Brazilian miner Vale has joined BHP Billiton in pushing customers towards more frequent pricing of iron ore, a move that could boost revenues for miners, but leave mills exposed to the changing spot market.
Talks with Japanese steel mills will set the stage for wider negotiations with Chinese mills, which account for 70 percent of the $88 billion global seaborne market.
BHP and other producers could lose billions of dollars in revenue if they agree to sell ore in 2010 on a contract basis rather than be exposed to the spot market which many analysts expect to build on the 11 percent rise seen so far this year.
Spot market prices for iron ore have soared above $130 per tonne, double the 2009-2010 contract price, spurred by strong demand from Chinese steelmakers and global strength in commodities markets.
At the same time, mills argue steel prices have not recovered sufficiently and demand is too weak to pass on to clients their increased costs of iron ore and coking coal.
"Vale has proposed to all major steelmills in Japan a quarterly pricing of iron ore," said a source with knowledge of the talks, who asked not to be identified because of the sensitive nature of the topic.
"Mills are resisting, saying they can't have such a change so easily."
The Brazilian firm, which had defended the annual benchmark system for years, wants mills to adjust prices every quarter based on spot prices in China of Indian ore, for example, the source said, adding that Vale had yet to make an official proposal on prices.
A global shift in the pricing system of the key input for steelmakers input away from the decades-old annual benchmark pricing could change the way they sell their steel or risk squeezing profit margins.
For a report on scenarios of Japanese mills's responses to quarterly coking coal pricing, click
Media reports and analysts said Vale had already told some Chinese mills that it plans to start pricing iron ore on a shorter-term basis.
Hu Kai, an analyst at consultancy UC361.com, said he had heard from local Chinese mills that Vale planned to drop the benchmark. He said he expected Chinese mills to probably be forced to accept the new pricing arrangement.
Under the benchmark system, the first settlement by Vale, Rio Tinto and BHP became the price for all other suppliers in any given year.
For a timeline on iron ore contracts, click:
TEN-YEAR CONTRACT
Japanese steelmakers, including the world's second largest, Nippon Steel Corp and No.6, JFE Holdings Inc, have resisted Vale's proposal, citing their 10-year supply contracts signed in 2004, the source said.
The contracts set supply volumes each year and the terms on provisional pricing, where Vale guarantees supplies at provisional prices for up to six months in case they fail to agree on prices.
Japanese mills are also worried about a lack of credible spot price indexes to base the quarterly prices, the source said.
Shorter-term contracts also conflict with Japanese mills' patterns of selling to automakers.
They sell much of their steel to carmakers on an annual basis and would feel exposed if the price they paid for raw materials was reviewed quarterly.
An iron ore trading source in Australia said Vale, BHP and Rio were looking at ways to calm concerns among buyers that spot iron ore prices will skyrocket in the next year.
The source said a twist on a mechanism implemented by Atlas Iron, where the final ore price is to be based on a combination of spot and quarterly term prices was among possible options under discussion.
The mechanism is aimed at ironing out uncertainties surrounding fixed iron ore prices and wild swings in the spot market and will be employed by Atlas to deliveries to Chinese steel mills.
Last week, BHP Billiton agreed a quarterly price with steel mills in Japan, China and Europe for coking coal, the other main input in steel making.
The Big Three miners -- Vale, Rio Tinto and BHP Billiton -- and Japanese mills recently resumed talks on iron ore in Tokyo after a brief hiatus. (Additional reporting by James Regan in SYDNEY; Editing by Nick Trevethan)