Boycott of Rio could bolster smaller rivals

Chinese steelmakers resist iron-ore prices as newcomers step in
BY ROBERT Guy MATTHEWS

THE PROSPECT OF a boycott by Chinese steelmakers of Rio Tinto PLC's spot iron-ore offerings could offer a window of opportunity to smaller competitors of the big iron-ore supplier.

The China Iron & Steel Association has asked Chinese steel mills and iron-ore traders to boycott Ric Tinto's spot iron-ore sales, alleging that the company isn't fully meeting its long-term contract supply obligations. The Chinese firms accuse the miner of limiting its lower-priced contract-supplied iron ore to force buyers to pay much higher spot-market prices.

The threat comes as the mining giant is pressing for higher contracted prices with China's steelmakers. Ric Tinto has said that it is honoring all its contracts and that the call for a boycott should be seen in the context of the continuing negotiations.

On Thursday Australian upstart Fortescue Metals Group Ltd, shipped its first load of iron ore to China in hopes of breaking the ironore grip held by the world's top three mining companies-Rio Tinto, BHP Billiton and Brazil's Companhia Vale Do Rio Doce. Fortescue shipped its first batch of iron ore from its new iron-ore deposits in Australia to 40 steel mills in China.

Likewise, iron-ore companies in India, Kazakshtan, Chile, Greenland and dozens of other countries across the globe have announced that they too will develop or expand their ironore output to take advantage of the high prices and current tight supply. Though most of these announced projects will take years to come online, they signal that the current tight supply and high prices may ease in the long term.

Rio Tinto said earlier this year that it would exercise a little-known option in its contract that allows the company to supply just 90% of the iron ore at the agreed-upon contract price. The other 10% could be priced and sold on the spot market.

Contract prices for iron ore are at about $85 a ton. Spot prices are hovering around $200 a ton.

Chinese steelmakers are resisting the spot price because of the huge spread, but they may have little choice. Their resistance and boycott threat might instead be more of an effort to whittle down the markup that Rio Tinto is seeking in current contract negotiations. Chinese steelmakers agreed to a 71% price increase earlier this year with Brazilian mining giant Vale. Rio Tinto and BHP want more than 71%, saying they deserve a premium because they are closer and can deliver the ore faster. The two sides have yet to reach an agreement, but steelmakers are under the gun to wrap up prices within the next 60 days. If they don't, they will have to buy all their iron ore from the spot market.

Smaller producers aren't a viable alternative at this point. Fortescue said it will take a year or so to get fully up and running. The group hopes to have 12 million metric tons of production by the end of the year, ramping up to 100 million by 2010. If successful, Fortescue would produce roughly in the same range as BHP Billiton, currently the third-largest ironore supplier.

"I think Fortescue is a major demographic shift in the supply of iron ore," says Andrew Forrest, the company's chief executive. "The three major [miners] have waited too long to increase their production."

Vedanta Resources PLC, a metals company with iron-ore mines in India, is another company hoping to make inroads into the iron-ore market. It says it plans to double its ironore production, most of which is exported to China, to about 25 million metric tons by 2010. "You are seeing new players from Australia, Ukraine and here in India come into the market," said Anil Agarwal, chairman of the company. "But there will be enough iron-ore demand for every one."

Meanwhile, Belarus wants investors to develop two new recently discovered reserves, which could potentially produce 500 million metric tons. Eurasian Natural Resources Corp., a mining and metals company in Kazakhstan, said it would pay nearly $300 million for a stake in the Brazilian iron ore-mining project that could produce more than 20 million metric tons a year. Greenland and Chile also are opening new mines.

One of the obstacles for the smaller mining companies is getting the ore from the ground to customers. Iron ore is heavy and bulky and requires a large investment in infrastructure like rail cars and shipping and specially designed ports to handle the huge bulk carriers to ply the world's oceans.

"The problem is thatyou need several billion dollars to get into the game," said Mr. Forrest. "It doesn't matter if you are in Africa, Europe or Australia, you have massive port challenges and even larger shipping challenges. Finding the iron ore is the easiest part"

Fortescue said that it is spending $2.8 billion in starting its iron-ore production in Australia. The company had to build rail lines and expand port facilities at Port Hedland in the Pilbara region of northwestern Australia.