China's wrong in the iron ore blame game

Chinese accusations that the big miners have been manipulating the iron ore price are far fetched. In reality it was China's steel mills that led to the recent wild swings in the spot price.

China’s National Development and Reform Commission mostly got its diagnosis of the factors behind the big rebound in iron ore prices since they bottomed out last year right. Except, that is, for the paranoid suggestion that the big three iron ore miners manipulated the price.

The NDRC, China’s main economic planning agency, was spot on when it said China’s steelmakers re-stocked iron ore and then increased purchases as confidence in the economy improved, igniting demand.

If one looks back at what happened last year, when the iron ore price tumbled below $US87 a tonne in September before recovering sharply to around the $US150 a tonne level, it is pretty obvious that the price was being driven by the actions of the mills, not the iron ore producers.

The price plummeted last September because of a confluence of influences. China’s economy had slowed as its policymakers tried to deflate a credit-driven bubble in property; there were wobbles in the eurozone which also affected China’s exports and there was a seasonal element which added to an excess of stocks. So the price dived.

It rebounded because the steelmakers started buying again. Chinese iron ore imports were at record levels, for instance, in December.

The iron ore producers have provided strands of the explanation for the subsequent price rebound – greater confidence that China’s economy had stabilised, concerns about the normal cyclone season in the Pilbara and a normal stock cycle.

The bottom line, however, is that the mills were buying more iron ore so naturally the price reflected their demand – which was part of the NDRC explanation for the price gyrations.

It’s the other part that raises eyebrows, where it has accused the top three iron ore producers – Vale, Rio Tinto and BHP Billiton – of delaying shipments, holding back stocks and even buying back ore on the spot market to produce a ‘’fake’’ market signal of supply shortages and drive the price back up.

It also accused them of using ‘’non-transparent’’ tender processes to influence the iron ore indices which are used to set the prices for long-term contracts.

While it is conceivable, albeit unlikely, that the Big Three might finesse their supply and engagement with the market to smooth prices it would be astonishing if they were able to manipulate prices to generate the kind of price movements seen post-September.

It’s the actual relationship between supply and demand that drives the price and it was very obvious that it was the mills’ withdrawal of demand that led to the September price slump and their return that forced prices back up.

While the Chinese mills have been cynical and suspicious about Marius Kloppers-imposed shift from the historic benchmark pricing model for iron ore to market and index-related pricing it actually worked for them last year when the price fell below $US87 a tonne.

The correlation between their demand and the price since says that it does work as envisaged to reflect the balance of supply and demand which – given the amount of new supply in the pipeline from the Pilbara, Brazil and elsewhere – is in the long-term interests of the Chinese producers.

For the producers, of course, while the price might be more volatile, it avoids the problem they encountered during the financial crisis when the Chinese mills simply refused to honour their benchmark contracts, instead buying ore more cheaply at spot prices.

Rio and Vale, which initially didn’t want to emulate BHP and change the nature of a pricing model that had worked so well for so long with the Japanese mills, were converted by that experience.

The Chinese mills largely have themselves to blame for a far more volatile pricing environment, both because of their decisions during the crisis and the major fluctuations in their own demand that have occurred over the past six months. The NDRC accusations, however, do speak to the continuing hostility and absence of trust between the mills and the producers.