By staff reporter Zhang Boling

(Caijing Magazine) It was the first time trading manager Wang Xiaofang had been invited to China's most important annual steel industry conference, and she was determined to dress smartly. So before stepping into the International Symposium on Raw Materials for Steel and Iron Production, Wang slipped into a pair of high heel shoes.

That was a big mistake. Intense, unplanned negotiations forced Wang to stand for hours on achy feet at the recent conference in Qingdao, while she mentally kicked herself for not wearing flats.

Wang wasn't the only industry representative facing unexpected discomfort at the mid-October conference, a traditional gathering designed to set the stage for annual price talks between Chinese steel mills and overseas iron ore suppliers. Steel executives from the around the country squirmed, ruminated and debated future industry policies. Some did business, while others discussed plans for China's upcoming talks with global mining giants Rio Tinto, Vale and BHP Billiton.

Among the least comfortable conference-goers was Shan Shanghua, secretary-general of the China Iron and Steel Association (CISA).

Shan is in charge of China's fixed, annual iron ore price negotiations. In a conference speech, he repeated previously heard calls for a unified, Chinese pricing model. He said the iron ore import market must be regulated, and that the number of eligible importers in China should be reduced.

But Shan got a cold shoulder; the conference hall where he spoke was half-empty. Meanwhile, Wang and hundreds of other supplier and buyer representatives stood in the hall's foyer, negotiating ore imports for 2010.

Disunity over Unified Pricing

CISA's proposed Chinese model calls for a fixed-price term stretching from January 1 to December 31. The long-term price would fluctuate according to volumes, with large volume buyers enjoying lower prices. And as long as a unified price is enforced, according to the model, ore suppliers would not be allowed to sell to Chinese enterprises at any other price.

If Shan gets his way, the plan would be fully implemented for the 2010 price talks, which begin soon. The first two conditions have been around since first being proposed in 2008, and the proposed restriction on suppliers was added in the current unified price policy unveiled by CISA in July.

The idea is to eliminate the difference between long-term fixed prices and spot market prices for iron ore. Suppliers would have to adopt the unified price when signing contracts with Chinese customers.

Eventually, the spot market for iron ore would vanish from the Chinese scene as all state-owned and private companies, steel mills as well as trading companies, would have to accept a single price.

"Unified pricing means a set, FOB (free on board) price for iron ore from different areas according to respective quality," Shan explained.

The CISA idea has won substantial support. Immediately after the unified price policy was released last summer, China's biggest state-run steelmaker Baosteel reached a unified agreement with Fortescue Metals Group Ltd., Australia's third-largest ore supplier.

Zhou Zhongshu, chairman of China Minmetals Corp. (Minmetals), China's second-largest iron ore trader, told Caijing he sees the market trend toward unified pricing, and thinks Shan's goal will be realized.

However, other insiders are pessimistic. "With the spot market accounting for half of the total supply" of ore sold in China, it's hard for it to be eliminated in a short period of time." said Xu Xiangchun, an analyst for the trade Web site www.mysteel.com.

As China's steel industry boomed, ore imports have been increasing by up to 6,000 tons per year. Increasingly, the big miners BHP Billiton, Rio Tinto in Australia, and Vale in Brazil, have been unable to meet China's demand alone. That fact has opened doors for small mines in India, Peru, Iran, Indonesia, Russia and Ukraine that do business on the spot market.

Australian and Brazilian imports are purchased according to long-term, fixed prices, while the sport market is used for imports from countries such as India. Yet China's prevailing spot market trading mechanism is drastically different from what's used to buy ore for the Japanese and European steel mills.

According a Mysteel.com estimate, the spot market now accounts for 60 percent of China's iron ore trade, a 7 percentage points increase from 2003. China imported 159.68 million tons of ore through the spot market in 2008 – more than twice as much as in 2003.

But due to their large numbers and modest scale, it's hard to require small mines to adopt a unified pricing system, said Xie Wei, chief representative of the iron ore trader United Overseas Resources Ltd.

"It is not possible to include iron ore mines from India, Peru and so on into the long-term, fixed price system," Xie told Caijing.

How High?

The debate over fixed versus spot pricing is not the only issue on the table. BHP Billiton, the world's biggest ore supplier, has proposed a price index system that China rejects.

Financial Times reported on the eve of the Qingdao conference that BHP Billiton, Rio Tinto and Vale would demand higher prices. The Financial Times said the miners wanted price hikes of 30 to 35 percent in 2010-'11 from current levels as a way to make up for a 33 percent price cut over the past year.

