Forrest blazes a lonely trail

If the China Iron and Steel Association seriously believes that the three big iron ore producers will agree to price cuts greater than those negotiated with their other customers on the basis of the "landmark agreement" CISA has struck with Fortescue Metals, the association is even more delusional than previously thought.

CISA and Fortescue have agreed a price for the sale of 20 million tonnes of ore to Chinese mills over the six months to end-December. The price negotiated represents a 35 per cent discount to the 2008 benchmark pricing, whereas BHP Billiton, Rio Tinto and Vale have been maintaining the stance that they won't increase the 33 per cent reduction for fines they agreed with their non-Chinese customers.

A condition of the deal between CISA and Fortescue is the completion of a $US5.5 billion to $US6 million financing agreement with Chinese lenders on terms acceptable to Fortescue. CISA has also guaranteed that a "priority" will be given to Fortescue to negotiate iron ore prices for 2010 "if the annual pricing negotiation is conducted".

While Andrew Forrest described the agreement as one that broke the impasse that had enveloped the Chinese industry and delivered price certainty to the Chinese mills, the reality of the agreement is that the linking of the iron ore pricing with Fortescue's refinancing needs probably means that it is more of a financing deal than a pricing deal. Fortescue could recover the extra discount through the terms of the loans.

A six month deal covering only 20 million tonnes of ore is hardly a landmark deal, given that the seaborne trade in iron ore is around 350 million to 400 million tonnes a year.

It is also unlikely to influence any of the major producers. Not only would any shift in stance upset the Japanese, Korean and Taiwanese mills who settled early but the major producers are already selling directly to Chinese mills at the prices set by those deals. They are also selling into the spot market at prices more than 70 per cent higher than the benchmark deals.

Whatever CISA might want to believe, Fortescue isn't going to be the benchmark price setter for 2010, assuming there is a benchmark deal. BHP in particular is keen on shifting the sector to an index-related pricing system that would do away with the need for annual price negotiations. Rio, after the Stern Hu affair, would probably also prefer something that involves less structural conflict and allows the market a greater role in price-setting.

CISA, which took over the leadership of China's negotiations from Baosteel earlier this year, has been criticised within China and outside it for its clumsy attempts to corral China's mills into a single negotiating position and its failure to negotiate a deal with the Big Three.

While it has been holding its hard line, Chinese steel production and demand for iron ore has rocketed, as has the spot price, undermining the CISA position and making it look commercially nave in the process. Its strategy has backfired so badly that there has been strong speculation within China that Baosteel will be reinstated as lead negotiator for the next benchmark pricing deal.

The agreement with Fortescue may save a little CISA face, but it doesn't break the impasse with the major producers or change the reality that supply-demand equation in iron ore doesn't provide the producers with any reason for giving the Chinese mills bigger price reductions than their other Asian customers.