Chinese Woes Could Force Steeper Iron Ore Price Cut

BHP Billiton and Rio Tinto could be pressured into a greater than forecast drop in iron ore contract prices as China's economic data worsens.

Figures last week show Chinese GDP grew at an annualised 6.8 per cent in the December quarter -- less than half the 13.9 per cent of 2007.

It will also be hit by India's decision to ban imports of Chinese toys for at least six months in an apparent bid to shield domestic manufacturers from cheap imports.

It is expected that China will use the worsening outlook as its bargaining tool to bring iron ore prices lower, with some -- including Hancock Prospecting chairman Gina Rinehart -- forecasting up to a 50 per cent drop in prices.

On average analysts are predicting a 30 per cent drop in the contract price, which jumped about 80 per cent to around $US100 a tonne during negotiations last year.

With talks now under way between the large Chinese steel mills and the top three iron ore producers - BHP Billiton, Rio Tinto and the Brazilian miner, Vale - CCZ Equities Research analyst John Chong said it was clear that China would use whatever means it could muster to negotiate prices downwards.

"China will use what it can, including the recent data," he said. "It wasn't surprising how quickly China got out its GDP numbers. It underestimates when growth is high and will very strongly overstate on the downside when it is weak and will use that in negotiations."

It is expected that the big iron ore players would be happy with a 30 per cent drop.

But the smaller producers and those with higher levels of debt, such as Fortescue Metals, would be hit hardest in terms of margins.

Fat Prophets analyst Gavin Wendt said it was already anticipated by the top producers that China would use weakening data to lower contract prices.

But he noted that sources close to the talks said a cut of 30 per cent was likely to be a fair outcome. "It is looking like it will be around a 30 per cent cut, not near the ambit claim of what China is trying to get," Mr Wendt said.

Chinese negotiators are expected to push for an early decision to the contracts, which take effect from April 1, to cash in on the negative news flow, but the producers could win some leverage the longer talks go on. "Despite what we are hearing from Chinese data, the spot price of iron ore has improved and imports into China have also been up over the past couple of weeks," Mr Wendt said.

CommSec market analyst Juliana Roadley said steel producers were also looking at setting the contract prices quarterly and not yearly. "We expect this would work in favour of the mining producers on an expected recovery in iron ore demand in late 2009," she said.

"The pick-up in demand for raw materials, especially steel, will come from new global government infrastructure spending," she said.

Australia's most valuable export, coal, is also expected to have its contract price cut by up to 60 per cent. But annual contract negotiations for the Japanese April-March financial year are yet to start.

The BHP Billiton-Mitsubishi Alliance, the world's largest coking coal producer, said last week that it would cut output due to weak demand.

Source: The Australian