evolving long term price for indian iron ore (2)

Evolving Long Term Price for Indian Iron ore

Framework and Modelling

K K KUMARGENERAL MANAGER-MARKETING & LOGISTICS

MSPL LIMITEDHOSPET,INDIA

CHINA – INDIA IRON ORE SUMMITBEIJING, CHINA 28-29 APRIL,2008

NOTICE

Views expressed in this paper are personal and do not necessarily represent the views of all Indian suppliers.

The frame work proposed is to stimulate discussion and arrive at a consensus through the process of dialogue between Indian and Chinese delegates on the challenging task of evolving a new benchmark price for Indian Iron Ore

OVERVIEW

• China is world’s largest steel making and consuming country accounting for over 30% of world steel making capacity

• China has been the largest iron ore importer in the world since 2003

• Close to 50% of the world sea borne iron ore trade is on account of China

• The phenomenal annual growth rate of China’s dry bulk trade @ 16.83% p.a. has taken sea-freight market to new heights- unprecedented in recent history.

CHINA IRON ORE IMPORTSCOUNTRY 2001 2002 2003 2004 2005 2006 2007

Australia 38.02 42.78 58.17 78.14 112.18 126.82 145.61

Brazil 24.54 29.77 38.40 46.04 54.74 76.42 97.63

India 16.98 22.53 32.30 50.17 68.58 74.75 79.37

South Africa 8.97 10.30 9.56 11.10 10.55 12.56 12.23

Chile 0.19 1.23 1.64 1.99 1.61 2.35 2.82

Canada 0.38 0.85 1.42 2.80 2.79 3.87 5.93

Peru 1.84 1.98 2.20 3.50 3.36 4.68 4.82

Venezuela 0.15 0.25 0.34 2.40 2.52 2.62 3.39

Vietnam 0.27 0.32 0.67 1.61 1.16 1.56 1.21

Others 1.04 1.49 3.51 11.11 17.76 21.07 30.08

Total 92.39 111.49 148.20 208.86 275.25 326.70 383.09

2001 2002 2003 2004 2005 2006 2007

Total Imports by China 92.39 111.49 148.20 208.86 275.25 326.70 383.09

India's Imports to China 16.98 22.53 32.30 50.17 68.58 74.75 79.37

India's Share in China's Imports 18% 20% 22% 24% 25% 23% 21%

Note : All data on calender year basis

MILLION TONNES

Impacts of China’s huge iron ore demand • The rapid growth in demand for iron ore by china

in a short period is resulting in greater demand-supply mismatch

• This mis-match is resulting in – Increase in prices of iron ore– Shipment of Iron ore from high cost and far- off

countries becomes viable– Increase in tonne-miles in seaborne trade causing

severe shortage of shipping capacity and thus increase in shipping freights to record highs

– Increased China’s domestic demand for coal/coke resulting in countries dependent on China ( Korea, Japan etc) for these products diversifying their sourcing to far- off countries like South-Africa

IMPACT OF CHINA’S HUGE IRON ORE DEMAND• This in turn is resulting in higher demand for dry bulk ships

and thereby driving up freights to record highs• High freights resulting in increasing differentials in landed

cost of iron ore from various sources– July 2006:

• Brazil – China ocean freight US$ 27 / mt• WA -Beilun ocean freight US$ 12/mt• Freight Differential US$ 15/mt

– March 2008• Brazil – China ocean freight US$ 77 / mt• WA -Beilun ocean freight US$ 30/mt• Freight Differential US$ 47/mt

• Demands for freight premium in benchmark prices – adding to further volatility in iron ore market

• Restricted availability of term-price ore to few entities in China resulting in un-even playing field among Chinese steel mills. Small-Medium steel mills unable to have access to cheaper term-price iron ore.

FUTURE OUTLOOK FOR IRON ORE IN CHINA

• Various research reports suggest that demand for iron ore from China will continue to be strong.

• China’s steel capacity is forecasted to reach 700 million mt by 2010 from the current 560 million mt

• China produced 489 million mt of steel in 2007 as compared to 421 million mt in 2006(+16%)

• Estimates vary that the tightness in demand will continue well into 2010 but with reduced intensity as more production from new mines/ expansions come into market both from Australia and Brazil.

• China’s domestic mines would also expand


• The trend of increased benchmark prices is likely to continue- however the rate of increase may moderate.

• Higher cost of mining ,rising input costs and huge capital requirement of mining will be the reasons for cost push.

• China’s domestic production cost too will tend to rise as more and more low grade ores will be mined. Higher cost of imported iron ore will enable higher cost of domestic production too.

• China domestic iron ore production growing fastROM Production (Mt)

588

712803

891944

0

200

400

600

800

1000

1200

2006 2007 2008 2009 2010Year


• Any softening of CFR prices will primarily be on account of shipping cost reduction rather than any other reason.

• However this reduction is unlikely to be significant in next 2-3 years given the shipping tonnage that is likely to enter the market and also huge tonnage that is already over-age that needs to be scrapped.

