Vale announced that it “has reached agreements on a new iron ore pricing regime with the majority of its clients, based on short-term market references and price changes on a quarterly basis. The agreements, permanent or provisional, reached 97% of our client base, which corresponds to 90% of the sales volumes under contracts. The structural change in iron ore pricing is consistent with our previous announcements about the implementation of a new marketing policy, involving, among other issues, a more flexible approach towards pricing.”

At the conference, Jia Yinsong of the Ministry of Industry and Information opened the conference by saying that, although Chinese steel demand had been strong last year and had exhibited a “classic V-shaped recovery,” steel prices had suffered a “W-shaped recovery.” The principal reason for the volatility in prices was overproduction caused by anticipated demand growth being higher than actual demand growth. Jia warned that this could happen again in 2010, and highlighted that steel product output grew by 27.1% year-on-year (YoY) over the first two months of 2010, while FAI growth was only 26.6%. Macquarie highlights: “the steel product output figure is somewhat unreliable and  apparent consumption of steel actually grew by only 24% YoY. Also, just looking at FAI ignores the strength of demand from the manufacturing sector.”

Jia stood out among the Government speakers for his apparent support of a shift to a more flexible pricing system for iron ore. He referred to annual pricing as “un-transparent and unhealthy” and said prices should reflect actual demand and supply.

“Other speakers were not so convinced,” according to Macquarie, “saying that big mills would suffer the consequences of small mills buying iron ore without caring about the price and of the big three miners doing their best to push up the price. The proposed solution? The same as always: eradicate the small mills and increase China’s self-sufficiency in iron ore. We maintain that this is a highly flawed view. The smaller mills have shown themselves to be the most sensitive to raw material price hikes, pulling out of the market when they can no longer make money. And when China is forced to rely more heavily on its domestic iron ore reserves, the spot price goes up, not down, to cover the higher production costs (although we believe that the iron ore price may overshoot to some extent).”

Wu Rongqing of the China Mining Association said that Chinese domestic iron ore output would exceed 1,000 Mt in 2010, up from 874 Mt in 2009 (on a run-of-mine basis). Macquarie notes there are problems with China’s official iron ore production numbers, “but we agree with the trend. Our current forecasts have China’s iron ore requirement increasing by just over 100 Mt YoY in 2010 (on a 63.5% Fe basis), of which 72 Mt will come from domestic mines.

Wu explained that the government raised the VAT on domestically produced iron ore from 13% to 17% on January 1 2010. This should serve to further raise the cost of domestic iron ore production and seems inconsistent with calls for lower iron ore prices. Wu called on the government to scrap VAT on domestic iron ore altogether to encourage production.

Pedro Gutemberg of Vale made the case for his company’s new pricing system. He said the benchmark system “had failed” the test in 2009, when many clients (not just Chinese) “opted out” of the benchmark system and took a lower price on the spot market. At the peak of this activity in May 2009, Vale was selling 70% of its material on a spot basis. Gutemberg estimated that 45-50% of total global iron ore sales would be on a spot basis (more correctly a “floating-price basis linked to spot”) in 2010, ensuring that the market was highly liquid.

When asked by a steel mill representative how the steel industry was expected to handle a 90% increase in iron ore prices, Gutemberg responded by saying that the new system reflected mills’ ability to pay: “If mills can’t afford the ore, they reduce demand, so the price falls.”

Much of the talk on the sidelines centred on how much further iron ore and steel prices had to run. Some believed that speculative activity would slow now that pricing arrangements for the June quarter appear to have been broadly agreed on and that this would lead to the spot price cooling. It should be noted, however, Macquarie warns, “that there is no evidence of stock building so far – the surge in buying seems to be on the basis of actual consumption needs.

The traders of Indian iron were keen to highlight to the conference that supply disruptions in Orissa would tighten the market. The Indian government is cracking down on illegal mining in the region and has banned the loading of iron ore onto trains to be taken to port. As a result, the equivalent of 5-6 Mt/y of ore is not being shipped (India exported 109 Mt of iron ore in 2009). Macquarie understands “that, although shipments are not moving, mining continues. As such, while there may be a short-term impact, the lost material is likely to find its way out eventually. We re-iterate our view that spot prices will eventually revert towards the marginal cost of production for domestic iron ore miners in China, estimated at $110-120/t on a 62% Fe basis.

“There was further evidence that domestic iron ore miners were coming back, based on conversations with manufacturers of iron ore concentrators. Sales were reported to have risen sharply since Chinese New Year as miners invested in improving the quality of their output. This activity has been stimulated by a policy introduced on  January 1 that allows miners to claim a tax rebate on any fixed asset investment. The price gap between iron ore grades has been widening, suggesting that Chinese domestic mining activity has been softening the market for lower-end material. This will likely encourage miners to improve the quality of their product through concentrating in order to take advantage of the higher prices.

“According to Malpas, the freight market is currently oversupplied. Additional freight capacity is expected to exert downward pressure on freight rates over the short-to-medium term. The order book for capesize vessels is full, with ~280 new builds scheduled to be delivered during 2010 and 2011, in addition to the current fleet of ~700 vessels. Malpas believes that cancellations are not expected to change this materially. Furthermore, Malpas indicates that only 5% of the current fleet is >25 years old, so there is unlikely to be material scrapping.”