What a spectacle in the energy and resource markets. The deep-freeze in the iron ore negotiations between Aussie producers and Chinese steel makers appears to be thawing. Yesterday’s Financial Review reports that the number we’ve all been waiting for here is: eighty five.
That’s the percentage increase in the annual iron ore contract price Aussie producers charge major Chinese steel makers. It includes the much sought after “freight premium” which recognizes that it’s cheaper to ship ore from Australia to China than from Brazil to China.
So what does it mean? Well, Chinese producer were hoping to NOT have pricing power in the ore industry lie with suppliers. But that hope seems to have faltered. Time for plan B. Plan B is to take equity stakes in a large number of smaller Aussie iron ore, and don’t discount the possibility of China Inc. taking a large stake in BHP a la Chinalco in Rio Tinto).
Plan B also includes raising steel prices. Granted, as you can see from the chart below, courtesy of Macquarie Research, steel prices are already up 65% this year alone. But as you can also see, Chinese steel prices trade at about a US$400 discount to U.S. and world export steel prices. Whether this is how the Chinese subsidise domestic steel consumption or not, we can’t really say.
But we can say that Chinese producers will increase exports this year and raise prices. Prices for domestic steel in China might differ from export prices. Who knows? But either way, you can be sure the Chinese steel producers aren’t simply going to absorb the huge increases in coking coal and iron ore. Chinese steel is going to get more expensive, whomever the buyer is.
Normally, you’d expect to see higher commodity prices curtail demand. But for both steel and oil (see below) you haven’t seen any evidence yet that higher prices are slowing down demand. In fact, as this second chart from Macquarie shows, Chinese steel production is slated to grow by 10% this year. It even looks like the double bottom in steel production growth rates is in. Is it the beginning of a new steel boom?
One company that hopes steel prices keep going up is Aquila Resources (ASX: AQA). The company told investors yesterday that it could produce about 25 million tonnes of iron ore per year from its ore bodies in the Pilbara… for the tidy sum of $4.1 billion.
Welcome to the iron ore boom, Aquila (a company which also has coal and manganese assets). The company’s announcement was a little like a new doctor in a small town hanging out his shingle right across from the old doctor. The company isn’t producing anything yet. But like the other ore hopefuls in the Pilbara, it believes that with a little capital and a little deep water port facility at Cape Preston, its pre-feasibility study indicates it would have a nice little business.
What is the difference between a shingle and a “for sale” sign?
Meanwhile, the original third wheel in the Pilbara, Fortescue Metals (ASX:FMG), begins loading its ore for shipment to China this week. It’s been a long time coming. But FMG’s business has opened the door in the Pilbara and the Mid West for a long roster of other, smaller ore producers. The good old days of just BHP and Rio are long gone.
The Daily Reckoning Australia