^[1]By Melissa Pistilli - Exclusive to Iron Investing News

The world's largest iron-ore producer and exporter Companhia Vale do Rio Doce ^[2] is now in the initial phase of negotiations with its Asian clients to raise prices. Vale has stressed that there was no guarantee that negotiations would conclude on a successful note.

The proposed increase ^[3] will bring prices for Vale's Asian clients on par with those charged to their European counterparts. Depending upon the ore grade, Asian steelmakers pay between 11and 11.5 per cent less than Vale's European clients.

Vale is attempting to raise prices in Asia for the second time this year. Effective April, Vale upped its ore price to Asian buyers by as much as 71 per cent. Last week, Vale emailed its Chinese clients ^[4] to say it would expand the current increase an extra 20 per cent from September 1. The mining giant has also asked Japan's biggest steel mill Nippon Steel ^[3] and its competitors to pay an additional 12 per cent on top of the 65 per cent increase agreed upon in February.

Perhaps the company believes its Asian clientele can afford an increase now that freight rates ^[5] have fallen nearly 50 per cent since June. Chinese, Japanese and South Korean steel manufacturers have declined to comment on the proposed increases; however, sources say some Chinese steel mills are planning to oppose the price increase.

Nevertheless, one-fifth of China's iron ore is imported from Brazil where the highest quality ore is produced. So, Vale may have the advantage. "They are going to have to accept it because there simply isn't an abundant amount of iron ore on the market," said Pedro Galdi ^[5], a mining analyst at SLW Corretora.

Some analysts have said that Vale's latest increase attempt may be due to Vale's concerns that its rivals Rio Tinto and BHP Billiton ^[3] had won substantial price increases last year, as well as a 97 per cent increase in June and July of this year. It seems Vale is looking to increase its prices before next year's contracts negotiations start. Together, the three miners control approximately 75 per cent of the 800 million tonne-per-year world seaborne iron ore market.

Will an Index System replace benchmark pricing?

If Vale's newest round of price negotiations with Asian buyers is successful, it will further move the market away from the traditional annual price negotiations system that has existed for decades between the world's leading iron-ore producers and steel manufacturers. Up until now, Vale has been the strongest supporter of the benchmark system. "This is another nail in the coffin for the benchmark as the one big supporter of the system is trying to change terms halfway through the year," a source at a global investment bank ^[4] said.

This latest move by Vale could press steel manufacturers into accepting BHP and Rio's push towards an index-based pricing system. "As spot and benchmark prices move closer, steelmakers will become more willing to accept an index system — no Chinese mills want to repeat the drawn-out negotiations we experienced this year," said an investment bank source ^[4]. BHP has urged such a shift since 2006 on the basis that it would permit consumers to hedge the risk of fluctuations in the market and lock in prices.

A Chinese industry official said he doubted China's top steelmakers would agree to abandon a system that gives them an edge over smaller competitors. Many others in the industry have their own doubts about an easy shift in pricing systems. "I don't think anyone is expecting the annual benchmark pricing system to disappear overnight," said a European steel industry source ^[4].

"Spot market trade in iron ore will continue to grow but will not replace term contracts," said Kamal Naqvi ^[4], Head, Hedge Fund Coverage for Credit Suisse's Commodities Group. "The bulk of next year's settlements will still be based on the annual system. We won't switch to an index next year as the market needs a lot more liquidity before it can replace the benchmark," said Warren Edney ^[4], metals analyst at ABN AMRO. However, Edney believes that annual and index-based hybrid contracts could become more common. Although changes are slowly commencing, the traditional system will most likely remain for at least another decade.