Iron ore pricing: oligopoly vs. oligopsony
A recent Wall Street Journal article ("China's Steelmakers Hold Out As Suppliers Set Pricing Deals", 5/19/06) documents the power of the iron ore mining oligopolies to dictate prices to steel companies across the world. The price of iron ore has gone up by 19% this year, according to the article, as dictated by the big three iron ore companies: Rio Tinto (an Anglo-Australian company), CVRD (Brazil), and BHP Billiton (Australia). That's on top of a 71% price rise last year. These companies between them control 75% of the iron ore production in the world.
Unlike most commodities, the prices of iron ore are set in annual company-to-company negotiations with big national steel companies in Germany, South Korea, Japan, Italy, and others. The prices set in the early negotiation generally set the price for all companies. The Chinese companies, the largest steel producers in the world and thus the largest consumers of iron ore, are trying to get a better deal, according to the article.
But do the Chinese companies have the leverage? Not according to the WSJ story:
While China's move to take the lead reflects its rise as the most important new source of global commodity demand, its failure to strike an early deal underscores the challenge it faces in leveraging that position for a greater say in commodity markets. Analysts said the one-two punch of agreements in Europe and other parts of Asia could make it all but impossible for China to secure a different outcome.
There is also a spot market for iron, reports the International Herald Tribune ("Ore-hungry China faces a seller's market", 5/21/06),
But Chinese steelmakers won't get any bargain there:
But with prices on the international spot market for iron ore about 30 percent higher than the existing contract price, most analysts believe China's steel mills will be forced to back down.
For our point of view, the problem is that the oligopsony of iron-ore buyers (the oligopoly of steel producers) is still not concentrated enough to fight the highly concentrated oligopoly of iron ore producers. The inevitable result, as we are seeing it in action, is a further oligopolization of the global steel market. With deals like Mittal's offer to buy Arcelor in the works and expansive moves by companies like Russia's Severstal and Germany's ThyssenKrupp, that process is underway, even though the protectionist instinct is especially strong with strategically important industries.
But Asia in general and China in particular still has lots of significant steel companies. Many of the Chinese companies (there are 15 of them that produce over 5 million tones), by all reports, are in deep debt, and will be hurt badly by the rise in steel prices.
The iron ore companies that take their negotiating cues from one another, have the upper hand. After all, the need for steel in China (due to construction and manufacturing booms) is near desperate. Add to that a surge in coke prices, and the situation gets worse. The inevitable result: some Chinese companies will fail and be taken over for further consolidation, as a leading company like Baosteel will, it is likely, become even more dominant in the Chinese market. A Forbes article ("China steel cos may see consolidation if ore price rises 19 pct - analysts", 5/18/06) quotes one analyst as saying "'If China agrees to a 19 pct hike, it will definitely accelerate consolidation in the country's steel industry.'"
The steel oligopoly will be at the mercy of the iron ore oligopoly until it too is concentrated into a handful of companies.
