Mining giant Vale's request for higher prices in already-settled contracts with Asian clients on annual iron ore prices would not change demand in China, but could challenge the system of annual contract negotiations, analysts said yesterday.

The Brazilian firm's demand clearly reflected its displeasure over the higher ore prices won by Australian miners, something never seen before, particularly when Brazilian ore was of a superior grade, analysts said.

Industry officials said last week Vale had e-mailed Chinese steel makers demanding an additional 20 percentage points from September 1 on top of the 65 to 71 percent increase in annual term prices it set in February. Japanese mills have also been notified of the higher ore prices. Iron ore is the main ingredient used to make steel.

Analysts have questioned the timing of Vale's request, which comes amid softening steel prices, freight rates and spot ore prices.

Mills have vowed to resist the ''unreasonable'' demand.

"The steel market is struggling to recover significantly at least before the year-end, so is the demand for ore," said Zeng Jiesheng, an analyst at Mysteel Research Institute. Zeng said high-level ore stocks and production cuts by mills had also softened iron ore demand.

Zeng said Asian mills were not likely to agree to the higher prices, given the weak market amid the global economic slowdown.

Vale confirmed this week it has been holding talks with Asian clients regarding the additional prices hikes. The further hikes would bring Asian prices into line with what the company was charging European customers, it said. Vale traditionally granted Asian clients discounts given the higher shipping fees across the Pacific.

"Vale highlights that this negotiation is not concluded and there is no guarantee that it will be successfully concluded," said the Rio de Janeiro-based miner, formally known as Companhia Vale do Rio Doce.

Still, Vale has its leverage in the dispute - its ore is of the market's highest grade.

Mills have been seeking higher-grade ores to reduce the use of coking coal, whose prices have also surged. Low-grade ore requires more energy during production.

Market watchers said Vale was asking for more in order to gain an upper hand in the new round of talks for 2009/10 contracts, due to start in November. They said Vale believed Asia could also afford to pay more for the product after sharp drops in shipping rates.

Benchmark rates

"Vale may delay shipments if the request is not met, helping reduce the high-level ore stockpiles at Chinese ports, therefore cementing its position in the new round talks," said Su Lifeng at Guoyuan Securities.

For the current 2008/09 contracts, Vale first agreed with China's Baosteel Group Corp, which represents major Chinese mills, in February on a 65 to 71 percent hike in prices for the fiscal year starting on April 1.

But the increases failed to set a benchmark, as had happened in previous years, after Asian mills agreed to gains of as much as 97 percent with Australia's Rio and BHP in June and July after lengthy and bitter talks.

Australia asked for premiums in annual ore prices to reflect the lower shipping costs between Australia and Asia.

Vale, Rio and BHP together control around three quarters of the 800 million tons per year global ore market shipped globally.

The significance of the Vale move is that Vale, once a strong supporter of the contract system under which the first deal reached between a miner and mill would set a global benchmark for the year, has now changed its position.

Australian miners have argued the traditional price system was born at a time when ore demand was weaker and supply was stable, which was no longer suitable for today's market. The annual negotiations, often deadlocked in recent years, also wasted too much time and manpower, the Australian companies said.

BHP has argued that the fees should be adjusted more regularly or be based on spot markets, which would allow clients to hedge the risk of price fluctuations in the market.

Zeng said it was not necessary for mills to hold firm on the current annual talks system, because it was very possible that spot ore, which accounts for less than 10 percent of world's shipped trade at present, could be cheaper. Spot ore prices and contractual prices had been converging, he said.

He said that Vale's latest move could help Australia's Rio and BHP in their quest for the index-based pricing system, but that would not come quickly.

"I don't think Vale's real intention is for a new pricing system, but more to show their displeasure and try to position itself in the upcoming price negotiations," Zeng said.

Australia is also trying for upper hand in the new round talks, by painting a picture of tight supply in the market, Zeng said.

(Shanghai Daily September 11, 2008)