***SPOTLIGHT: New system, same problem

The change in the predominant iron ore pricing mechanism — moving away from the annual benchmark system to a quarterly, index-linked methodology — was always bound to cause a stir

Trucking up: confusion reigns as market grapples with new iron ore pricing

The change in the predominant iron ore pricing mechanism — moving away from the annual benchmark system to a quarterly, index-linked methodology — was always bound to cause a stir.

Sure enough, as the third quarter of 2010 approaches, conflicting reports have already begun to circulate about settlements for new deliveries during this period.

Last week Chinese market participants told MB that the world’s largest iron ore suppliers — Vale, Rio Tinto and BHP Billiton — are looking to raise prices to $160 per tonne for deliveries in the third quarter.

“Vale has notified that contract iron ore prices will increase by about 23% to $160 per tonne cfr for the third quarter, based on the average spot prices recorded during March to May,” said a source at Wuhan Steel, China’s fourth-largest steelmaker.

Iron ore traders were quick to confirm the news, saying that they expected Rio Tinto and BHP Billiton to also look for similar prices.

But as press around the world began to circulate news of the so-called settlements, Vale denied that any new prices had been settled, or indeed that they had even been calculated.

Reports that the company has asked for a 23% increase are just pure speculation, Vale marketing director Pedro Gutemberg told MB.

Prices for the third quarter will be based on the average of a number of indices between March and May 31, he said. This number has not been calculated yet, never mind proposed to customers, according to Gutemberg.

“Maybe people are starting to make projections,” the Vale executive told MB. “Since the quarter is not over, any number that is raised is either speculation or projection from market analysts.”

Furthermore, the reports from Chinese market participants suggest a basic misunderstanding of the new pricing system that Vale has proposed, he continued.

“It is not a question of negotiation,” Gutemberg told MB. “We agreed on a formula which for the third quarter is based on the average index prices for the March 1 to May 31 period, so at the end of May the price will be clear.”

“This is a pricing concept that the vast majority of our clients accept,” he continued, saying that the company had worked hard to retain an aspect of flexibility in the new agreements.

“Some [steelmakers] wanted to change some little things in the formula and that is why we decided to leave some flexibility,” he said.

Within Vale’s methodology there is a certain amount of flexibility with regards to factors like freight calculation and the indices used to calculate iron ore prices. But, once these factors have been agreed, the quarterly price is calculated automatically, Gutemberg said.

Be that as it may, the projections being reported by the Chinese market will probably not be that far off.

For those customers that have specified the Metal Bulletin Iron Ore Index (MBIOI) as their preferred reference, the average price in between March and May was $156 per tonne cfr Qingdao for 62% Fe content material, according to director Cameron Hunt.

This is a big leap up from around $130 per tonne in the second quarter, and a figure that steelmakers are likely to find uncomfortable as finished product prices tumble.

Chinese steel prices have recorded significant losses in the past three weeks, with hot rolled coil prices in Shanghai dropping 450-500 yuan ($66-73) since the middle of April, and some smaller mills in Hebei province have been forced to cut production.

This may be why reports of Vale’s proposition may have circulated. That they also suggest BHP and Rio will ask for similar levels make them even more doubtful, one analyst told MB.

“Vale has come out [publicly] with its pricing formulae but BHP and Rio Tinto have not given any indication of their pricing mechanism — neither officially or unofficially,” he said. “We don’t even know if Rio Tinto has agreed any contracts.”