I’ve argued on this blog, and elsewhere, that Beijing really doesn’t mind price-fixing and cartel behavior – so long as the cartels and price-fixers are working in Beijing’s (perceived) best interests. And those interests are usually best represented by state-owned industries.
For Beijing’s economic policy-makers, few commodities need to be “fixed” more than the the 400 million+ tons of iron ore that the China Iron & Steel Industry estimates that China will import in 2007 – all to fuel its world-beating steel industry (with something like 35% of the world’s total production in 2007). Yet despite being a key international commodity, there’s no actual open market or index for iron ore. Instead, European and Asian buyers looking for the rock have two options: negotiate a one-year “benchmark” price with the consortium (read: cartel) formed by the the world’s three largest iron ore producers (Australia’s Rio Tinto and BHP Billiton, and Brazil’s CVRD) or go looking for whatever ore you can find in India and elsewhere, and bid the “spot price” – basically, a market price on demand for whatever’s left over after the big three sell their supplies to their preferred buyers.
[North America has a large and steady supply of domestic iron ore for its mills, and thus US and Canadian mines and mills don’t get involved in the price-fixing that occurs elsewhere in the world]
Generally, the big three iron ore suppliers are only interested in negotiating benchmarks with the world’s largest steel mills (in China, those are almost entirely state-owned), thus leaving the smaller mills (in China, the private ones) to fend for themselves on the spot markets. The result is that the state-owned mills get a much better price on their ore than the smaller private mills left to the markets (US$185/ton v. $US47.10/ton as of late September).
[which is all the proof you’ll ever need to show that China’s state-owned mills remain inefficient state-subsidized employment programs.]
The price differential has not always been so steep. Before 2005, China’s individual steel mills negotiated benchmarks individually with the big three ore producers. But as world ore prices rose over the last decade – largely as a result of Chinese demand – the Chinese steel industry began to understand that – divided – they were at a serious competitive disadvantage in negotiations for benchmark prices. So, in 2005, somebody in Beijing (I hate to use the all-purpose hand-waving term “the Chinese government”) announced that, henceforth, Bao Steel would negotiate the benchmark ore price on behalf of the entire Chinese steel industry. As it worked out, though, the inexperienced Chinese negotiators were totally outclassed in 2005 and ended up conceding to a 71.5% increase in the price of iron ore (against the backdrop of record world demand). In 2006, the better-prepared Chinese entered the negotiations with better preparation and managed – as a cartel – to extract a relatively modest 19% increase from the ore cartel.
From the perspective of the big three mining companies, such a small increase is anything but ideal – especially with spot prices at triple the benchmark. After all, the point of cartel behavior is to protect your margins – and not to protect those of your buyer.
So, earlier this week, BHP Billiton announced that it was now in favor of establishing an iron ore price index. That is to say – now that China’s state-owned mills have figured out a way to succeed against the selling cartel (form a buying cartel), BHP Billiton is ready to allow its iron ore to trade on the open market.
And, predictably, China’s large state-owned mills don’t like this idea. Yesterday Bloomberg quoted Chen Xianwen, deputy director of market research at the China Iron & Steel Association, as saying:
The current iron ore pricing mechanism is supported by European, Japanese and Chinese steelmakers and the miners … The established mechanism should be protected, though we welcome any suggestions that would benefit both sides.
Who can blame the Chinese? After years of getting the short end of the iron ore pricing stick, they finally figure out a way to collude with the world’s biggest mines, and now the biggest mine decides that it wants … a market-oriented pricing system. How on Earth can the big state-owned mills survive if they have to pay the same ore price as the small wild-cat mills that actually have to turn a profit?