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Raymond J. Learsy

Raymond J. Learsy

Posted: April 6, 2010 02:25 AM

Iron Ore Falls Into the Crude Oil Trading Pit

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Once upon a time crude oil was bought and sold on the basis of contracts, posted prices and the occasional opportunistic spot cargo. Until a few weeks ago this had been the case for iron ore. Growing demand, especially from China over the last decade, has significantly shifted the balance of pricing power to the iron ore mining industry. This is especially true of such majors as Vale of Brazil, BHP Billiton and Rio Tinto. Seaborne shipments of iron ore have grown to 900 million tons per annum, from just 450 million in 2000. China's needs represented 70 percent of these loadings in 2009.

Concurrent to China's staggering growth, a significant spot market was emerging, accounting for some 10 percent of the iron ore trade. Spot market prices were steadily higher than the contract prices and became pivotal to the changing pricing system. The net change in pricing for this year's next quarter, according to the Financial Times, ("Annual Iron Ore Contract System Collapses" 03.31.10) is that steel mills around the world will be paying 80 percent to 100 percent more than 2009 contract prices that were then set at the $60/ton range. The result will be an almost immediate and significant rise in the price of steel on all manner of products imaginable and will place significant additional pressure on a barely resuscitated building industry. Steel makes up 95 percent of the world's metal fabrication and iron ore, of course, is the core component of steel making. Its effect on pricing and employment portends to be dramatic.

Happily cheering this dramatic change in pricing policy are none other than those benevolent proprietary traders, the good folks at Credit Suisse. Morgan Stanley is already deeply involved in trading and facilitating iron ore swaps with predictions of explosive growth in iron ore derivatives/futures just around the corner. All to the fervent pom-pom waving by the cheerleaders at Barclays, Goldman Sachs and JPMorgan. The same folks who helped us bear witness to $147 oil in 2008, and have helped the price of oil to more than double over the last fourteen months while world loadings and consumption of oil fell, activities that of course added great economic value to the well being of our society.

"A 100 percent increase in iron ore prices is an insult," said Gordon Moffat, Director General of Eurofer Acea, which represents car and truck makers in Europe. Steelmakers, especially in Europe, as well as the antitrust regulators of the European Commission, echoed Mr. Moffat's outrage and questioned whether the spot market truly reflects supply and demand. And that is the key question as to the parallels between the current oil market and the emerging iron ore market. Are these markets being manipulated?

Yet there is one key difference. You see the steelmakers question the veracity of the market as a true reflection of supply and demand and raise the issue of its trustworthiness. The steelmakers are steelmakers and in almost all cases, not iron ore miners. That is a consummate and key difference to the oil industry, where virtually all the major oil producers not only produce the raw material but for the most part are refiners and therefore consumers of oil, from Shell, to BP, to Exxon, to Chevron, to Aramco, to Total, to Venezuela (Citgo) and on and on. So for the oil producers there is virtually no push back and enormous resources are used to poison the public's perception of what is happening, helping to encourage such articles as the New York Times' "Oil Prices Find A Sweet Spot for the World Economy," singing praises to $80/bbl oil with a laundry list of dubious argumentation. Don't have me go there or this post will never end.

Just one last observation as to what $80/bbl oil has accomplished. As we are aware, Saudi Arabia's great wealth is generated by exports from its highly diversified economy of high tech equipment, heavy machinery, basic agricultural products and food grains, planes and cars, a vital entertainment industry, luxury goods and services, pleasure yachts and on. Of course, what I am really saying is that other than oil, gas and downstream products, Saudi Arabia produces very little. At $80/barrel, that "sweet spot" in oil pricing heralded so fervently by the New York Times is generating a cascade of cash and disposable national income. Excess to the degree that the Times of London could report that "Saudis fund Balkan Muslims spreading hate of the West" activities that in all likelihood are a microcosm of funding and actions elsewhere.

"That Saudi Arabia is pouring hundreds of millions of pounds into Islamist groups in the Balkans, some of which spread hatred of the West and recruit fighters for Jihad in Afghanistan...Islamic fundamentalism threatens to destabilize the Balkans...Fundamentalist Saudi organizations are clashing with traditionally moderate local Muslim communities." Well this all seems a long way from iron ore. Or are we just at the beginning of another massive distortion in the trade of a commodity basic to the world economy, unaware how it will all play out in our daily lives? If the oil market is the harbinger, beware!