Iron ore pricing

飞雪寒冰

Miners knocking back middies in Port Hedland yesterday had reason to cheer. Soon the price of iron ore leaving BHP Billiton's port in Western Australia will be based on market prices rather than negotiated annual contracts. Even better, the Anglo-Australian miner is moving to sell iron ore at landed prices – that is for digging it up, transporting it to a port, tipping it into a boat, plus – for the first time – the shipping cost.

It is right to be raising a beer glass to the latter. The idea of a global price for iron ore is ridiculous. Tectonic luck placed Australia closer to the booming markets of Asia than Brazil so the total price for Australia's ore should be cheaper. Chinese clients have sometimes paid up to $50 a tonne more to ship ore from Brazil. Using a landed price means BHP now has a real long-term competitive advantage over far away Vale.

飞雪寒冰

The benefits from ending the system of so-called benchmark contracts, however, are less clear. BHP has been aggressively pursuing this for years, as has Vale. Their reasoning is obvious: spot prices are sky-high and the process of annual negotiations is a shambles. Producers were also worried that things were becoming a tad one-sided. During the depths of the financial crisis some steel mills refused to honour their contracts, buying cheaper ore in the spot market.

But long-term contracts can be symbiotic for producers and clients if properly enforced. In boom periods, steel mills need guaranteed supply. But in leaner times producers benefit from certain demand. Mills are expensive to turn off and on, while the capital needed to open up a new mine site is crippling. Spot prices are also volatile. All these factors, in theory, favour longer-term negotiated prices. Don't write them off yet.