By Melissa Pistilli-Exclusive to Iron Investing News

For nearly thirty years, the pricing mechanism for iron ore has involved annual price negotiations between the world’s three leading mining giants and major steel mills.

This year’s negotiations led to 79.88 per cent to 96.5 per cent price hikes for Rio Tinto and BHP Billiton with a 65 per cent-71 per cent increase for Vale.

The 2008 negotiation results obviously did not sit well with Vale, who seems to have been “out-bargained” in the Chinese market by Rio and BHP. As it stands, the price of some of Vale’s ore varieties are 11 per cent to 11.5 per cent lower in Asia than in the European market. Now, Vale is making a brazen attempt to increase the contracted iron ore price by as much as 20 per cent for its Asian steel manufacturing clients.

Vale is hoping to convince its Chinese clients to pay the same prices as their European counterparts. If successful, the hike will give Vale a nearly 3 per cent increase in the company’s total income from the 2007/2008 fiscal year, which was US$35.5 billion.

Vale’s newest proposed increase has no doubt provoked the ire of China’s steelmakers, who did not expect that Vale would attempt any price hikes before the 2009 talks. Some analysts suggest that China’s steel industry players should respond by forming a “few sourcing groups to gain some leverage in their upcoming negotiation” with Vale, Rio and BHP for the 2009 long-term iron ore price negotiations.

To counteract the market dominance of the world’s three major iron ore suppliers, analysts like Vice-Director of Mysteel Wang Jianhua, suggest China should encourage consolidation in the steel industry by organizing three to five groups to minimize sourcing and transportation costs and maximize power over pricing. Jianhua believes four such groups can form in China: the four large state-owned steel manufactures led by Wuhan Iron and Steel Corp.; private medium and large steelmakers led by Shasteel; small and medium state-owned companies led by Sinosteel; and other steel companies and steel trade and logistics companies led by Minmetals.

Chinese buyers said they will make their decision after first discussing the issue with the China Steel and Iron Association (CISA), which is notoriously “unenthusiastic” when it comes to price increases. CISA has obtained responses from China’s steel mills, said Vice-Chairman Luo Bingsheng, but the organization declined to openly discuss their intended countermeasures.

The China Iron & Steel Association has said Vale’s petition for a price increase midway through the annual contract cycle is a break in convention and against trade law. Although Vale has emphasized that it is still in negotiations and the price hikes are not set yet, CISA Deputy Secretary General Zhang Jinjang has said that many Chinese steelmakers at port in Brazil have not been allowed to load ore resources. Vale has reportedly refused to load the ore unless China agrees to the price hike. Mr. Jinjang is adamant that this action is in defiance of trade law since the term price was already set for this year.

Iron ore purchases have acquired some power “in the supply/demand relationship” because of slowdown in the global economy. Spot price is nearing contract price and could possibly fall below it in the future, say some analysts. Under these changing circumstances, said Mysteel analyst Zeng Jiesheng, “Vale’s demands are out of accord with international game rules, and it will not be accepted by the steel industry.”

However, Jiesheng acknowledges that Vale has advantages of its own. Although Brazilian iron ore is much costlier to ship by sea than Australian ore, Vale’s ore is of much better quality. And now that sea freight prices are declining, Vale no doubt feels all the more justified in raising prices. Regardless, this dispute will no doubt cast a cloud over negotiations for the 2009 iron ore contracts set to commence in two months.