***MB CONFERENCE DIARY: Forecasting takes a back seat as the industry analyses new pricing models in Prague

Before the first morning of the conference had even finished, Vale had already caused a stir.

Before the first morning of the conference had even finished, Vale had already caused a stir.

Quickly running through the diversified miner’s new iron ore pricing structure, director Pedro Gutemberg left delegates quietly considering his presentation, so much so that questions from the audience were few and far between once his slides had come to an end.

But, by the time delegates spilled out into the networking area after his session, Vale’s new pricing model was already the only topic of conversation.

Like BHP Billiton and Rio Tinto, the world’s largest iron ore miner has moved away from annually-agreed supply contracts with its customers, agreeing new quarterly index-linked prices with its customers.

The model each miner has employed seems to be different, but there is still a great deal of uncertainty over the mechanics of how they all work.

“These changes have apparently been made with transparency in mind, but as far as I can tell it’s as clear as mud,” one delegate told MB as the conference returned from lunch. Most others agreed.

So far, the changes have upset the steel industry, enough to prompt European steelmakers’ association Eurofer to notify the European Commission of what it said were “strong indications of illicit co-ordination and pricing models” among major iron ore suppliers.

Vale, for one, vehemently denies that this is the case, and Gutemberg himself took time out of the Prague conference to run MB through the new model in an effort to try and dispel some of the confusion surrounding it.

Vale’s new quarterly pricing formula will be based on an average of iron ore indices in the preceding quarter, he told MB, saying the company would rely on these published indices to track this market as closely as possible.

As required, customers will be able to propose their preferred index or ask to base the mechanism on an average of two or all of them. The formula boasts some flexibility and can be tailored to each customer’s needs, Gutemberg says.

The new prices will be agreed on a fob basis, subtracting the freight from the average of cfr prices.

“One of the most important concepts of this new formula is transparency, and this transparency will be given by public, published prices source,” he told MB.

Steelmakers may scoff at just how transparent this is. But at least Vale is trying.

There has been a major structural shift in the way the seaborne market for iron ore operates, and the company is attempting to find a solution. By outlining these principles at a leading event like this one, it is also trying to give as much disclosure as it feels it can.

More and more it seems that these new measures are just a temporary solution – speakers in later panels agreed that they felt quarterly pricing would certainly be the first step into an even more flexible pricing environment, with an even larger spot market.

Speaking in the final panel of the first day, speakers from the over-the-counter iron ore swaps community were quick to capitalise on these comments, saying that a move towards index-linked pricing made the case for iron ore price risk management even stronger.

With the ability to fix prices for not just twelve months, but even further into the future, by using these products, iron ore miners and their customers will be able to dramatically improve their business models, they said.

Speaking on the second day of the conference, leading bankers from the structured trade and project finance community recognised the merits of hedging could provide to those looking to secure funding, although it is still early days, they said.

“The availability of hedging will increase the debt capacity,” said Deutsche Bank’s Kris van Broekhoven.

But for them too the new pricing models were the most pressing issue. With shorter-term contracts the norm, balance sheets are more sensitive to price volatility. Until fixed prices though hedging become a reality, satisfying financier’s demands could be more difficult, particularly in the post-crisis world, they agreed.

“We’re spending a lot more time in the due diligence phase with clients,” said Sumitomo Bank’s Pepi Bedi. “We need to be very wary just how resilient markets are.”

The whole industry needs to be careful. It seems unquestionable now that a change in iron ore price mechanics was inevitable, and a major one at that.
Now that the changes have begun to occur, they will come quickly and all industry participants need to adapt just as rapidly.

As the conference in Prague starts to wrap up, a lot more has become clear. But, as the hotel empties, there is a sense that a lot more is yet to emerge.