SEOUL, July 20 The inelastic system of setting iron ore prices annually has favoured buyers to a large extent and caused global miners to give up two years worth of sales value over the last four years, CLSA estimated on Monday.
But the market is unlikely to shift completely to a spot-based pricing system, though the development of a deep spot market would allow more efficient contract pricing, the report said.
"The iron ore market is already efficient... With the emergence of large volumes of seaborne iron ore being sold at spot prices into China in 2008-09, we believe the spot iron ore market will push the contract market into efficiency," CLSA analysts Matthew Whittall and Leavitt Pope said in a note on Monday.
"If iron ore producers can reduce earnings volatility by maintaining some contracts, the question then is why do BHP and Rio want to end the benchmark system? As long as a sufficiently deep spot iron ore market remains, there appears relatively little advantage in pursuing 100 percent spot sales."
Australia's BHP (BHP.AX) (BLT.L) has been in the vanguard of pursuing the demise of the decades-old benchmark pricing system, urging customers to switch from annual contracts based on a single fixed annual price to a mechanism that would adjust prices more regularly, retaining the security of long-term contracts while allowing one or the other to benefit from changing prices.
CLSA said historical evidence showed spot prices would have benefited miners more, as profits they missed out on at the peak of the cycle have been larger than the losses avoided in the down cycle, there is a lag in contract prices relative to spot prices and a lack of adequate market-clearing price discovery makes the contracts market inefficient.
Its estimate comes as the 40-year-old annual pricing system suffers severe strain this year after China, the world's biggest iron ore buyer, passed a June 30 deadline to set annual iron ore prices.
The annual event turned into an international row this month after China detained four Rio Tinto (RIO.L) (RIO.AX) officials from July 5, alleging they were involved in spying and bribing Chinese officials during the annual pricing talks.
To read the lastest stories on the detention of Rio's China executives, click [ID:nSP473911] (Reporting by Miyoung Kim; Editing by Clarence Fernandez)