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June 26, 2008

Iron Ore Deal Could Signal Consolidation Ahead for Chinese Steel Mills

SHANGHAI (Interfax-China) -- Baoshan Iron and Steel Group (Baosteel Group), China's largest steel mill and representative of Chinese steelmakers at the annually contracted iron ore price negotiations, has settled on an up to 96.5% increase with Australian iron ore miner Rio Tinto [NYSE:RTP; LSE:RIO; ASX:RIO], according to Baosteel Group.

This year's iron ore FOB prices for Pilbara Blend Fines (PBF) and Yandicoogina Fines will increase by 79.88%, while Pilbara Blend Lump (PBL) will see a 96.5% price hike when compared with the previous year.

The new prices of PBF and Yandicoogina Fines per dry tonne Fe unit now stand at $1.4466 and PBL, at $2.0169. These prices will be the benchmark for all long-term Hamersley contract sales for this year, commencing April 1.

Baosteel Group said in the announcement that the benchmark prices agreed on with Rio Tinto are in line with the long-standing international pricing scheme, and Chinese steel mills will support Rio Tinto's further iron ore production expansions to deliver more quality ore for the market.

"The agreement reflects the continuing very strong demand in the market for Hamersley's products," Sam Walsh, chief executive of Rio Tinto's Iron Ore Group, said.

Australia-based Rio Tinto, the world third-largest iron ore miner, expects to reach production capacity of 200 million tonnes of iron ore this year and is moving towards 320 million-tonne and 420 million-tonne per annum goals in the future.

Debate over a possible premium on iron ore prices to reflect shipping advantages prevented Australian miners and Chinese steel mills from reaching an agreement until now. Brazilian miner Vale [NYSE:RIO] settled on between 65% and 71% price hikes with Chinese steelmakers in February.

Concerns were previously high over massive spot sales from the Australian miners if negotiation talks were to fall through. Australia is China's largest single iron ore supplier.

"This year's benchmark price increase with Rio Tinto has been raised by an average of 85% so far, which means by calculation, there is an RMB 430 ($62.56) increase in production costs per tonne of steel produced from Rio ore. It is expected that the higher steel product prices have already offset the ore price increase," Mao Zuhong, an analyst with United Securities, told Interfax.

Commentary

Baosteel Group and Rio finally nailing down a weighted-average 85% price increase for Rio's fine and lump ore products this year was fairly predictable after the sharp 71% increase in Brazilian ore prices reached in early February. Debates over a possible price premium to reflect lower shipping costs dragged this year's talks with Rio to the end of June, but the negotiated price will only partly satisfy Aussie miners' desire for a shipping premium.

Steel mills will be better equipped to handle this slightly higher increase from Rio, especially as higher steel product prices can offset the increase and pass costs along to the end customer, but next year's talks will be no easier for Chinese steel mills, as the Aussie miners may seek to launch a proposed iron ore index to better reflect market prices and narrow the gap between long-term contract prices and spot market prices. The unprecedented gap between Brazilian and Australian iron ore prices may accelerate talks to establish a new iron ore pricing system.

Increased production costs, including higher iron ore, coke, crude oil and electricity prices will pressure domestic steel mills, particularly small operations, and will result in a more rapid phasing out of small mills, which will facilitate industry consolidation.

© Interfax-China 2008. Commentary provided by David Harman. For further information regarding Interfax China Commodities Daily Reports, contact David Harman at david.harman@interfax-news.com.

By Ginger Ding - 25 Jun 2008 at 09:32 AM GMT-04:00

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