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TheStreet Open House

Iron Ore Sea Change to Hit Dry Bulk

Stocks in this article: DRYSEXMDSXVALERTPBHPEGLE

NEW YORK ( TheStreet) -- The ongoing price negotiations between China's state-owned steel industry and its iron-ore suppliers has already had serious ramifications on dry-bulk shipping companies.

At stake in the negotiations is not only what price China's buyers will pay for iron ore, but the very system by which the global steel and mining industries have conducted business for the last 40 years.

Traditionally, steelmakers in China, Korea, Japan and Europe have acquired their seaborne iron-ore after striking an agreement with miners that would lock in prices for that year. Some trade would then occur on the spot market, but the vast majority of ocean-going ore was bought and sold under an annual contracts.

Now, however, led by BHP Billiton (BHP) especially, the world's biggest iron ore producers (Brazil's Vale (VALE) is the biggest, Rio Tinto (RTP) is No. 3 behind BHP) want to upend the annual system and move to a shorter-term, variable pricing regime. This would likely mean quarterly contracts, though some speculation has indicated a move toward an all-spot market, just as most commodities are traded and priced.

Altogether, Chinese steelmakers produce more than half the steel that's manufactured each year globally and, for this reason, they've argued that they deserve a discount.

Be that as it may, after 2009's pricing talks collapsed in acrimony, China's steel mills have been forced to buy their ore on the spot market for the past year. Traditionally, only about 10% of the world's ore has been traded on the spot market. But since last April that percentage has surged to 50% (and as high as 70%).

Most steelmakers hate the spot market and, in China and Europe, they've complained loudly about the move away from contract pricing. The miners, meanwhile, have basked in widening profits as prices for the crucial steel feedstock have risen sharply since last year.

That very rise has fueled speculation that the next benchmark pricing settlement for 2010 will double from last year and approach 2008 levels, a remarkable turnaround for a commodity so linked to economic expansion. Japan's steel industry reportedly struck an agreement with Vale over the weekend for a 100% price increase. Rumors swirled Monday that China had agreed to the same.

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