RIO DE JANEIRO (Reuters) - The benchmark pricing system that has governed the global iron ore market for 40 years may be unraveling faster than expected.
Officially, Brazil's Vale, the world's largest producer and exporter of iron ore, says the system that brings steelmakers and mining companies together every year for sometimes acrimonious negotiations is still intact.
But recent company comments suggesting Vale is warming to the spot market have fueled speculation that 2010 could mark a critical juncture in the transition from the current stable but rigid system to a fast-moving, derivative-driven market for the principal commodity underlying the world's infrastructure.
Vale's director of ferrous metals, Jose Carlos Martins, said on a conference call this month that the differential between the spot and benchmark rates -- currently more than 100 percent -- is unsustainable.
"To keep the benchmark, we needed to define a system that could have some kind of flexibility to cope with these variations," Martins said. "It's impossible to (maintain) business as usual with this huge difference between spot and benchmark."
Hardly a call to burn the benchmark at the stake. Vale's official position is that it simply wants a higher benchmark and that it is happy to sell under either system.
But many analysts interpreted the comments as unusually supportive of the spot system for a company that has fiercely defended benchmarking and resisted new price mechanisms backed by Anglo-Australian mining giants BHP Billiton and Rio Tinto .
"Vale's apparent acceptance of a shift away from the current pricing system is a significant development in coalescing the miners' position on pricing away from annual benchmarks, which BHP in particular has been advocating for some time," said the Eurasia Group in a research note.
The Rio de Janeiro-based company is famously cautious in any comments about the benchmark system. Vale consistently denied it was selling on the spot market well into 2009, even though analysts said it began spot sales in 2008 in the wake of the global economic crisis.
It first acknowledged spot sales in mid-2009.
China's rapid economic growth, coupled with the 2008 crisis, upended the iron ore business by making Beijing the most powerful buyer -- letting its quasi-state steel giants and dozens of importers overturn established market protocol.
Instead of buying the volumes they agreed to take under contract, many Chinese players are now simply buying the cheaper of benchmark or spot prices.
Vale could face shareholder pressure to seize on the opportunity to boost revenues with more spot sales, possibly leading it to increase spot shipments this year.
Markets are moving toward the use of derivatives such as iron ore swap contracts, a dedicated contract that replicates a timeline and is based on an index price, allowing buyers to lock in a fixed price in a volatile market.
A broad move to the spot market could involve some risks for miners, most notably another economic downturn that would push prices down again without the safety net that a benchmark system could provide.
Martins estimated spot sales were almost 50 percent of the world's total sea-borne iron ore market and near 70 percent of the Chinese market.
CHINA'S ONE-WAY BET
Vale is positioning itself for better access to the spot market by ordering a fleet of ships that will help it avoid exposure to volatile freight prices and better compete for Chinese market share with Australian miners that can ship to China at much lower cost.
And last year's chaotic conclusion of benchmark talks with China -- which ended in the arrest of Rio executives and no formal deal -- suggests this year's talks may not come to a quick conclusion.
Price talks between miners and customers in Asia usually start in November and in most cases are settled before June.
Vale's fourth-quarter results showed iron ore revenues fell more than $350 million from the previous quarter. In the same period, spot prices for 62 percent iron ore -- a grade of ore often used for pricing -- jumped to a peak above $130 per tonne from about $85 per tonne.
Analysts say this is because Chinese buyers insisted Vale -- along with other miners -- return to selling at benchmark rates as spot prices climbed above the benchmark.
"Vale honored the contracts and the commitments to those customers, and in the process they left tonnes of money on the table -- their earnings could have been double if they had gone to spot," said one analyst who asked not to be identified.
"I don't think Vale's going to let that continue."
The company does not provide details on how much ore it ships under the spot pricing system. But it publishes the total tonnage sent under shipping contracts known as cost and freight, or C&F, in which the seller pays freight costs -- a number many analysts use as a proxy for spot sales.
Vale shipped 6.8 million tonnes of iron ore under C&F contracts in the fourth quarter, compared to 22.5 million tonnes the previous quarter -- cutting spot sales precisely when they would have been the most profitable.
A company spokeswoman said the only details on spot market sales and C&F shipments available to the public were those provided by Martins on the February call with analysts.
"I've always thought price stability through annual talks made a lot of sense, but when the contract price is so far below the spot you have to question that," said Chuck Bradford, a metals analyst with Affiliated Research Group in New York.