2010-06-12 10:20

LONDON - BHP Billiton Ltd, the world's largest mining company, may use last month's 16 percent decline in iron-ore prices to persuade steelmaking clients to pay cash instead of contract-based prices from the next quarter.

Vale SA, Rio Tinto Group and BHP, the world's biggest exporters of the ore used to make steel, scrapped a 40-year custom this year of pricing supplies in 12-month periods, replacing it with quarterly contracts based on the average cash or spot price over three months. Ending fixed-term contracts altogether would be the next step.

"There has been a drive from the large players in the iron ore market to spot prices for some time," Alex Tonks, a commodity strategist at Bank of America Merrill Lynch in Sydney, said by telephone. "It really should occur this half; I would be thinking the next quarter."

The slump in prices in May could help BHP negotiate a move to spot-based sales, offering clients a lower rate than quarterly contracts in anticipation of future gains. Yet supplies based on fluctuating spot prices may squeeze profit margins at steelmakers and create price volatility for end users such as Toyota Motor Corp and Volkswagen AG.

Goldman Sachs JBWere Pty estimated in March that Rio, BHP and Fortescue Metals Group Ltd, Australia's biggest exporters of the ore, may be missing out on $20 billion of sales a year by not selling ore at cash prices.

"BHP are all about expediting the process, about moving to shorter-duration contracts," Olivia Ker, a London-based mining analyst at UBS AG, said by phone. The next couple of quarters will be the testing point, she said.

The cost of ore, the largest raw-material expense in steel production, is about $170 per ton of steel, based on current prices, according to Bank of America Merrill Lynch. Steelmakers use 1.6 tons of iron ore and 0.5 tons of coking coal to make 1 ton of steel. Raw materials account for as much as 75 percent of production costs for mills, according to JPMorgan Cazenove.

The quarterly price for BHP's and Rio's Australian ore is likely to rise about 23 percent to about $148 a metric ton starting on July 1, Colin Hamilton, an analyst at Macquarie Group Ltd in London, said by phone. That's a premium of about 6 percent to his forecast spot price at the same time of about $140 a ton, he said.

Bloomberg News