Rio, BHP face supply chain threat
A review of the global commodities supply chain has concluded the major resource houses can influence the price of iron ore by deciding to produce a certain amount of the mineral each period, depending on their knowledge of the mine capacity of their competitors.
But in a report on the state of global commodity markets, two European think tanks - the Centre for European Policy Studies and the European Capital Markets Institute - have warned the miners' control of iron ore supply to Asia could be threatened by changes in the global freight industry.
The world's three biggest miners - Vale, BHP Billiton and Rio Tinto - control about 65 per cent of the world's seaborne iron ore market. The miners are so big they have a "first-mover advantage" in the regions in which they operate, the report says.
"[An] oligopolistic setting is often influenced by external factors, such as freight industry capacity and easier (cheaper) connectivity between regional areas," the report says. Freight costs are an important part of the seaborne iron ore price and can expose the market to unprecedented volatile patterns.
"Recent changes with the increase in capacity of the freight industry have stabilised costs of freight for some time and ensure easy connectivity at the global level.
"This may increase the accessibility of new regional areas to the global market and reduce space for an oligopolistic setting as marginal costs become less predictable."
Stable freight costs could allow smaller producers to agree to non-profitable prices to win contracts in Asia, and this could move the market away from its oligopolistic "equilibrium".
The report is likely to be welcomed by iron ore newcomers such as Fortescue Metals Group and Gina Rinehart's planned Roy Hill project.
The report also describes how global investment banks such as Goldman Sachs and JP Morgan have been making billions of dollars in profits by running a network of global commodity warehouses linked to the London Metal Exchange.
It says the price of aluminium stored in a network of LME-linked warehouses in the United States has been artificially inflated by long queues to get the aluminium out.
A recent New York Times report said Goldman Sachs had been exploiting industry pricing regulations set by the LME by "shuffling aluminium among the 27 warehouses it controls in the Detroit area".
"The manoeuvre lengthens storage times and generates millions a year in profit for Goldman, which charges rent to store the metal for customers," the article said.
The report from the European think tanks says the practice could restrict access to an important hedging tool for global market participants and increase the cost of aluminium for final users.
"[It] could ultimately end up affecting the price formation of LME aluminium cash contract as a global benchmark price," the report says.
Frequently Asked Questions about this Article…
European think tanks warn that changes in the global freight industry — especially increased shipping capacity and more stable freight costs — could loosen the grip big miners like Rio Tinto and BHP Billiton have on supplying iron ore to Asia. More predictable and cheaper connectivity makes it easier for other regional producers to access Asian markets, undermining the oligopolistic position of the largest miners.
The article notes that the world's three largest miners — Vale, BHP Billiton and Rio Tinto — control about 65% of the seaborne iron ore market. For investors, market concentration at that level means these companies can influence supply and pricing, but that influence could be weakened if freight dynamics change and open up access for more competitors.
Freight costs are an important component of seaborne iron ore pricing. Volatile freight can reinforce large miners' pricing power, while increased freight capacity and more stable costs can reduce transport barriers, allowing smaller or regional producers to compete on price and potentially disrupt established supply strategies.
Yes — the report suggests that newcomers such as Fortescue Metals Group and projects like Gina Rinehart's planned Roy Hill could benefit from lower and more stable freight costs. That improved accessibility might enable smaller producers to win contracts in Asia, even by offering very low prices to gain market share.
The 'first-mover advantage' refers to the large miners' established positions in the regions where they operate — infrastructure, customer relationships and scale — which historically helped them secure markets and influence prices. The report cautions that changing freight dynamics could erode some of that advantage over time.
The article says banks such as Goldman Sachs and JP Morgan have built networks of global commodity warehouses linked to the London Metal Exchange (LME) and have made substantial profits from running those networks. These warehouse operations form part of how commodity markets and pricing function in practice.
The report highlights that aluminium stored in networks of LME-linked warehouses — with long queues to withdraw metal — has seen prices artificially inflated. A New York Times story cited in the article described how warehouse practices (for example, shuffling aluminium among multiple warehouses) can lengthen storage times, raise costs for users and restrict access to an important hedging tool for market participants.
Yes. The think-tank report warns that manipulative or congested warehouse practices could affect the price formation of the LME aluminium cash contract, which serves as a global benchmark. That could make hedging more costly or less effective for users and influence global aluminium pricing.
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