A New Approach to Iron Ore Negotiations?

News, cover
Issue 513
April 4, 2011
Translated by Tang Xiangyang
Original article: [Chinese]

The National Development and Reform Commission (NDRC), the Ministry of Industry and Information Technology (MIIT), the Ministry of Commerce and other central government departments are weighing the use of various policy measures to deal with the recent rapid rise in the price of iron ore imports, the EO has learned.

The fact that the central government is researching the use of such measures, suggests that contentious issue of iron ore pricing may have been lifted to one of national strategic significance.

Possible measures that could be taken to rein in prices include encouraging steel enterprises to further their operations abroad, futher regulation of trade in iron ore and the strengthening of anti-monopoly investigations into the business practices of the mining companies that dominate international trade in iron ore.

Special attention will also been paid to analyzing the wide array of new financial products that have emerged in the iron market since the system that saw long-term contracts negotiated on annual basis break down after three decades of use in 2009

One indicator of a tightening of the central government's position emerged during recent talks between the NDRC and Rio Tinto, an Anglo-australian mining company that along with BHP-Billiton and the Brazilian Vale, dominates the seaborne trade in iron ore.

During the meeting, Rio Tinto representatives emphasized that they considered pricing negotiations to be a business matter and that recent price increases could be explained by market forces. The representatives of the NDRC however, despite acknowleding that the iron ore prices were effected by market factors and that they support general market principles, also noted that market factors were not enough to explain why the profits of the suppliers were up to 20 times that of the buyers and that they believed that certain "high-level market distortions" helped lead to this outcome.

The NDRC also went on to warn the Rio Tinto team that although iron ore price negotiations are conducted by companies, if an industry is threatened and this impacts on the employment prospects of hundreds of thousands of people, well then it becomes an issue for the government.

United Actions

A unnamaed source from MIIT revealed to the EO that over recent years, the rising price of iron ore and the strong-arm tactics employed by the mining companies to push through with changes to the iron ore pricing system, have already had a large impact on China's steel industry, pushing down the profit margins of China's large-scale steel makers and putting there plans to expand production under a lot of pressure. Small and medium-sized steel mills face even tougher prospects, with many expected to be hit with losses.

In February, Rio Tinto and many of the major Chinese steel firms published their annual reports. Rio Tinto earned net profits of over 14 billion US dollars, equal to the combined profits of the 70 large Chinese steel mills that dominate China's steel production.

According to China Iron and steel Association (CISA) statistics, since 2003, Chinese steel makers have paid an extra cost of over 200 billion US dollars due to unreasonable increases in the price of iron ore.

These figures have attracted the attention of government officials.

As indicated by the meeting between the NDRC and Rio Tinto referred to above, government officials are now beginning to inform the mining companies that trade in iron ore also impacts on China's national security.

On Mar 31, a source within MIIT told the EO, that China's approach to iron ore negotiations remained unchanged and that CISA was still coordinating the process, while Baosteel led the negotiations themselves.

However, behind the scenes there have been some major changes. A small group made up of representatives from a variety of central government ministries has been set up to investigate and research what is perceived by some to be the risk that China will slip into a weaker and weaker position when it comes to iron ore trade.

In terms of the distribution of responsibility, MIIT is the government department that is responsible for administrating the domestic steel industry and thus it also gets a say in issues related to iron ore.

However, an unnamed official with MIIT told the EO that "questions about whether China should alter its approach to iron ore negotiations or whether CISA should continue to act as the coordinator of the negotiations, these were matters on which MIIT did not have the final say, these required decisions be made by higher level officials."

This reference to "the decisions of higher levels" appears to indicate that policies related to iron ore trade have already been lifted beyond the ministerial level.

New Financial Instruments

A department of the Ministry of Industry and Information Technology has also began to conduct research in to the many new financial instruments that are playing a role in helping to determine the price of iron ore on the international market.

On January 29th, the Mumbai-based India Commodity Exchange (ICEX) issued the world's first iron ore futures.

Before that, with encouragment from BHP-Billiton, the iron ore market has already developed a range of indicies. Promoted by TSI, MBIO and Platts, exchanges in Singapore, London, Chicago and America have all established platforms to conduct iron ore swap transactions.

In an interview with the former head of CISA that appeared in the EO earlier this year, Shen Shanghua told the newspaper how it was obvious that the mining companies were pushing for the "financialization" of the iron ore trade.

An unnamed official with the MIIT also noted that if we look at how the market for various internationally-traded bulk commodities such as oil, agricultural products and non-ferrous metals developed, the trend towards further "financialization" of the iron ore trade was inevitable. The same official said, since the supply of iron ore was essentialy monopolized, China had little say in the matter and so the reasonable thing to do was to accept what's going on and to gradually work at developing measures to deal with them.

According to information received by the EO, the ministry has already begun to devote resources so that they have a better understanding of how the futures market, various indices and other financial derivatives work. They're also looking into what kind of role China should seek to play in these markets and avoid earlier episodes of simply remaining a passive observer.

The MIIT will be able to make use of a large amount of resources and information culled from various financial institutions and investment banks to help them deal with the situtation.

However, based on the current situation, China's will face many challenges when it comes to dealing with the increased use of financial instruments in the iron ore market.

MIIT knows that almost no one in any of the major steel companies is familiar with the workings of these financial instruments. There are also likely to be other institutional barriers due to the fact that most of the large steel companies are state-owned enterprises and also because they still remember the case of Chen Jiulin, former president of China National Aviation Fuel who was sentenced to 3-years prison for a derivatives deal gone wrong.

This article was edited by Paul Pennay