarterly contracts and managed to gain support of other miners and forced Japanese steel producers to accept the same.
Iron ore prices have gained strong momentum in the spot market in the past year—prices have increased by around 170% from the lows of $50/tonne FOB to around $135/tonne FOB. This was mainly driven by strong demand for iron ore from China. Iron ore imports by China have increased by around 42% from 443 mt in CY08 to 630 mt in CY09. Iron ore imports by China have been increasing month-on-month since 7-8 months. Higher iron ore imports have also been complemented by increase in steel production.
Chinese steel production has increased by around 14% from 500 mt in CY08 to 570 mt in CY09. Chinese steel production is expected to cross the 600 mt mark in CY10, which will maintain the strength in the iron ore demand by China. China has produced 99 mt steel in January-February 2010 (year-on-year, or y-o-y, up 21%) and has imported 96 mt iron ore (y-o-y up 22%) over the same period. The share of China’s steel production in the global steel production has increased from 38.6% in CY08 to around 47.4% in CY09.