China’s Iron Ore Hardball Backfires

08/10/2009 3:17 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

China has so far refused to sign a long-term contract with the world's big iron ore exporters, Vale (NYSE: VALE), BHP Billiton (NYSE: BHP), and Rio Tinto (NYSE: RTP). Its goal was to get a big break on iron ore prices.

But it now looks as if China's tough stance has backfired. Chinese companies are now either buying iron ore on the spot market at prices about 50% higher than those in the annual contracts signed by Korean and Japanese steel makers back in April, or are scrambling to sign side deals at the price set by Korean and Japanese buyers.

The result is that spot iron ore prices are booming. The big three iron ore exporters are getting higher prices for their ore than they forecast just a few months ago. And Chinese steelmakers are announcing huge price increases for their products just as China tries to revive its economy with a big shot of spending on iron- and steel-intensive infrastructure.

The country's negotiator, the Chinese Iron and Steel Association, has said the 33% to 44% cuts from 2008 prices negotiated by Korean and Japanese steel makers back in April are not acceptable.  A cut of somewhere between 60% and 75% that would roll back the entire 2008 price increase would be required, it said.

And to show how seriously the Chinese government takes iron ore prices, back on July 5th it detained Stern Hu, the head of sales and marketing in China for Australia's Rio Tinto, and three other staffers on an accusation of stealing state secrets. That charge escalated on August 10th when an editorial in the magazine of the National Administration for the Protection of State Secrets announced that large amounts of intelligence data has been found on Rio Tinto computers.

The article said, "the economic spies, using bribes for six years, forced the Chinese steel companies to pay more than 700bn renminbi more for imported iron ore than they would otherwise."  (Chinese law lets the government decide what is a state secret well after the fact. Publicly available and already published information can become a state secret.)

Needless to say, the Chinese demands for huge price cuts and the detention of employees of foreign iron ore miners have brought negotiations to a standstill. That has pushed some Chinese iron and steel makers into the spot market and pushed prices there up to $110 a metric ton. That's a ten-month high and about 50% higher than the prices set by the April negotiations with Korean and Japanese steel makers.

Other Chinese steel makers have gone off on their own to strike side deals with overseas iron ore miners so that they avoid paying the spot price. Most of these deals are getting done near the Korean/Japanese price target.

Among the stocks of the big three (soon to be big two if the Rio Tinto/BHP merger goes through) iron ore miners, my choice is Brazil's Vale. For more on that stock and a few words on timing a buy, see my post "Chinese Stocks Crack" from July 29th.

For more of Jim Jubak's stock picks and market commentary, go to his blog Jubak Picks.

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