Tough decision for China steel makers

Rio Tinto and BHP Billiton have asked their Chinese steelmaker customers to accept the largest ever increase in iron ore prices or risk an end of supplies from Australia, Tootoo.com has learned.

Traders and industry officials said the mining companies have demanded price increases for their annual iron ore contracts in excess of the record 71.5 per cent rise of 2005 and were fighting for increases of 85-95 per cent.

Rio and BHP have warned their Chinese clients some annual contracts will expire next Monday and they would cease supply under the old terms. They have told them the ore would instead be sold into the spot market, where prices are higher.

The bold step indicates that the heated annual price negotiations, already well beyond their traditional conclusion date, are set to move into a hostile phase.

Analysts said most of Rio’s iron ore contracts would expire on June 30. However, some BHP contracts do not expire until September, leaving the latter time to negotiate and allowing Rio to take the lead in the discussions.

Macquarie, the Australian bank, said Rio was committed to securing a price in excess of the 85-95 per cent the market is expecting. “That stance suggests investors should be prepared for an extended and potentially hostile conclusion to the negotiations,” it said in a report.

Rio and BHP are demanding a larger price increase than Brazil’s Vale because their proximity to China reduces shipping costs.

Traders said that freight costs from Australia to China collapsed last week by 37 per cent as at least one of the mining companies stopped booking some vessels for July to ship under the old contracts. That move signalled their intention to move shipments into the spot market if the negotiations failed.

If Rio and BHP carry out their threat of diverting shipments into the spot market, analysts said the steelmakers would be likely to retaliate by stopping buying for as long as possible. Although China has record high iron ore inventories, the country depended heavily on imports, they said, and it would not be long before it had to cave in and buy into the spot market.

Morgan Stanley said in a report the ore market was under “unprecedented” pricing developments and . . . “remains very tight and in significant deficit”.

Rio and BHP declined to comment.