THE DISTILLERY: Iron ore improvements

One jotter explains BHP's efforts to shift the status quo on iron ore contracts, while others question the viability of the smaller miners.

So much of Australia’s prosperity is shaped by the iron ore price. But once upon a time, not too long ago, the steelmaking ingredient was priced via terribly inefficient annual contracts. The Australian Financial Review’s Matthew Stevens offers this reminder in his piece this morning, as other commentators look at the viability of some iron ore plays outside BHP and Rio Tinto, some big names and some small.

The Australian Financial Review’s Matthew Stevens explains how Australian iron ore producers are benefitting from the efforts of BHP Billiton to push Asian customers away from annual benchmark pricing. By March 2012, it had pushed the majority of its Asian customers onto market pricing.

"Fast forward just 33 months to London and a Rio Tinto outlook seminar where chief executive Tom Albanese, one of those originally sceptical of BHP’s initiative, breezily suggested that his company had identified 100 million tonnes of domestic Chinese production that was uneconomic at current prices and claimed that ‘a large proportion’ of that number had been removed from the marketplace. ‘Frankly, the markets have been working,’ Albanese observed. To help appreciate the importance of the removal of that volume of production, 100 million tonnes of iron ore a year represents about one-third of China’s input to a steel production system that, at peak, devours about 800 mtpa. The reason this matters is that, if this outbreak of rationality in the face of market signals is sustained, then the logic of the transition to shorter-term, flexible pricing is essentially proven while the seaborne producer’s massive investment in a supply-side response to China’s economic miracle is made substantially less risky."

The efficiency with which iron ore is priced isn’t just important for the buyers that were recently delighted by the plunging price, but producers that want to know that their production will be rewarded when less efficient players fall over.

Question marks have been hanging over Gina Rinehart’s Roy Hill project for some time because of the iron ore price. Fairfax’s Elizabeth Knight writes that South Korean giant POSCO might be wondering what will happen to the project, which is expected to cost around $9 billion. It’s a sum of cash that Australia’s richest woman is, largely, still yet to find.

"The trouble for Posco is that it as taken an equity stake in the Roy Hill project. As such, its money is locked in and there is no incentive for Rinehart, who has ambitions to get her dream development away one day, to hand the money back. Despite her vast wealth Rinehart still has to find most of the funding for Roy Hill, harder in an environment where costs continue to rise. Roy Hill is certainly not the only resources project under threat. The Pilbara is full of resources that are geographically stranded and/or financially orphaned.”

Like Knight, Business Spectator’s Josh Kenworthy emphasises that there are a lot of junior players in the Australian iron ore market that are hoping the iron ore price stands at and above $US120 a tonne.

"For the many junior miners who started projects when the price was going up, and which are still under construction, a $US120 significantly improves their prospects. For example, analysts generally see it as the price at which those projects in Western Australia’s mid-west, like Jack Hills and others revolving around the stalled Oakajee Port and Rail project, will begin to look more attractive to potential financiers, which will be essential to their survival. The question is whether the jump above $US117 is a lasting adjustment or just an overcorrection after the sharp drop to below $US90 in September?... Goldman Sachs speculated in a note that the spike in price may be the beginning of a fourth-quarter buying spree by the Chinese steel mills as the traders and steel makers who drove prices down 36 per cent in the last two months begin buying again. Given that we know China put its economic brakes on a little too hard in trying to deflate its growing property bubble, it is possible that its stimulus measures will lead to an adjustment as iron ore stockpiles begin to fall and steel production increases.”

The Australian’s economic editor David Uren writes that the world economic outlook next year is darkening with the International Monetary Fund lowering its global forecasts. But the government is pursuing its pledge to bring the budget back to surplus.

"The Reserve Bank has cut its cash rate to within a whisker of the 3 per cent low reached in the depths of the 2008-09 crisis, believing that Australia's economy will need the support of below-average rates through next year. Yet the government is holding to its resolve to return the budget to surplus in 2012-13 and is preparing a new round of spending cuts to ensure it gets there. ‘We are absolutely determined to bring our budget back to surplus even though there are more difficult conditions,’ Wayne Swan told parliament yesterday. The Treasurer's arguments are familiar. The economy is growing at its long-term trend rate and, if the budget cannot achieve a surplus now, then when will it?”

Uren goes on to say that the government should be supported in its efforts to bring the budget back into surplus. However, Fairfax’s Michael Pascoe would point out that Australia’s economic outlook was actually upgraded by the IMF. Is it really so gloomy?

The big company story from yesterday was of course the Nine Entertainment restructure ‘agreement,’ that was actually only agreed by one of the relevant parties – mezzanine lender Goldman Sachs.

Fairfax’s Malcolm Maiden equates the debt negotiations going on over Nine Entertainment to a medical drama. Two teams of surgeons are arguing over how to save the patient, while the sickly one’s vitals get dimmer and dimmer. Meanwhile, The Australian’s Richard Gluyas writes that the game of brinkmanship between the two is reaching "a critical stage”.

Elsewhere, Fairfax’s Peter Ker explains how Rio Tinto is maintaining that the delays to the power link for its flagship Oyu Tolgoi copper-gold project is not the result of Mongolian-Chinese rivalry.

The Australian’s John Durie reports that NBN Co is attempting to negotiate a new set of long-term deals with construction firms that will lock them in for four years. At the moment, they’re on two-year deals with one year extension options.

The Australian’s Asia Pacific editor Rowan Callick writes that Chinese telco giant Huawei needs to become more transparent if it’s to make serious progress with American business.

Meanwhile, Fairfax’s Carolyn Cummins has made an important observation. She reports that the economic slowdown has seen demand for sub-let offices, primarily driven by legal and financial services, fall for the first time in three years.

The Australian’s Robin Bromby writes that Iraq is the dark horse in the energy market, with the potential to lift its daily oil production to 6.1 million barrels a day by 2020 from its present three million. It all depends on how the local government can get the industry together.

And finally, The Australian Financial Review’s Chanticleer columnist Tony Boyd has a great yarn about the potential for Australia to become China’s "preferred partner” in the Asia Pacific, told from the perspective of Shanghai’s leading financial industry official Fang Xing-Hai.

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