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Iron Ore Upheaval Reaches U.S.

The shockwaves sent out by the revolution in worldwide iron-ore pricing will eventually reach the good old U.S.: Here's how.

An iron-ore mine owned by Cliffs Natural Resources in the Iron Range of Minnesota.



) -- Iron ore hasn't seen this much excitement since perhaps the dawn of the Iron Age (circa 1300 B.C.).

Though it had been brewing for more than a year, a sea change swept across the iron-ore trade when

BHP Billiton

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announced on Tuesday that it had struck agreements with a "substantial number" of steelmakers in Asia. Not only did the behemoth Australian mining concern hike its iron-ore price by 90% from 2009, it also, in combination with similar moves by Brazil's


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killed the benchmark pricing system

that had structured the miner-steelmaker relationship for the last four decades.

The ramifications of the shift are just beginning to be felt, and they extend far beyond the Australian and Brazilian mining districts and the Chinese steel-mill zones that have come to define more than 70% of the world iron-ore business. From the assets of

Cliffs Natural Resources

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in the Minnesotan Iron Range, to start-up mining entrepreneurs with dreams of exploiting huge ore bodies in remotest Canada, to the corporate corridors in steel towns like Pittsburgh and West Chester, Ohio, the changes to the benchmark iron ore pricing system, a seemingly international phenomenon, will eventually have an impact in good old North America.

It all began about eight years ago, when China's breakneck growth fueled an unprecedented expansion of its homegrown steelmaking industry. Roads, bridges, buildings, factories: the need for steel grew so acute in China that demand for iron ore (steel's core ingredient) drove the world price of the raw material ever higher. By 2008, it had risen by some 375% over the previous several years.

The global recession did nothing to dampen China's growth or its hunger for steel. All kinds of records were set in 2009: tons of steel produced, tons of iron ore imported, tons of iron ore extracted, even as the benchmark price a year ago fell by about 48% from the 2008 peak.

With the price of the metal (chemical symbol Fe, atomic number 26, abundant in meteorites) shooting higher, the world's three biggest iron ore miners -- Vale, BHP and

Rio Tinto


, in descending order of size -- began to politic for a change to the benchmark pricing system, in place since the 1960s.

Under that system, at the beginning of each year, the big global miners would begin negotiating with their steelmaker customers in Japan, South Korea and China. The first pair to strike a deal set the annual "benchmark" for the seaborne iron-ore market (that is, the ore that's hauled over the oceans, which is the majority). Using that price, all other miners and steel companies would fall into line for the rest of the year.

BHP, especially, came to argue that the annual-contract status quo was unfair: Iron ore ought to trade like other commodities, BHP argued; it ought to have a robust spot market, where, traditionally, only about 10% of the world's iron ore was bought and sold. Steelmakers, for their part, wanted to maintain the stability of a yearly fixed price. The annual contract negotiations grew contentious: Some even blamed the heated talks on the still-unfolding drama surrounding China's arrest and conviction of four Rio Tinto iron-ore salesmen on bribery and commercial espionage charges.

And there was the added friction caused by the ineluctable global mining consolidation that had resulted in three companies controlling more than 70% of the iron-ore market. Steel trade groups raised their hackles, hinting at collusion. Says one stock analyst covering mining and metals in the U.S., "If I were a steel mill, I'd be screaming and running to any antitrust authority I could find."

But the miners had the advantage. In China, especially, with demand roaring despite the severe recession elsewhere, they needed their iron ore. In one key move away from the annual-contract pricing regime, the Singapore Stock Exchange last April began trading iron ore swap contracts -- the first time in history that the raw material changed hands on an exchange.

(Last year, the big three and China's buyers never did come to an agreement, and China wound up doing all of its ore buying on the spot market.)

Now, with BHP and Vale claiming victory, everyone agrees that the old system is dead. There is no going back; you can't go home gain; the genie is out of the bottle. Choose your cliché.

Over the short term, industry observers and participants agree, the sea change will benefit the miners. And that includes more than just the big three in Australia and Brazil, where iron-ore grades are the best in the world.

Look no farther than the taconite iron ore fields of Minnesota and the Upper Peninsula of Michigan. That's where Cliffs Natural Resources, the only major independent iron-ore miner in North America, owns six surface mines that, via the Great Lakes, feed the rust-belt steel mills in places like Gary, Indiana, and Cleveland.

Cliffs has long used a formula to strike long-term pricing arrangements with its customers. The supply contracts can sometimes cover as many as 12 years, though there is room for the price to fluctuate as supply and demand ebb and flow, and as steel prices themselves change over the short term.

The precise details of the formula are secret, but Cliffs is open about its three basic components: the going price of hot rolled band steel (a staple product with automotive uses), the costs of production (energy, fuel, and other commodities, part of which it gauges by using the producer price index), and the world price of seaborne iron ore -- as set, in the past, by the Vale-BHP-Rio benchmark.