• The dry bulk shipping market has other drivers in addition to iron ore. Commodities like Coal, Food-grains, fertilizers etc continue to show high growth rates which will keep the freight market buoyant at-least till substantial new tonnages come into market around 2012-2015.

• Therefore, iron ore prices are unlikely to come down in a hurry.

ROLE OF INDIAN IRON ORE IN CHINA

• INDIA IS CURRENTLY THE 3RD LARGEST SUPPLIER OF IRON ORE TO CHINA

• INDIA HAS SUPPORTED THE CHINA’S GREAT STEEL STORY BY RAPID INCREASE OF EXPORTS IN A SHORT TIME (CHART)

Iron Ore - Production and Exports

020406080

100120140160180200

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Year

Qty

in

Millio

n T

on

ne

s

Production

Exports

Year 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Production 58.67 64.50 66.58 66.60 75.72 70.68 74.94 73.21 86.22 99.07 122.80 142.70 155.00 172.00

Exports 31.50 28.00 31.34 31.70 35.61 31.27 32.91 37.49 41.64 48.02 62.57 78.14 89.27 93.79

Growth in production is driven by exports


• India fills the demand - supply gap in China by offering cargoes in the spot market.

• Indian iron ore caters to the need of Steel mills that do not have access to term price ore.

• Indian iron ore is also used in blends with ores of other origin• Spot market prices of Indian iron ore are a fair indicator of state of

China’s iron ore market• Any reduction in exports from India in next 2~3 years will accentuate

demand-supply balance of iron ore in China leading to sharper price increase.

• With India’s iron ore exports stagnating around 95~100 million mt in 2007 ( almost at same level as in 2006),the impact on 2008 benchmark prices is profound. ( 65% +)


• RISING DOMESTIC DEMAND FOR IRON ORE IN INDIA AND CALL FOR RESOURCE CONSERVATION MAY LEAD TO DECLINE IN IRON ORE EXPORTS FROM INDIA

• THIS MAY NECESSITATE INCREASE IN IMPORTS FROM OTHER COUNTRIES

• GIVEN THE OLIGIPOLISTIC NATURE OF IRON ORE MARKET, THIS TREND MAY FURTHER STRENGTHEN PRICING POWER OF SUPPLIERS.

UNIQUE ASPECTS OF INDIAN IRON ORE

• UNLIKE IN BRAZIL AND AUSTRALIA, IRON ORE MINES IN INDIA ARE VERY SMALL

• IRON ORE LEASE HOLDERS ARE MANY

• SMALL SIZE LEASES DO NOT ENABLE SCALE ECONOMICS AND HENCE COSTS ARE HIGH

• MANY IRON ORE MINES HAVE POOR CONNECTIVITY WITH INADEQUATE LOGISTICS INFRASTRUCTURE.THIS ADDS TO COSTS.

UNIQUE ASPECTS OF INDIAN IRON ORE

• HIGH LOGISTICS COST, INADEQUATE PORT CAPACITY, LOW SHIP LOADING RATES, LACK OF MECHANICAL LOADING FACILITIES IN MANY PORTS ADDS TO COSTS - MAKING INDIAN ORE EXPENSIVE

• SOME COMPARISIONS

• INDIA– Average loading rate in

Chennai/Goa (Mechanical)• 50,000 mt/ day

– Maximum load carried in a railway rake

• 3886 mt

– No. of days taken to converge quantity for one panamax shipment of 65,000 mt to Chennai from Bellary-Hospet Sector

• 20 days

– Average transport cost per tonne

• USD 6/ 100km/ mt

• BRAZIL / AUSTRALIA

– 150,000 mt/day

– Upto 39,312 mt (312 cars*126 mt/ car)

– 5 days for a Cape vessel

– USD 1.125/100km/mt

• INDIA– Income tax rate in India

• 33.99%

• BRAZIL / AUSTRALIA– Brazil 15.5%– Australia 26.9%

THE TAKEAWAY

• INDIAN IRON ORE HAS A SIGNIFICANT ROLE IN CHINESE STEEL MAKING

• REDUCTION OF INDIAN EXPORTS MAY ADD TO PRICING POWER OF SUPPLIERS

• GIVEN THE HIGH COST STRUCTURE OF INDIAN IRON ORE, PRICING PARITY WITH LARGE SCALE SUPPLIERS NOT POSSIBLE

• CHINA EXPRESSING INTEREST IN LONG TERM PRICING FOR INDIAN IRON ORE

• HENCE, NEED TO EVOLVE A NEW BENCHMARK PRICE FOR INDIAN IRON ORE

INTERNATIONAL BENCHMARK PRICE SETTING TILL 2007

• Since 1969, price negotiations between Buyers and Sellers have been the basis of agreeing on Benchmark prices

THE PRICE NEGOTIAION PROCESS

European Steel Mills(Corus, Arcelor-Mittal, Thyssen Krup, RIVA)

Asian Steel Mills(NSE, POSCO, JFE)

Chinese Steel Mills(Bao Steel)

Brazilian Suppliers(CVRD, MBR)

Australian Suppliers(Rio Tinto, Billiton)

Other Suppliers(KUMBA, QCM, IOC,

LKAB, Etc.)

