China’s Steelmakers to World: We hate market prices.

I’m dealing with a new computer, jetlag, and months of statistics suggesting that Shanghai Scrap’s readers prefer Olympics-related blogging to Iron Ore-related blogging. But, you know, sometimes you have to eat your vegetables before you get to dessert. Or something like that (dessert will be served late tonight or tomorrow).

Anyway. I wasn’t planning on returning to the blog until tomorrow, but yesterday’s reports that Bao Steel and Australian mining giant Rio Tinto have finally settled upon a 2008 iron ore contract price (nearly doubling the 2007 price) have forced an early resumption.

[More Shanghai Scrap posts on iron ore: here, here, and here.]

A very brief backgrounder: traditionally, the world’s three biggest iron ore firms set their annual prices in closed negotiations with their largest customers, thus providing both parties with pricing certainty over what has typically been an unpredictable commodity. Meanwhile, firms not party to the negotiations are left no choice but to purchase ore on the open “spot” market – typically, a much more expensive option (at the moment, a three times more expensive option).

Anyway, prior to 2005, China’s steel mills either bought iron ore on the open market, or they negotiated an individual contract price with one of the world’s big three mining companies (Brazil’s Vale; Australia’s Rio Tinto and BHP). After 2005, at the direction of Beijing, Bao Steel was given sole authority to negotiate the contract price on behalf of the entire industry – out of the belief that higher volume purchases would strengthen China’s leverage over the increasingly expensive resource. Unfortunately (for China), it didn’t work out that way: ore prices have been doubling for China, year on year, and show no sign of abating.

Meanwhile, with the world market for iron ore tightening, the Australians, in particular, have openly speculated on doing away with the annual contract negotiations and just selling their ore on the open market. Now, as much as the Chinese dislike the annual increases that come out of the contract negotiations, they absolutely hate the prospect of paying an actual market-determined price for iron ore.

Just how much do they hate it?

Back in March, Chinese ports started blocking delivery of Australian iron ore sold at market prices.

But hate can’t change the facts, and the fact is – so long as iron prices increase – there will be more and more interest in a worldwide market pricing mechanism that will replace the contract negotiations. And many traders expect it to be announced in late 2008.

For China, which has built provincial economies on cheap, subsidized steel made in cheap, subsidized mills, this development amounts to an impending economic catastrophe (the vast majority of China’s ore is imported). Yesterday, Bao Steel, which has spent months complaining about the dirty dealings of Australia’s (rumored) price-fixing miners, suddenly changed its tune and praised the negotiations for having “maintained traditional pricing mechanism and normal market order, and kept the long-term friendly cooperation between the upstream and downstream sectors.”

Which is to say: “Price fixing between friends sure beats having to compete with rivals on the open market.”

I’ve repeatedly argued that there’s nothing inevitable about China’s move to market mechanisms and, in fact, in some industries (natural resources, in particular), it is actually moving backwards, toward state-control. Beijing’s desire to maintain a tight, private buyer-seller relationship with Australia’s mining firms is a large step in this direction – and away from the small, private mills left to figure out how to compete in a distorted, higher-priced marketplace.