SYDNEY (Reuters) - Iron ore prices are in tailspin -- down 20 percent in the last month and clocking seven straight weeks of losses -- and the world's biggest producers couldn't seem to care less.
Last year's contentious shift away from once-a-year pricing of ore in favor of shorter term contracts is now delivering lower returns on sales of more ore, yet miners appear unworried about the market's gloomy performance, moving full steam ahead on massive expansion projects.
That's because the more iron ore is sold at spot, the less smaller suppliers can compete with the mega-producers -- namely Vale (VALE5.SA), Rio Tinto (RIO.AX)(RIO.L) and BHP Billiton (BHP.AX)(BLT.L) -- who enjoy vast economies of scale and together control more than 70 percent of the global seaborne market.
"The big producers are taking a much longer view on market forces, which takes into account growth projections in China and are gearing up for that by developing more mines," said Grant Craighead, a mining analyst with Stock Resources in Sydney.
Some 86 percent of Rio's third-quarter sales were based on average prices for the preceding quarter -- lower than earlier sales over comparable periods as spot sales increased -- Tom Albanese, chief executive of Rio, the world's No. 2 iron ore producer, told financial analysts in a presentation this week.
"Shipments are strong and we are selling everything we can produce," Albanese said.
Rio is accelerating a program to lift output by 50 percent to 333 million tonnes a year by 2015. BHP is aiming for a 37 percent rise in production to 220 million tonnes by around the same time.
Vale aims to boost yearly iron ore output to 469 million tonnes by 2015 from 308 million in 2010.
The next biggest producers, including South Africa's AngloAmerican (AAL.L) and Fortescue Metals Group (FMG.AX), mine less than 50 million tonnes a year each.
Rio and BHP, more than Vale, have been aggressively selling directly into the Chinese spot market over the last month after running their mines above capacity, further undermining the price.
Such sales came mostly as buyers of lower-grade ore mined in China switched away to exploit the chance of acquiring richer Australia ore at comparable prices. Marginal Chinese domestic iron ore production is now $20 a tonne higher than a couple of years ago, boosted by grade declines and cost inflation.
This helped offset the effects of what many industry players consider to have been a moratorium in China from taking delivery on shipments priced on the contract basis over the second quarter. By most accounts the ban has passed, with mills again in restocking mode.
BHP alone sold eight capesize cargoes of iron ore in 24 hours in September, which Bank of America Merrill Lynch analyst Peter O'Connor called an outcome that would normally have taken several weeks.
Rio's level of averaged-price sales is also outside the norm, driven by its strong production that allowed more sales into the spot market.
Iron ore prices plummeted a further 8 percent last week, the seventh straight week of losses and the sharpest drop since July 2010.
BHP Chief Executive Marius Kloppers, whose mantra is "run assets at full capacity all the time and achieve market price," defends short-term pricing because it means customers have little reason to dispute or delay shipments.
"I have not seen any of what I saw in the global financial crisis, which was the equivalent of forum shopping, where one party's customers defaulted but bought from another," he said on the sidelines of BHP's annual meeting in London.
Vale, the largest of the three producers, reluctantly discarded the once-a-year-price system after BHP and Rio bowed out, cognizant it would upset customers. In the end it had no choice but to follow suit.
Now, with spot prices trailing the last quarter's average price mark and lead times on Brazilian cargoes to China much longer than the Australian miners, Vale has announced it is open to alternative pricing systems.
UBS commodities analyst Tom Price said Vale had already agreed to a request from customers in China for provisional pricing to remove the quarter-long lag on the spot versus contract price.
This mechanism varies from spot in that it reflects the average spot price for the quarter, not that for any given day.
Vale is leading this move as it remains the most vulnerable to losing volumes, according to Price.
"Lead times on its deliveries are longer, allowing clients to delay decisions on Australian material for longer than with Vale," he said.
Already, Chinese steel mills under pressure to maintain sales margins are said to be delaying iron ore purchases on expectations that prices will continue to drop. China steel futures fell more than 5 percent late last week in the contract's steepest decline ever, suggesting such delaying tactics might spread.
Even before China announced slower-than-expected 9.1 percent third-quarter GDP growth, evidence of a slowdown in its steel sector was mounting.
China's road construction is facing unprecedented capital shortages, with some provincial governments failing to pay engineering companies for two to three consecutive months, according to the official People's Daily.
More telling, say analysts, the price of rebar used for construction in China is down 20 percent since August.
Still, such warnings may fall on deaf ears.
"Miners are still seeing a very high profit margin despite falling prices, and they can also take the advantage to beat smaller emerging rivals to retain market share, so why not produce?" asked a senior iron ore trader in Shanghai.
UBS said it sees the spot price correction reversing next month as China's steel producers resume seasonal restocking of raw materials following a summer respite.
Iron ore prices hit a 13-month low around $144 a tonne on Friday, and were unlikely to sink much lower, according to a high-ranking executive at South Korea's top steelmaker POSCO (005490.KS).
"I think the $130 to $140 levels will be a bottom. When prices fall below $130 to $140, China will not produce (iron ore), but import it. I see prices rebounding," the official, who declined to be identified, told Reuters.
Australian forecasting group BIS Schrapnel believes that while volatility is likely to continue over the next five years, healthy Asian demand for iron ore and other commodities is set to continue.
"Rapid economic growth in developing, metals and energy intensive economies such as China and India continues to drive strong demand for Australian resources, despite the prospect of weaker economic growth in Europe and the United States," BIS said in a report.
Not everyone agrees.
Goldman Sachs expects the iron ore price to keep to a downward course through at least 2014, when it will average only $110 a tonne -- a far cry from the record $192 of last February.
"The risk for the big producers now is that prices keep falling and with it goes profit margins," said Stock Resources's Craighead.
Still, the mining companies insist they are more interested in the long haul, unfazed by daily ups and downs in prices and more attuned to the massive growth projections for China in justifying their big spends to ramp up output.
That may eventually prove wise, though it could be a rough course to hold given the over-weight exposure to iron ore these so-called diversified miners hold.
"For a commodity such as iron ore, you're really very focused on the strength of the Chinese economy," said Catherine Raw, a portfolio manager for the natural resources investment division of fund manager BlackRock (BLK.N).
"With over 50 percent of the world's iron ore consumed by China, your outlook for the iron ore price is going to be determined by your outlook for Chinese economic growth."