Shan argued that a 33 percent increase is unreasonable. "Although mine profits have been dropping, they are still in the black with the current iron ore price, while China's steel mills have suffered losses," he said. "The two parties will discuss a reasonable price at which steel mines will not suffer loss."

Shan further pointed out that steel production capacity is expected to fall. Current iron ore stocks in China amount to about 100 million tons.

Magnus Eeicsson, senior partner for Sweden's Raw Materials Group, said at the Qingdao conference that global crude steel production fell 1.2 percent in 2008 and predicted production would continue to decrease, falling 15 percent in 2009 until iron ore supplies surpass demand.

Moreover, Han thinks steel industry investment in China will decrease as bank lending declines next year. "It is not probable that crude steel production next year will reach this year's level," he said.

Falling steel production as predicted by Eeicsson, Han and others would logically put pressure on ore suppliers to lower prices next year. But some say the opposite price movement is more likely.

Ore prices may, in fact, rise globally as business conditions improve following last year's financial crisis. Mike Elliott, an executive at Ernst & Young's Global Mining & Metals Sector, told Caijing that steel production in Europe would bounce back because the economy is gradually recovering. "Iron ore prices will increase in the next year," he said.

Importer Limits

Regardless of the debate over ore supply and demand, the Chinese government appears on course to implement more careful guidance of iron ore imports, with the goal of improving the domestic steel industry's bargaining power. Regulators also argue about the need to restore market order by reducing the number of importers and preventing suppliers from raising prices easily.

"China will not have an edge in iron ore negotiations unless the domestic market is regulated," said a senior manager responsible for ore trading at one of China's three, largest steel mills.

The course was set in 2005, when the Ministry of Commerce started launching an ore importer eligibility system. It began when CISA and the China Chamber of Commerce of Metals, Minerals & Chemicals Importers and Exporters issued criteria that reduced the number of importers to 118 from 523. A new regulation issued in December 2006 further reduced the number to 112.

Some insiders blame recent price hikes on these importer restrictions, saying they deprived many steel mills of opportunities to buy ore at fixed, long-term prices.

Indeed, the long-term fixed price had been lower than the spot price for ore since early 2008. But fewer enterprises are entitled to buy ore at fixed prices. As a result, mills with permission to buy at the fixed price have launched profitable side-businesses by working as spot market ore brokers for small- and medium-sized mills.

This spot market channel took some pressure off major ore suppliers, making China's negotiating position more difficult. One industry researcher told Caijing that some discussions now center on reducing what's already a small number of importers to influence prices.

"In fact, five iron ore importers are enough," the researcher said. "Two major trading companies including Minmetals and Sino Steel, plus three large steel mills owned by the central government including Baosteel, Wugang Group and Angang Group, should be the eligible importers.

"This structure will make China's iron ore price negotiations go more smoothly."

According to this plan, import quotas could be allocated to these five eligible enterprises according to agency fees. The lower the fee, the larger the quota. Buyers would bid for ore, paying "FOB price plus agent fee," the researcher said.

This practice would not eliminate the need for ore price negotiations but likely would accelerate mergers and acquisitions in China's steel industry.

"As long as steel mills do not have access to raw materials, they will look for acquirer," the researcher said.

Nevertheless, the five-importer plan exists only on paper. Shan said most CISA policies do not have complete details. "A lack of feasible measures makes those policies exist in name only," he said.

Mine Investments

Another strategy aimed at satisfying China's raw material needs involves the acquisition of overseas mining companies by domestic steel mills. It's had limited success.

"The strategy of China's overseas investment in equities is sensible," said Xu Hanjing, chairman of Sino Gold Mining Ltd. in Australia. "However, the emphasis on controlling position is not pragmatic."

Xu said Japanese enterprises investing in Australian companies usually hold less than 15 percent of the shares and do not ask for controlling positions. In contrast, Chinese enterprises emphasize controlling positions in pursuit of lower prices for raw materials.

"How can a country endure when her resource enterprises are in foreign hands?" Xu asked, referring to the attitudes toward Chinese investors in resource-rich countries such as Australia.

Jin Jianhua, executive director of CITIC Securities, said Chinese enterprises should put more focus on projects that are in the exploration stage, in addition to existing mines.

"The number of existing mines is limited," Jin said. "The rush of investment will not only push up prices but also meet more resistance from foreign governments during approval procedures."