Tuesday, 08 Nov 2011
Iron ore prices have been sliding in the spot market over the past few months as a result of weak demand. In response to this, industrial customers for iron ore are asking for shorter iron ore shipment contracts that are priced closer to the spot market prices.
Historically, iron ore prices have been relatively stable and most contracts have been annual contracts that were generally priced based on the average spot price in the previous year. However, in order to take advantage of the sharp increase in iron ore prices in the past few years, miners decided to move to a quarterly contract system, whereby the contracts would be priced based on the average price in the preceding quarter. Moving to a quarterly contract system helped the companies’ margins when raw material prices went up.
However, in the past few months, the trend has reversed and iron ore prices are slipping due to a fall in the demand. Steel manufacturers, the largest consumers of iron ore, have started to demand even shorter-term contracts, with some Chinese buyers entering into monthly contracts.
The slowing economic growth in China has been a primary driver of the decline in iron ore prices. Rio’s contracts are priced an estimated 23% higher than the prevailing spot market price, and 86% of the company’s contracts are priced quarterly. Should the company begin offering monthly contracts to gain higher volume, margins would likely take a big hit. We see iron ore becoming an over-supplied commodity in the near-term as Chinese iron ore production rises over the next few years.
Miners also differ in their take on these new contract requests BHP Billiton is already selling majority of its Iron Ore on monthly contracts, while Vale sees no need to move away from quarterly contracts. Rio Tinto currently enjoys a healthy margin from iron ore sales, but we expect that to decline going forward.
(sourced SeekingAlpha)
Iron ore prices have been sliding in the spot market over the past few months as a result of weak demand. In response to this, industrial customers for iron ore are asking for shorter iron ore shipment contracts that are priced closer to the spot market prices.
Historically, iron ore prices have been relatively stable and most contracts have been annual contracts that were generally priced based on the average spot price in the previous year. However, in order to take advantage of the sharp increase in iron ore prices in the past few years, miners decided to move to a quarterly contract system, whereby the contracts would be priced based on the average price in the preceding quarter. Moving to a quarterly contract system helped the companies’ margins when raw material prices went up.
However, in the past few months, the trend has reversed and iron ore prices are slipping due to a fall in the demand. Steel manufacturers, the largest consumers of iron ore, have started to demand even shorter-term contracts, with some Chinese buyers entering into monthly contracts.
The slowing economic growth in China has been a primary driver of the decline in iron ore prices. Rio’s contracts are priced an estimated 23% higher than the prevailing spot market price, and 86% of the company’s contracts are priced quarterly. Should the company begin offering monthly contracts to gain higher volume, margins would likely take a big hit. We see iron ore becoming an over-supplied commodity in the near-term as Chinese iron ore production rises over the next few years.
Miners also differ in their take on these new contract requests BHP Billiton is already selling majority of its Iron Ore on monthly contracts, while Vale sees no need to move away from quarterly contracts. Rio Tinto currently enjoys a healthy margin from iron ore sales, but we expect that to decline going forward.
(sourced SeekingAlpha)
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