China Accepts Price Cut in Softening Iron Negotiations

Robert Hsu, July 15, 2009

The talks between Chinese steel mills and the world's second-largest mining company, Rio Tinto, are finally making some progress. China's steel mills had demanded a price cut of 45% but many are now accepting a temporary price cut of 33%. The decrease is the first drop in seven years.

Iron ore prices are negotiated annually, in order to give the market some degree of certainty since the business demands major outlays in order to underwrite ore extraction. Since the economy has lost much of its momentum, other major steel-production countries of Japan and South Korea had earlier also accepted a 33% decrease, which put further pressure on China to conclude negotiations.

However, the negotiations have been overshadowed by recent events -- four Rio Tinto employees were detained in China on charges of stealing state secrets. The four are accused of bribing executives from 16 of China's major steel mills in exchange for confidential government documents in order to gain an edge in the contract negotiations. Rio Tinto has denied all accusations.

Also under investigation are several other executives in the China iron ore trade, with at least one Chinese executive already detained.

The arrests are of great concern throughout the investor world due to the possible effects it may have on doing business in China. The arrests come a month after Rio Tinto broke off a $19.5 billion investment deal with China's state-owned corporation Chinalco. Some Australians are questioning whether these arrests are retaliation for scrapping the planned deal.

So while a number of China's steel mills have accepted a temporary price cut, the China Iron and Steel Association, the bargaining body of Chinese steel producers, is still negotiating with Rio Tinto on a benchmark contract price. China is the world's largest consumer of iron ore, steel, cement and copper -- China's iron ore consumption reached 900 million tons last year. And its demand for natural resources is only increasing as it spends its $586 billion economic stimulus package. So far, iron ore imports have risen 26% in China this year, an impressive figure especially considering the global economic downturn.

Considering China's robust demand for iron ore, it's vital for both sides to reach an agreement soon. But it's also likely that there may not be an official announcement about the price agreement to better help both sides save face.

These negotiations are the longest-running talks in the 40-year history of setting annual benchmark prices for delivery of iron ore. Talks began in January and are only now seeing some possibility of conclusion.

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