The stakes are high, so it is not surprising that Anglo American subsidiary Kumba Iron Ore is going all out to disengage from an agreement entered into when the world - and steel and iron ore prices - was very different.
An indication of just what is at stake, this year alone, is that there is speculation that contract steel prices (often referred to as benchmark steel prices), which are negotiated annually between the world's largest iron ore producers and Asian steel mills, may be settled upwards as much as 80%. Iron ore is used in the production of steel.
Robrecht Himpe, CEO of ArcelorMittal's Flat Carbon Europe business, was quoted in an Australian newspaper last week as saying: "What we're hearing from Asia is in the direction of 70%-80%."
Nimrod Zalk - Watching carefully
Others in the market say prices could rise by 40%-50% on last year's levels.
This means Kumba would miss out on another 80% increase in iron ore prices if it has to continue selling 6,25 Mt of iron ore, plus the lower-quality ore from the Thabazimbi mine, to ArcelorMittal SA at cost plus 3%. Two years ago Kumba lost out on the 65%-70% price rise, receiving little of the upside because of the 2001 agreement.
If Kumba were successful in pulling off or even modifying the agreement, its profits would surge. For ArcelorMittal SA, it would mean it would have to buy iron ore at international prices (see story "Heading for a hard place"). This could drive up steel prices by 21%, says a steel stockist. That spike would be in addition to the 25% rise in steel prices he expects as a result of the 25,5% electricity tariff hikes over three years.
However, it is unlikely ArcelorMittal SA would be able to push up prices to compensate for dramatically higher iron ore input costs. "If the iron ore price went up 30%-40%, it wouldn't be able to get that price increase through. The prices would be too high and we would see more imports coming into the country," says the stockist.
ArcelorMittal SA shifted from import parity pricing (see graphic on previous and current model) to an international basket price - a nod to the department of trade & industry (DTI) which a few years ago failed to agree on a special pricing formula for local steel sales with the company.
Industry sources say the move from import parity pricing to the basket price failed to significantly lower the price for SA buyers.
There is little love lost between ArcelorMittal SA and its many buyers (see story on page 36). They feel that if the contract were renegotiated, there would be more competition, which would open the door for cheaper iron ore and steel prices. " Arcelor has made excessive profits in terms of the iron ore agreement in the past six years. The feeling now is let's get back to the normal international market rate'," says a trader. "There is not too much sympathy that the deal has gone sour for it."
He says ArcelorMittal SA changed its pricing model, which gave it a competitive advantage that it did not pass on to SA steel end-users. "We have looked at the landed price here [Johannesburg]. Normally there is an 8%-10% difference to imported steel. It rarely opened up to more than 10%-20%, even when the rand was strong."
In an unusual move, smaller steel producers like Scaw, Cisco and Cape Gate said last week that they planned to increase their steel prices for April delivery, says the stockist. Normally they tend to follow ArcelorMittal SA's lead.
This may have something to do with the competition commission referring four cases involving steel products to the competition tribunal as part of its widespread industry investigation which started in 2008. "There are ongoing investigations looking at traders and steel companies. Our broad focus [in the steel sector] is looking at cartels," says Simon Roberts, chief economist and manager of policy & research at the commission.
The DTI is closely watching the development of the negotiations because of the knock-on effect of possible price hikes on the SA economy. "We are assessing the impact [any change in the supply agreement to ArcelorMittal SA might have] on cost and pricing of steel and cannot comment until we have completed that," says Nimrod Zalk, DTI chief director: industrial policy enterprise & industry development, who has been looking at pricing across various industries for a number of years.
Steel and iron ore pricing is often, to say the least, opaque - especially as premiums are added and discounts given for a multitude of reasons.
Benchmark iron ore prices are usually lower than the spot or floating price. A move towards the sale of more iron ore at floating prices, perhaps linked to indices, would mean iron ore companies would stand to make higher margins - Kumba will be well aware of this.
Unsurprisingly, there is a push in the market by Marius Kloppers, CEO of global diversified resources giant BHP Billiton, for a greater proportion of iron ore sales to be done on a floating or indexed basis.
The floating price is now about 100% higher than the 2009 benchmark price. BHP is the world' s third-largest producer of iron ore.
The dynamics of the iron ore market have changed since contract agreements were entered into to give security to both steel producers and miners in terms of supply and sale price. There are now a number of financial instruments that can be used to mitigate risk when it comes to buying at a floating price, similar to the buying of steel or base metals.
In a market briefing, BHP marketing president Tom Schutte said the iron ore market was developing trading and financial instruments that would use indexed pricing as the mechanism to link the physical or the spot market to the financial forward market.
"The development of financial markets usually follows volatile physical trading conditions," he says.
WHAT IT MEANS
 More pricing transparency in iron ore
Competition may get a boost
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BHP Billiton spokesman Illtud Harri adds: "In terms of the split between sales on annual versus shorter-term reference pricing, in the half-year ended December, 2009, 54% of Western Australia iron ore shipments on a wet metric tonne basis were based on annually agreed pricing, with the remainder sold on shorter-term reference pricing."
Kloppers, speaking to journalists in SA last year, said: " This is a good thing [floating prices]. We like pricing systems that are transparent, where the market discovers and establishes the price."
For the ArcelorMittal group worldwide, sourcing iron ore does not appear to be too much of a problem.
Last year 75% of its iron ore came from its own mines. But given that SA is one of its lucrative global units, the impact of any increase in raw material costs would be huge. Kumba won't say on what basis it intends to price its iron ore sales to ArcelorMittal SA should it be successful in its dispute with the company and no longer have to supply at cost plus 3%.
Kumba in SA also sells to Scaw and to Highveld Steel and Vanadium. The company won't disclose what price it charges these two steel makers. When it comes to selling to ArcelorMittal SA, Kumba says: "We have tendered iron ore at commercial prices. "
Whatever the outcome of the dispute, buyers of iron ore and steel will be hoping they will see more pricing transparency and competition in the local market.
