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Today's quote:

Friday, December 18, 2020

The gift that keeps on giving


Until a decade ago, iron ore had been priced through annual negotiations between the big producers – Rio, BHP and Brazil’s Vale – and the Chinese mills, echoing the way the price had been set with Japan’s mills for over 40 years.

But whereas the Japanese had always honoured their contracts, the wily Chinese reneged on their contracts whenever the spot price fell below their contract price. Confronted with this "heads we win, tails you lose" attitude by the Chinese, former BHP chief executive, Marius Kloppers, adopted market-related pricing - and all other suppliers followed - and the contract system disappeared.

When BHP's iron ore marketing executives were summoned to a video call with the China Iron and Steel Association last week to discuss the near-70 per cent increase in iron ore prices this year, they made all the right sympathetic noises but, given the backdrop of the widespread Chinese trade sanctions on other Australian products and on BHP's own coal exports, one suspects it was done with a bit of schadenfreude. After all, that’s how markets work. The mills didn’t complain – and nor did the miners - when, in 2016, the price fell below $US40 a tonne.

The recent rise in the price of iron ore - from less than $US90 a tonne at the start of this year to more than $US150 a tonne, and it may be heading back to its previous record of US$200 a tonne - has more than offset the impact on the Australian economy of the Chinese bans on the exports of barley, beef, coal, cotton, lamb, lobster, and wine.

Given that the iron ore price is largely driven by market forces, there’s little China can do but sit back and take the iron ore prices they get. It will be several years before Brazil ramps up its production again, and even longer for China's Simandou Project in Africa to fill the gap.

In the meantime, Australia's three producers - BHP, Fortescue, and Rio - are rolling in it! Who would've expected the December iron ore price to come wrapped in a Christmas bow and a stocking jammed full of royalties and dividends? Not me either; in fact, I did sell down my holdings in BHP shares at the end of June but, luckily, held on to some to give me an early Christmas present. It's the gift that keeps on giving.

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