Just one month ago, analysts were looking for a 40pc increase in the iron ore benchmark this year. Now some are saying an 80pc increase will still make the commodity look cheap.
We are even seeing a shift in the position of the Chinese, as they learn their intransigence could cost them money. If the country''s steel makers fail to agree on a sensible price hike, they may have to buy at the spot price. This could get very expensive indeed, as the spot has got way ahead of last year''s agreed benchmark. It is now more than double the $60.40 a tonne agreed with Japan in last year''s pricing talks.
The current spot price is at about $134 a tonne, however, industry publication Steel Business Briefing reported last week that some spot deals to China from India were taking place at more than $140 a tonne.
China believes it is a special case that should not be bound by the usual economics of supply and demand. This is obviously unrealistic.
Last week, Zhang Xiaogang, chairman of China''s Angang Steel, which is the largest steel group listed in Hong Kong, appeared to weaken the Chinese hand.
"Iron ore negotiations are under way. I personally am very pessimistic about the results, Mr Zhang told journalists at China''s yearly parliamentary meeting in Beijing. "China''s steel mills originally expected a 20pc price increase, but they will not get that."
With this market background, the minimal increases that China would like to see are looking increasingly foolish. A 20pc increase in benchmark prices would see a price of $72.50, which is still 46pc below the current spot price. It simply isn''t going to happen.
The world''s three largest providers of iron ore – Rio Tinto, BHP Billiton and Vale – will simply walk away and the Chinese will have to buy at the expensive spot price.
Iron ore is essential for these three miners – and profits this year will be highly impacted by what happens in these talks. For example, a staggering 51pc of Rio Tinto''s earnings before interest and taxation (EBITDA) comes from iron ore.
Moves by Vale in Brazil last week have also made China''s position look untenable. Brazilian customers will see near doubling of iron ore produced in their own country.
Steel Business Briefing reported: "Brazilian mining group Vale is seeking to increase its iron ore prices for domestic buyers by 40pc in March and another 40pc in April, according to normally reliable sources in the domestic iron and steel sector."
This would result in a 96pc rise in the benchmark price over a two-month period. If this is true – and there is no reason to believe that it is not – Chinese expectations of a "China Price" that rises just 20pc are nonsense.
Vale has traditionally been a defender of the benchmark system, with BHP Billiton being the most vocal miner arguing for a move away from the annual system. With last week''s move, it looks like Vale is getting more aggressive and is, slowly, coming around to BHP''s way of thinking.
Demand is not going to fall in China. Mr Zhang also said last week that China may add a further 50m tonnes of steel capacity this year. The country produced a record 568m tonnes last year.
Angang also plans to increase output of the steel used to make cars to 2.5m tonnes in 2010, up from 1.7m tones in 2009 as China has become the world''s largest car market.
Steel groups elsewhere are already accepting the fact that price rises are inevitable. On Thursday, ArcelorMittal, the world''s largest steel maker, said that it expected an 80pc hike in benchmark contracts.
"What we''re hearing from Asia is in the direction of 70pc to 80pc," said Robrecht Himpe, the chief executive of ArcelorMittal''s Flat Carbon Europe business.
Steel makers'' margins are also going to be squeezed further by rising coking coal prices. About 70pc of all the steel produced
globally uses this type of metallurgical coal.
BHP Billiton, which is the world''s largest coking coal exporter, has agreed a 55pc increase in the benchmark cost of this commodity with Japanese steel manufacturer JFE Holdings
JFE will pay $200 a metric ton for a three-month contract starting April, according to Bloomberg. This is significant not only because of the price rise, but because this is the first time a quarterly price has been set for coking coal. BHP''s move to more short-term pricing appears to be expanding beyond iron ore.
Of course, selling at the spot price is good in a bull market, but bad in a bear market, as prices are not locked in and visibility will not be clear. However, the Asian material bull market should be in place for many years to come.