Some of the world's biggest miners are forcing Asian buyers to change the way they purchase several key commodities, a boon to producers but a move expected to increase prices throughout the global economy.
From potash to coking coal and now iron ore, several mining companies have pushed through dramatic changes in how these products are priced and sold, forcing users in countries such as China, Japan and India to pay more for specific resources
The latest move came Tuesday when BHP Billiton Ltd. announced it was no longer negotiating annual iron ore contracts with a "significant" number of Asian customers and will instead set prices on a short-term basis. Brazil's Vale SA reached a similar deal, also running for just one quarter, with a major Japanese steel maker, at a price of $100 (U.S.) to $110 a tonne. Rio Tinto PLC is expected to follow suit.
The announcement ended a 40-year-old tradition in the mining world and will translate into price hikes of at least 90 per cent for some steel mills, analysts said.
"A momentous day," Brendan Harris, an analyst at Macquarie Securities, said in a report. "It's not every day that the pricing terms for one of the core commodities in world trade change."
He and other analysts said steel producers will almost certainly pass on some of the added cost to their customers, which include car makers and many other manufacturers, given the prominence of steel in so many products.
"I think they will have to pass it through in higher steel prices, fairly quickly actually," said Bank of Nova Scotia economist and commodity market specialist Patricia Mohr. "There will be some upward price pressure definitely on steel from these very big price increases, and yes, it will gradually percolate through into the cost of all sorts of capital equipment and major consumer items like motor vehicles."
For years, the price of iron ore and other bulk commodities was set through annual contracts negotiated between producers and users. The spot market, where prices move daily, was insignificant and used to source emergency supplies.
The rapid industrialization of China and India changed the dynamic, pushing up demand for many commodities and making the spot market suddenly more relevant. Today, the spot price for iron ore is more than double the price set in the last annual contract.
BHP had been pushing for changes to the pricing system for more than two years. It wanted to move toward a more flexible arrangement, where prices were set quarterly to keep them in line with the spot market. To entice buyers, BHP offered to keep the quarterly price below the spot price.
The idea didn't go far until this year, when the iron ore market recovered sharply thanks largely to buying from China. Last month, officials at Rio Tinto, a long-time backer of the annual pricing system, and Vale warmed up to the idea. Analysts also said the big miners were missing out on $20-billion in annual revenue by not charging the spot price.
Steel makers in Europe have chafed at the change and officials in China have reiterated their support for the annual contract system. Some analysts have also worried that the change to flexible pricing could lead to less transparency and consistency in pricing.
Change is coming elsewhere too. Earlier this month, BHP, Rio Tinto and Teck Resources Ltd. dropped annual pricing for some of their coking coal, which is used to make steel. They shifted to a quarterly system that could see prices jump by 55 per cent from the previous year.
A group of potash producers, consisting of Potash Corp. of Saskatchewan Inc., Mosaic Co. and Agrium Inc., made a similar move earlier this year, dropping annual contracts with China and India and moving toward a quarterly system for the key ingredient in fertilizer.
All of the producers were motivated by a belief that the price of their commodity will keep rising at least in the short term. But no matter what happens to prices, some analysts believe the changes are here to stay.
"We are not expecting a resurrection of annual benchmark, even if the iron ore trade weakens in favour of steel mills," UBS analyst Tom Price said in a report.
With files from Bloomberg News