As China probes Rio, BHP quietly pushes iron ore index

SEOUL (Reuters) - While the global steel industry is riveted to the intrigue surrounding Rio Tinto and its iron ore negotiations with China, miner BHP Billiton is quietly pushing its own index pricing agenda with bedrock Asian customers.

In its latest attempt to break down the decades-old benchmark system, BHP gave customers in Japan and South Korea a choice: pay up for iron ore supplies that were ordered but not delivered last year, or write off unsold volumes and switch the contract to prices based on market-based indices.

As a result, at least some customers have been unable to finalize new contracts for the April to March 2010 period, even after agreeing to the same 33 percent price cut versus last year that Rio Tinto set as the industry's early benchmark in May.

"An annual iron ore deal with BHP hasn't been agreed yet due to differences over how to settle carry-over amounts but we expect to conclude negotiations this month," Kwon Young-tae, executive vice president of raw material procurement at the world's No. 6 mill, POSCO, told reporters on Monday.

"We hope to agree on prices with BHP at a similar level that we have already signed with Rio Tinto," he added.

Under iron ore contracts that normally span a decade, mills and miners agree at the start of each year how many tons of ore will be sold; in the previous 2008/09 period, however, many mills ultimately took far less than agreed due to the collapse in demand that forced some to cut production by as much as half.

BHP now says they must agree to fulfill their previous contract purchases -- at last year's record-high prices -- before moving on to this year's supplies, which are some $30 cheaper per ton, unless they are willing to change the terms to spot price indices.

For the moment there seems little doubt that the traditional buyers -- more conservative than their Western or Chinese peers and fearful of ceding more control to three miners that own 70 percent of the world's traded ores -- will choose to pay up for old tonnage rather than abandon the fixed price mechanism, but BHP's move underscores the growing pressure on the benchmark.

"That has made it difficult for Asian mills to wrap up this year's benchmark deals, although they are likely to go for the second option as they have preferred to keep the benchmark system in place," said the source close to the matter.

BHP, the world's No.3 iron ore miner after Vale and Rio Tinto, has yet to decide which iron ore indices it wants to use for pricing and is open to discuss it with Asian customers, the source said.

A spokesman for Japan's Nippon Steel said on Tuesday it has yet to complete a formal agreement with BHP on the 2009 term price, although sources said they have basically agreed with BHP already by settling carryover issues.

Its smaller rival JFE, which market sources say had little carryover volume from last year's pricey contract, is the only major Asian mill that has officially signed a 2009 deal with BHP.

RIO TIED IN CHINA

BHP has been in the vanguard in pursuing the demise of 40-year-old benchmark pricing, 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.

The Australian miner has said it will honor deliveries already contracted under future benchmark prices but would not negotiate new benchmark contracts for as-yet undecided volumes. Instead, it favors an index-type pricing mechanism based on taking prevailing spot prices into account.

Rio Tinto has said it is ready to sell on whatever basis its customers want, though it prefers more flexible prices, while top-ranked Vale of Brazil wants to retain the benchmark system.

Asian steelmakers, however, have refused a switch to a spot-market based system for fear of a volatile cost structure, which could also affect broader industries, such as autos, construction and home appliances, that use steel as a key input.

BHP's push with its legacy customers comes as larger iron ore rival Rio Tinto leads negotiations with Chinese mills, which have already run past the June 30 deadline as the steel industry rejected the 33 percent deal and pushed for a bigger discount, dealing a potentially major blow to the once-yearly mechanism.

Its marathon talks took a fresh turn last week when China detained a top iron ore executive of Rio Tinto in China and three Chinese employees on suspicion of stealing state secrets during this year's pricing talks.

The outcome of that process remains uncertain, as do the prices that Chinese mills will ultimately pay.

But there is little doubt about the fact that the tussle has put the system, where producers and steel firms decide prices of around $88 billion a year seaborne iron ore trade, under still more strain this year, with an eventual shift toward independent market pricing -- rather than negotiating might -- inevitable.

(Additional reporting by Yuko Inoue in TOKYO)