ANALYSIS - India iron ore tax hike another blow for China mills

Last Updated: Wed, Dec 30, 2009 11:50 hrs

/BEIJING (Reuters) - India's 5 percent iron ore export tax hike may further tempt Chinese buyers back into a loveless annual relationship with the big three miners, in preference to the uncertain supply and volatile prices of the spot market.

Smarting after losing the battle to win bigger cuts in 2009 contracts than Asian rivals, China will now face even more pressure to accede to miners' demand for a hefty increase in 2010 contract prices, as spot prices rise to record levels and output in the world's top steel producer continues to surge.

Analysts have been steadily upping their forecasts for a rise in settlements between Chinese mills and miners BHP Billiton, Rio Tinto and Vale to around 20 percent, but there are already indications that an eventual settlement may be higher.

"Our figures show that market tightness will actually increase over the next two years, particularly for seaborne material, so an early resolution to the benchmark prices will be an advantage to iron ore buyers," said Cameron Hunt, director of the Metal Bulletin Iron Ore Index in London.

India, which supplies nearly a fifth of China's iron ore imports, lifted the duty on iron ore fines to 5 percent from zero, while iron ore lumps faced a 10 percent duty from Dec. 24, up from 5 percent.

The news helped lift the Steel Index's iron ore benchmark to a lifetime high of $112.10 a tonnes, while deals for 63.5 percent Indian fines in China were done at a record $119-121 a tonne on Tuesday, according to Chinese consultancy Mysteel.

This is about 50 percent higher than contract prices agreed for this year between miners and Japanese and Korean mills.

"The impact is massive and it is affecting prices in the whole industry. The Indians will have their cake and eat it because they can pass the costs entirely onto Chinese customers," a trader in Shanghai said.

PAY UP OR PERISH

The higher spot prices may prompt China's steel mills -- led by Baosteel after the China Iron and Steel Association's problematic one-year reign as chief negotiator -- to settle early and at higher values than analysts had been looking for.

CISA said on Wednesday that foreign miners were calling for a 20-30 percent increase in benchmark iron ore prices in 2010.

A Chinese analyst who was not authorised to speak to the media said: "Twenty percent higher is the minimum but 40 percent is possible."

The consensus in the market has been for an increase of 15 to 20 percent for the 2010 settlement, after a 33 percent reduction won by Japanese and South Korean mills in 2009 that was largely if unofficially followed by Chinese steelmakers.

"This swings the negotiating table further in favour of the Australians and Brazil," said Jonathan Barratt, managing director of Commodity Broking Services in Sydney.

"Buyers are nervous about availability of supply next year and more and more are inclined to lock in -- pay up or perish," Barratt said.

China's government has castigated a iron ore production joint venture between top tier miners Rio Tinto and BHP Billiton as having the "obvious colour of monopoly".

Together BHP and Rio would have about 350 million tonnes a year of production capacity, ahead of Brazil's Vale. If BHP's expansion plans stay on target, that would increase to 375 million tonnes a year next year.

The three producers supply more than half of China's total iron ore imports.

India's iron ore exports have risen 21 percent in the first seven months of the financial year from March to 53.225 million tonnes, driven by Chinese demand and soaring international prices.

Domestic steel makers such as Steel Authority of India, Tata Steel, JSW Steel and Jindal Steel and Power have been pushing for an export duty to increase their cut of India's iron ore output.

"Higher pricing on the Indian front may see a shift in Chinese demand from the Indian market to the competitive markets of Australia and Brazil," Vinita Goyal, an analyst with Hyerabad-based commodity brokerage Karvy Comtrade, said.

"The decision pushed shares of six major steel product firms up as a sign of relief."

With iron ore spot market prices expected to increase even further over the course of next year, Chinese mills will face a tough time.

China's steel output this year is expected to come in at a record 565 million tonnes, and mills are expecting demand to surge further in 2010, with automobile output at a record high and construction activity still benefiting from a 4 trillion yuan ($585.7 billion) government fiscal stimulus package.

Wuhan Iron and Steel, China's third-biggest steelmaker, will raise crude steel output by 24 percent to 37.9 million tonnes next year to meet soaring domestic demand, Chinese media reported on Tuesday.

"Most of our iron ore is sourced from India and the main problem for us is supply, as we are expecting demand to increase a lot next year," an official with a medium-sized Chinese steel mill said.

(Additional reporting by Ratnajyoti Dutta in NEW DELHI; Editing by Michael Urquhart)