Views exchangedon markets

Prices, quantumof increase etc.,

BUYERS SELLER

INTERNATIONAL BENCHMARK PRICE SETTING IN 2008

• Till 2006 Japan took lead in settling Benchmark prices

• In 2007 China took the lead in settling the prices. All suppliers agreed on uniform 9.5% increase.

• 2008 saw a new trend. Difference in market view of individual large suppliers. Only VALE has reached agreement on price settlement with European, Japanese and Chinese steel mills in mid February 2008, before start of new pricing year 1st April, 2008.

• Other suppliers yet to agree on the hike with Chinese steel mills

• This indicates new trend. Price setting may not be a smooth affair any longer.

EVOLVING BENCHMARK PRICE FOR INDIAN IRON ORE

• The biggest challenge is change of mindset – both in India and in China

• Indian suppliers have to: – Balance domestic demand and export market

attractiveness– Look for stable business cooperation with China

rather than seek top-of-market prices for each shipment

– Focus on cost efficiency by increasing productivity – Focus on increasing capital investments,

mechanization and value addition


• Chinese buyers have to:– Recognize Indian iron ore as an important resource – Recognize important role played by Indian iron ore in

influencing the benchmark price changes– Recognize the high cost structure of Indian iron ore

mining, logistics and thus its high cost relative to other large suppliers

– Award a COST COMPENSATION (CC) to Indian iron ore considering the unique aspects of small size mines, high cost structure and competing need of domestic steel industry.


– Recognize the advantages of Indian supplies viz.,• Reduction in secondary inland logistics costs in China. ( due

to India’s ability to ship in small Handy and Handymax vessels to smaller ports , inland transport cost from ports to steel mills is reduced)

• Reduction in multiple handlings in terms of lightening of ships, tran-shipment to low draft ports, reduction in handling losses etc., leading to cost savings

• Short transit time from India • Lower capital blockage in LCs due to smaller size shipments• Increased rotation of bank credit limits – an important factor

when Chinese govt. is imposing credit squeeze.

– ALL THE ABOVE COST SAVINGS WILL MOSTLY NEUTRALIZE THE COST COMPENSATION COMPONENT(CC)


MODEL 1- FOR HIGH GRADE ORE

( Price basis 65% FE)

Basis: Brazilian Benchmark Ore price + spot freight+ Cost

compensation (-) Indian Handy-max freight

= INDIAN fob BENCHMARK for High Grade Ore

Example: $ 77.33+71+30 (-) 38 = $ 140 pdmt


MODEL 2- FOR MEDIUM GRADE ORE

( Price basis 63.5% FE)

Basis: INDIAN fob BENCHMARK for High Grade Ore (-) $ 12*

Example: $ 140 pdmt (-) $12 = $ 128 PDMT

* Based on price differentials between HGF and MGF observed in recent past.


RATIONALE:• Indian iron fills the demand-supply gap of term price ore

and hence CFR price of Brazil is considered for High Grade ore

• Most Chinese steel mills have COAs only for committed long term quantity. Any extra quantity has to be moved under spot freight only. Hence Spot freight of Brazil-China considered

• Spot freight ( both for Brazil-China and India-China) considered is based on trend observed in FFA and physical market for the entire year 2008. The ratio of Indian freight to Brazilian freight is mostly in the ratio of 1: 1.87

• Indian Handy-max freight considered as many ports can handle only Handy-max


• Cost Compensation considered includes current Export tax of India ( $ 7.5) and higher logistics costs and other cost items detailed in earlier slides

• If the Export tax is further raised, need to increase CC component.

• The difference between High Grade Ore and Medium Grade ore is based on price difference observed in recent times for these grades.

WHAT HAPPENS AFTER THE BENCHMARK PRICE FOR INDIAN HIGH GRADE IS SETTLED

• Both Chinese and Indian suppliers can enter into long term price agreement for one year and decide on volumes

• Focus on time schedules, quality, cost control instead on price discovery for each shipment

• Indian suppliers have assured revenue stream and can plan for capacity enhancement, investment in logistics etc.

• China is assured of definite quantity from India and is assured of supplies.

• Stable supplies will enable focus on strengthening of relationships with all suppliers

• Avoid build up of large inventories at ports• Stable supplies will reduce speculation in iron ore market. Small and

medium steel mills can avoid price risk of iron ore price changes and can become cost competitive

WHAT HAPPENS AFTER THE BENCHMARK PRICE FOR INDIAN HIGH GRADE IS SETTLED

From next year onward, Indian suppliers can adopt the changes in this benchmark price in line with existing system.

CLOSING REMARKS

• Arriving at a new benchmark price for Indian iron ore is a challenge for both China and India

• It will be a win-win proposition for both

THANK YOU

evolving long term price for indian iron ore (2)

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