Chinese Steel & Brazilian Iron

Negotiations of iron ore prices between Chinese steel makers and the three big mining companies -- Vale (VALE - Analyst Report), BHP (BHP - Analyst Report) and Rio Tinto (RTP - Analyst Report) -- have been going on for months, and up 'til now, no decision has been reached.

Some weeks ago Korean and Japanese steel companies accepted an iron ore price reduction between 33% and 44%. We thought that this was a good indication of what would be accepted by Chinese companies, too.

However, it seems that China wants more.

Yesterday Mr. Luo Bing Cheng, from CISA (Chinese Iron and Steel Association), announced that China wants at least a 40% price reduction for iron ore, well ahead of the 33% minimum accepted by both Korea and Japan. Additionally, market sources have said that an agreement could be reached with China accepting the same price reduction offered to Japan and Korea if the new contract was for just 6 months and not for the usual 12 months.

Prices of iron ore in the spot market continue to trade with around a 45% discount, if compared to the 2008 price agreed between China and the three big producers. Despite last year's negotiations, iron ore producers are selling the product with discounts between 30% and 40%.

Average iron ore volume imported from China reached a monthly average of 47.1 million tons during the first four months 2009, compared to just a 38.3 million tons during the first half of 2008. It seems a huge volume increase for a difficult economic period.

Even stranger is the fact that Chinese internal steel production was flat during the first four months of 2009 from 2008. Chinese companies are taking advantage of the good price to build inventories.

It is important to note that China is the only buyer in this market, as Europe the U.S. and Japan are all into deep recessions.

Usually the second half of the year is a soft period for iron ore demand. Even worse, we do not expect a strong recovery in the developed world in the following months, and Chinese inventories should be loaded. If we add to this entire difficult business environment the idea that China would like to renegotiate prices in six months, we begin to wonder if there is some room for price appreciation of the iron ore in the following quarters.

Apparently, China made its move in order to be sure that prices would stay down for more than just a few months. We find it difficult to justify the more positive view of the market towards iron ore producers in the last few months. We prefer to remain cautious and keep our neutral view on Vale.