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Last Updated: Tuesday, 1 March 2005, 00:12 GMT
Steel industry feels the squeeze
By Will Smale
BBC News business reporter

Red hot steel
Steel prices have risen by almost two-thirds over the past two years
To say that recent increases in the price of iron ore have startled the global steel industry is probably a bit of an understatement.

So much so that one leading analyst, Peter Fish, director of Sheffield-based steel consultancy MEPS, says the steel world "hasn't seen an increase of this magnitude probably in 50 years".

Mr Fish is referring to the announcement that Japanese steel giant Nippon has agreed to a 71.5% rise in the price of iron ore from two of its main suppliers - Brazilian miner Companhia Vale do Rio Doce (CVRD), and the Anglo Australian firm Rio Tinto.

As is common practice in the steel industry, the deal for its core raw material will run for the financial year beginning 1 April, 2005.

Posco, the leading South Korean steel producer, has also just signed an annual deal with CVRD for the same 71.5% rise.

To put the 71.5% figure in perspective, last year's average rise in iron ore prices was 19%, and the year before that was 9%. The 71.5% increase really is unprecedented in modern times.

Tough negotiations

Yet with European and US steel firms now in negotiations to determine their iron ore prices for the next financial year, steel analysts are in agreement that they are going to struggle to secure better deals - such is the concentration of the iron ore industry.

Together with Anglo Australian BHP Billiton, CVRD and Rio Tinto - the big three iron ore producers - account for 70% of the world's production.

"The (price) standard has now been set," says Imtiaz Ali, steel analyst at Metal Bulletin Research.

"The Europeans will have very little ability to negotiate for less. They might get it for 5% less, but that is about it."

But why are the iron ore producers demanding - and getting - such high price rises? And what will be the knock-on affect for steel producers - such as carmakers - and consumers?

In simple terms the iron ore producers are securing such high rises because steel prices are currently at record highs after increasing by almost two-thirds over the past two years.

China factor

"The iron ore producers want a bigger slice of the pie, it is as simple as that," says Mr Fish.

I'm confident that the steel producers can afford to absorb the increased cost of iron ore, but it is only natural that they will instead seek to pass on the cost to their customers, such as car manufacturers
Steel analyst Peter Fish

"They have seen steel prices go through the roof over the past year and up until now they have been missing out."

Mr Fish says the great increase in the price of steel has been fuelled by virtually one factor alone - China's booming economy.

"It has pretty much all been China-led," he says.

"The situation for European steel producers is actually pretty flat, and the US has not been overachieving."

Before the announcement of the 71.5% iron ore price rises, Mr Fish had been predicting that steel prices would peak this summer, but he now expects the cost of steel to increase still further throughout 2005.

"The problem is that iron ore prices have always been based upon what happened to the price of steel during the previous year, rather than what is expected to happen during the year ahead, which some might say is a stupid way of doing things," he says.

"What it does mean however, is that the iron ore producers always play a game of catch up, enabling them to share in the profits, or alternatively, share in any bad times."

Knock-on effect

Steel analysts estimate that the increased iron ore prices will add an average of 10% to the price of finished steel, and most are in agreement that steel producers will pass on the cost to their customers - even if they can afford not too.

"I'm confident that the steel producers can afford to absorb the increased cost of iron ore, but it is only natural that they will instead seek to pass on the cost to their customers, such as car manufacturers," says Mr Fish.

Yet this should not immediately mean increased car prices, as Mr Fish says all the main carmakers should already have secured their steel prices for the next year at a set price.

In the longer term Mr Ali says that both iron and steel prices will remain high until demand slows, which in turn will require China's burgeoning economy to pause for breath.

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