Rio Tinto's record settlement for benchmark iron ore annual contract prices, announced this week, is akin to oil prices instantaneously moving up to $270 a barrel, or gold bullion jumping in a jiffy to around $1 800 an ounce. Unlike oil, gold, and other well known commodities, most iron ore trades under contracts, where major counterparties negotiate annual changes, if any, in prices.
Vast amounts of iron ore go mainly by rail to inland markets; much of that tonnage, in turn, is subject to long term prices that may be State influenced. The more visible and decidedly free seaborne market is dominated by Vale, Rio Tinto, and BHP Billiton, three names which also rank as the three most valuable mining stocks in the world. While each stock is classified as diversified, bulk commodities comprise the majority of each stock's current value: iron ore, coal, base metals (dominated by copper and aluminium), and other bulk commodities and metals.
BHP Billiton also operates an oil and gas division, bulk commodities which currently trade at infamous levels. But where oil and gas prices have been on the move for years and recently peaked (for now), base metal prices first peaked as early as 2006. Iron ore and coal prices have been laggards, in a sense, during the commodities upcycle, in place since early 2002. In the past 12 months, where oil and gas prices have risen between 80% and 105%, benchmark Appalachian coal prices have risen by 157%, underpinning a substantial and ongoing revaluation of listed coal stocks across the world, possibly with the exception of overheated Chinese equity markets where corrections continue across all sectors.
Iron ore prices started to move during 2004, after more than two decades of trading in a churning band between USD 0.22 and USD 0.40 per metric ton unit (mtu). The individual pricing of iron ore products differentiates chiefly between lump and fines, with lump trading at a premium to fines. Iron ore prices roared upwards in 2005, but the 2008 settlements are unprecedented both as to value and also percentage escalation. In its announcements this week, Rio Tinto said its 2008 fines prices had been raised by 79.9% year-on-year to USD 0.14466/mtu, while its lump was up 96.5% to USD 0.2069/mtu.
The increases compare favourably with recent announcements by Vale, the world's biggest iron ore digger, and biggest seaborne iron ore player, regarding increases of 65-71% for Carajás fines. The differentials between Rio Tinto's products and Vale's Carajás fines settlements are not something discussed by the companies, but represent the achievement for Rio Tinto of a sought-after "freight differential component" of about USD 4.5/t in Rio Tinto's free-on-board (FOB) contract fines pricing. This translates to about USD 8/t, when viewed on a weighted fines/lump settlement basis.
The numbers can be compared with the existing 10 year forward shipping differential (Brazil (Vale)-China vs. Australia (Rio Tinto)-China) of USD 25-30/t, and existing spot freight differential of around USD 50/t. Spot freight rates have been especially volatile for some months; the benchmark Baltic Dry shipping index has declined by more than 20% from recent highs, while the Baltic Capesize (encompassing the giant dry bulk ships typically used to transport seaborne iron ore) index is down by a third.
Traditionally, Vale is the first to fix iron ore annual contract prices, followed by Rio Tinto, and then BHP Billiton. BHP Billiton is likely to fall in line behind the recent - and delayed - Rio Tinto settlements, but has apparently persisted in its aggressive stance of expressing an interest in refraining from signing fresh benchmark volume contracts on a forward basis, preferring to continue in its bid to transact in new OTC (over-the-counter) forward market iron ore products.
The iron ore market is embracing increasing sophistication in terms of pricing differentiation for different classes of products, and also, as seen in the Rio Tinto settlements, directly including freight differentials. Premiums are also being used to reward product quality; where Vale previously settled iron ore pellets (for both blast furnace and direct reduction) at 87% higher, Rio Tinto scored a yet higher increase for its Hamersley lump.
Given the ongoing tightness in spot iron ore markets, and the continuing underpricing of freight differentials in Rio Tinto's latest settlements, the analytical community is anticipating further price increases in iron ore, varying according to both mine location and quality, during 2009. Such a development would also be constructive for other players in seaborne iron ore, such as Kumba Iron Ore, Luossavaara Kiirunavaara AB (LKAB, Sweden; State-owned), and Société Nationale Industrielle et Minière (SNIM, Mauritania, State-owned), along with newcomers such as Australia's Fortesque, which during 2003 took the notable decision to redirect its attentions away gold mining and towards digging iron ore out of the Pilbara.