By Melissa Pistilli – Exclusive to Silver Investing News

Traditionally, the price of iron ore has been calculated using a global benchmarking system that typically involved one of the three major producers of seaborne iron ore-Vale, Rio Tinto, BHP Billiton-negotiating annual prices.  This system often takes months to reach a final resolution.

This year, however, Rio and BHP have negotiated much higher increases in their annual iron ore prices with Asia’s steel producers than Vale. Their power to settle prices on different terms than Vale, say some mining analysts, may cripple the traditional benchmarking system. Over the past four years, a spot market in iron ore has formed to “meet the needs of steelmakers who are unable to satisfy demand within their annual volume contracts,” reports Andrea Hotter of Dow Jones Newswires.

Last year, according to the Raw Materials Group, nearly 45% of the 1.63 billion tonne iron ore market was traded internationally.  Only a small share was traded on a spot basis, yet it was significant compared to the annual output in the aluminum and copper markets, which are “the most widely spot-traded metals.”

Hotter says “news agencies have been quick to capitalize on the need for a benchmark spot price by launching indexes based on surveys.”  Some banks have followed their lead and have created hedging instruments based on the news agencies indexes. Last month, two such institutions, CreditSuisse and Deutsche Bank AG, started over-the-counter iron ore swaps that trade against those indexes with various expiration dates.

BHP’s CEO Marius Kloppers says they’ve been predicting over the last few years that “the benchmark system is coming apart at the seams – we’ve sort of lost a pant leg now.” These various “so-called benchmark prices,” as Klopper sees it, help to prove this prediction.

Kloppers believes that the iron-ore market may soon experience what happened in the steam-coal market: a shift from a benchmark pricing system to a physically traded market. There is a “great interest” in this shift. Kloppers says the company is already utilizing the over-the-counter market.

Unlike the benchmark contract system, an over-the-counter system could produce a more transparent market. “I think that over the next couple of periods, we will see a greater transparency in physical markets developing to augment the traded market,” said Kloppers. “And I think those two things need to come together to really give us accurate price discovery going forward.”

Believing the “situation is largely irreversible,” BHP is not looking to enter into any new term iron-ore contracts based on the benchmark system and would prefer to sell against the burgeoning index spot market.

Rising Price Concerns

Another concern over the future of iron-ore prices is what sort of influence BHP’s attempted takeover of Rio Tinto will have over global iron prices. So far, BHP’s bid has faced much opposition particularly from European, Australian, and Chinese regulators.  Rio Tinto itself has reject BHP’s $133 billion as too low.

Already stressed with the rising costs of raw materials, the world’s steelmakers are worried that a superpower combination like BHP and Rio will raise the price of iron, which has increased 85% already this year, even more. Any further increases in price are bound to affect China and India the most, two largest iron-hungry developing nations.

Regulators in the US have already granted preliminary approval. As of last week, Australian regulators have put off their decision as they await further information from BHP. A decision from European regulators is due by this year’s close.

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