For this reason, both Cliffs and its much smaller North American rival, the

Iron Ore Co. of Canada

(which is majority owned by Rio Tinto anyhow) will say publicly that they are "price followers" or "price takers," and that, as yet, they've taken no public stance on the huge changes now sweeping through the iron ore business.

"I don't think we have anything to say on that," said Christine Deutsche, a Cliffs spokesperson. "We're going to have to wait and see how this affects us. It's kind of too early to call."

Others aren't so circumspect. Michael Locker, a longtime steel industry consultant, believes that Cliffs too will soon shift to shorter-term pricing arrangements with its customers. "The days of the long-term contract are over, for everybody," he said. "Assuming they want to make more money, I could see Cliffs switching." Likely that would mean a built-in mechanism that somehow traces the fluctuation in spot prices.

More immediately, Cliffs will benefit from the 90% rise in the world price of iron ore that this week's BHP and Vale deals have indicated. The last time the benchmark popped by such a degree -- 86% in 2008 -- Cliffs was able to raise its prices by perhaps 25%, estimates Peter Kakela, an iron-ore industry expert at Michigan State University.

Some analysts believe Cliffs will now need to lift its earnings projections for the coming year. The company's earlier guidance had called for just a 40% increase in the 2010 seaborne benchmark price. Cliffs' shares have indeed rocketed higher this year as investors have betted on just this outcome (and a recovery in U.S. steel business in general). Since Feb. 8, the stock has gained 77%.

(Cliffs owes its existence to the collapse of the once-formidable American steel industry. In the late 1980s and early 90s, near-bankrupt steel concerns sold their iron ore assets, many of them to Cliffs, in a bid to free up capital.)

As for manufacturers of steel, the move to short-term iron ore pricing is either a boon or a major annoyance. Squarely in the former group are

U.S. Steel

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, both of which control their own iron-ore sources. They thus gain a global competitive advantage when rivals elsewhere, who don't own so-called "captive mines," must contend with rising ore prices. Inevitably these steelmakers must pass along the cost to their customers.

Verticially integrated companies like U.S. Steel, on the other hand, can keep their products' price tags low, or let the proceeds from rising steel prices -- their own iron ore costs fixed -- drop to their bottom lines.

Steelmakers without such mines blanche at the heightened volatility that will likely arise when ore prices are no longer sealed by annual contracts. No surprise, then, that Eurofer, the trade group representing Europe's steel industry, lodged another complaint in Brussels Wednesday, urging regulators at the European Union to investigate the big iron-ore suppliers for anti-competitive behavior. There have been, Eurofer says, "strong indications of illicit coordination" between the miners to fix prices.

Back in North America, the rising price of iron ore has given rise to a slew of iron-ore mining juniors. At least four such companies have floated shares in Toronto, raising capital in order develop what they say are huge iron-ore bodies in Canada. One of those juniors -- normally the territory of gold prospectors and, once upon time, uranium con men -- even wants to tap a lode on Canada's Baffin Island, above the Arctic Circle.

Partly fueling this iron-ore land grab has been a revived desire among steelmakers to own captive mines and thereby free themselves from the Big Three. That desire might now be heightened even further, industry players say, since steel manufacturers will want to avoid the wild swings in ore prices that a short-term contract will almost assuredly create.

This is especially true of China's steelmakers, who are "actively spending money all over the world" in bids to acquire captive iron-ore sources, says Bish Chanda, senior vice president of

New Millennium Capital Corp.

, one of those Canadian iron-ore juniors.

New Millennium, for its part, already has a deal in place with a major iron consumer: India's

Tata Steel

, by some estimates the sixth largest producer in the world. It owns a 19.9% piece of New Millennium with an option to acquire an 80% stake in one of the start-up's projects, thereby guaranteeing itself a ready supply of ore from a new captive mine. All it needs to do now is review the latest feasibility study and decide whether to pay $300 million to cover the costs of developing the rest of the project, located in far northeastern Quebec and Labrador. New Millennium hopes that will happen sometime this year.

With a projected capacity of just 4 million tons of iron per year, it's a small project. New Millennium's real hopes rest on a much larger ore body: a potential mine that could yield, the firm hopes, 22 million tons per year. That's nothing compared to a global market in which 1 billion tons of ore are traded annually. But it's enough for Chanda and his group to hope for a Tata payout.

New iron-ore projects are starting up all over the world, not just in far northeastern Canada. Many are the work of steel companies looking for captives, others are the dreams of speculators looking to get rich off the boom. ArcelorMittal is developing mines in Liberia and Guinea. Australian billionaire Andrew "Twiggy" Forrest, perhaps the world's foremost iron-ore entrepreneur, is pursuing huge projects under the auspices of his

Fortescue Metals Group


If the move to spot-market pricing quickens an already gung-ho rush to develop iron-ore assets, the endgame could well be a familiar one. "Are we getting a better situation with this?" Chanda asks. "In the short term, yes. In the long term, maybe not. Because the oversupply will come."

-- Written by Scott Eden in New York

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Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.