Minmetals warns of volatility in iron ore pricing

SHANGHAI, Sept 6 (Reuters) - The abolition of a decades-old annual iron ore pricing mechanism has damaged the long-term stable relationship between iron ore majors and Chinese steel mills, a senior official at Chinese metals trader Minmetals said on Monday.

"The current iron ore pricing scheme, based on the spot price index, will bring more volatility to the market and the index derivative will also be easily controlled by speculators," Feng Guiquan, vice president of the mining giant, told a conference.

The three big iron ore miners, Rio Tinto (RIO.AX)(RIO.L), BHP Billiton (BHP.AX)(BLT.L) and Vale (VALE5.SA)(VALE.N) have ditched annual iron ore benchmark prices, which were largely favoured by Chinese steel mills, and turned to more flexible index-based pricing since the second quarter.

However, the China Iron & Steel Association has led big steel mills in a stand against the change and those mills have had to buy shipments at a temporary price settled on a quarterly basis, with prices based on the average index price for the previous quarter.

Rio Tinto and Vale have recently unveiled plans to cut iron ore prices by around 10 percent for the fourth quarter, in response to falling iron ore spot prices during June to August.

China's steel industry is easily the world's biggest, but it is highly fragmented and has much more production capacity than it needs. That makes for a highly competitive sector which, coupled with stiff competition from Japanese and South Korean mills, has repeatedly undermined the association's calls for unity in search of a better deal for China's steel giants.

Minmetals also warned that the more flexible iron ore pricing system would increase risks for importers as they are not able to lock in purchasing prices.

"Moreover, some related interested parties will be likely to breach contracts if sales prices are lower than purchasing costs," Feng said.

Minmetals is the leading iron ore trader in China and aims to supply up to 10 million tonnes of iron ore each year by 2015, from the current 5-6 million tonnes a year, Feng told Reuters on the sidelines of the conference. (Reporting by Wang Lan, Writing by Ruby Lian and Tom Miles, Editing by Jacqueline Wong)