Two Trends Following Iron Ore Price Hike

The decision to shift to a spot pricing model by the world's top three iron ore producers has triggered two major events in the industry.
Author:
Publish date:

NEW YORK (TheStreet) -- The decision to abandon the decades-old benchmark pricing mechanism and shift to a quarterly-based or spot pricing model by the world's top three iron ore producers, Vale (VALE) - Get Report, BHP Billiton (BHP) - Get Report and Rio Tinto (RTP) has triggered two major events in the industry.

First, China has initiated measures to reduce reliance on imports from the mining giants,

the stocks we recommended before the iron ore price hike

. Second, demand for iron ore swaps and price indices, allowing market participants to hedge against exposure to volatile prices, has been on the rise.

Credit Suisse

(CS) - Get Report

expects iron ore swaps volumes to double by end 2010, as demand for these products has increased in order to hedge against volatile iron ore prices.

The growth in iron ore swaps will likely follow the pattern of thermal coal swaps that took around two years for the volumes to grow significantly and become a vital hedging activity for the steel industry.

Meanwhile, rapid increase in the liquidity for swaps, providing a chance to lock in prices, will likely benefit

junior mining companies

by easing access to project finance.

China Story

China is taking initiatives to lower its excessive reliance on iron ore imports from the mining giants in order to fulfill the country's iron ore deficit. China is the largest producer and consumer of iron ore, accounting for around 54% and 40% of the world's demand and supply, respectively.

Reportedly, state-controlled steel mills have stepped up iron ore mining to increase domestic iron ore supply and reduce dependence on imports. For April, domestic iron ore production increased 10.5% to 88 million tons, a 45% increase year over year, according to the country's National Bureau of Statistics.

Meanwhile,

China's iron ore imports during March increased 20% month-over-month to 59 million tons

. However, the contribution of the three mining giants was estimated to have declined on a percentage basis. For instance, Iran's iron ore exports zoomed to 270% year-on-year to 1.19 million ton during the period March 21-April 20. Of these exports, China alone accounted for 1.16 million tons.

However, going forward iron ore imports from Iran and India will likely decline, on the back of increasing demand for iron ore from domestic steel producers in the respective countries. Hence, China will likely accelerate domestic output until an amicable solution is reached.

Until then,

iron ore producers will continue with their capacity expansion plans

notwithstanding major impediments such as

the Australian "Super Profit" tax

. During the March-quarter operations review,

Rio Tinto raised the company's iron ore forecast

.

As per the World Steel Association,

Global steel demand will escalate 10.7% during 2010

and 5.2% for 2011, sustaining the buoyant demand for iron ore. In the United States, increasing demand for iron ore will benefit

Cliff Natural Resources

(CLF) - Get Report

,

our base metal stock pick

.