July 10, 2009 / 12:41 PM / 11 years ago

SNAP ANALYSIS -China iron ore strategy leak sows price confusion

SEOUL (Reuters) - The detention of four of Rio Tinto’s China staff now appears to revolve around access to commercial information about the domestic steel industry’s negotiating position in annual iron ore price talks, which have yet to be publicly resolved.

The Shanghai office of China’s State Security Bureau accused Stern Hu — Rio’s top China iron ore salesman — and three of the local Rio staff of bribing Chinese steelmakers during the talks, using improper methods and stealing Chinese state secrets, the China Security Journal said.

On Friday, a source with knowledge of the probe told Reuters that Tan Yixin, the head of iron ore imports for state-owned steelmaker Shougang, was also taken into custody on suspicion of “revealing China’s negotiation strategy” to Rio.

The latest revelations confirm what many had suspected — the probe was directly related to the increasingly acrimonious annual rite of negotiating prices for 12-month iron ore contracts, which this year dragged on past the June 30 deadline as both miners and China’s steel mills stuck to their guns.

Regardless of what Rio knew about the Chinese position, most market analysts had long believed that the China Iron and Steel Association — which was leading the talks — would fail to win anything better than the 33 percent price cut that Rio had set as a benchmark in late May deals with other Asian mills, after which the spot market rallied and the economy brightened.

The question now is what happens to the long-term contracts that still tie Rio, the world’s No. 2 iron ore miner, to China, which imports more than half of the world’s traded ore. At the moment some of those supplies may be reverting to a spot basis, but at some point the issue of annual pricing must be resolved.

Analysts are initially divided: some believe China may use the probe as a negotiating tactic to win price cuts nearer the 40 percent or better that they had initially fought for; most others say market forces will dictate it eventually accepts the 33 percent cut — unless it has already done so.

DEAL IS DONE, NO GOING BACK

Earlier this week — the morning after Rio first announced that four of its staff had been detained — a second-tier Shanghai-based newspaper reported that a deal had been reached at 33 percent, on a six-month instead of 12-month basis, but that the two sides had agreed not to release it publicly.

Although one Chinese executive and a Rio Tinto spokesman both said talks were ongoing, some analysts say the initial report may have been correct, but an announcement — which would normally follow a day or two after such a deal — has been delayed by the intrigue around the detentions.

“China could have tentatively agreed already. But they have yet to sign it and thus officially they are still in talks,” said an analyst who asked not to be named.

“But I don’t see the investigation affecting the price talks, as it’s a commercial deal and the probe could be simply China’s efforts to rectify foreign firms’ information gathering activity.”

This could potentially be a face-saving opportunity for CISA, which had mistimed an initial demand for at least a 45 percent price cut, as both iron ore and steel markets recovered.

CISA can blame the failure to make a breakthrough in the negotiations not on its own stubbornness but on spying by Rio.

LEVERAGE TO RENEGOTIATE

China could use its findings to pressure Rio Tinto to reverse iron ore deals it might have signed with Chinese mills, claiming Rio Tinto took advantage of state secrets it had obtained during price negotiations.

Chinese law is vague on what constitutes “state secrets” but economic data such as gold holdings and currency movements have at different times been deemed secret, so it would not be a stretch for information about a lucrative, largely state-owned industry such as China’s steel business to be included.

TALKS FURTHER DELAYED

The investigation could simply delay already protracted iron ore pricing talks, as Rio Tinto, already in a better bargaining position on the back of rising iron ore prices, may choose to take more time to press China, while arguing it was not aware of any evidence that would support spying allegations.

While it is nearly unprecedented for talks to go past the June 30 deadline to agree on prices for the April-to-March fiscal year, sources say some of the iron ore contracts would remain intact until September 30, at which point the entire long-term agreement could be scrapped.

If negotiations were to continue, it’s unclear who would lead them: Rio Tinto has been largely leading this year’s talks, with BHP Billiton and Brazil’s Vale taking a back seat, although either one could step in to take over the lead if China believed that Rio had access to privileged information.

IN THE END, 33 PCT INEVITABLE

Despite all the ructions, China appears to have almost no alternative but — in the end — to accept the 33 percent price cut as iron ore markets are on the rise and a further delay would put its mills in an uncompetitive position against regional rivals which have already fixed their production costs.

“The iron ore spot price is about 20 percent higher than the contract price of Japanese blast furnace producers, creating relatively severe raw material cost pressure for companies which are highly reliant on spot procurement,” said Morgan Stanley analyst Harunobu Goroh.

Reporting by Miyoung Kim; Editing by Jonathan Leff

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