Citing the sluggish economic conditions and volatility in iron-ore prices, steel giant Posco (NYSE:PKX) and some other steel companies are pitching for shifting back to an annual contract pricing method.  This could impact the EBITDA margins of mining giants including Vale (NYSE:VALE), Rio Tinto (NYSE:RIO) and Cliffs Natural Resources (NYSE:CLF), if the steelmakers push the miners to once again change contract pricing method even as the shift doesn’t look imminent. Below we take a look at how the move could impact the value of the miners.
A few years ago, iron-ore miners moved to quarterly pricing from annual contract pricing in order to take advantage of rising prices. However, grappling with slow demand and falling ore prices, steel manufacturers pushed for a spot pricing method, wherein the prevailing market price for ore is better reflected in the contract price. But, in the current dwindling economy, steel manufacturers are looking for stability and spot pricing makes it difficult to predict input costs. This has prompted some steel companies to look back at annual contract pricing, as it will help them lock in iron-ore prices for a long term period and manage cost more effectively.
However, a shift in contract pricing method would be significantly dependent on Chinese steelmakers as they make up for 60% of the world’s iron-ore demand.  They have not yet explicitly expressed their willingness to change the pricing method.
Spot pricing had hurt the miners as iron-ore prices tumbled in the recent past. Whether a shift in contract pricing method benefits the miners or steel makers will largely depend on the iron ore prices, going forward. While we estimate iron-ore demand to increase, we project the prices to remain subdued for the next few years as additional capacity comes online.
However, better than expected pick-up in steel demand following an eventual economic recovery could boost the iron-ore prices. In that case, the annual contract pricing will hurt the miners as they will seek to lock in the contract prices at lower rates, which will eventually hurt their EBITDA margins. Vale, being the largest iron ore miner in the world, would be most impacted as ferrous minerals (iron ore mainly) constitute nearly 60% of the company’ value, by our estimates.
If iron-ore prices remain weak, in line with our expectation, a shift will only benefit the miners as they will receive higher prices for per ton of iron ore in a downward trend.
- Posco wants return to annual ore contracts, Vale amenable, Reuters, June 22 2012 [↩] [↩]