Page last updated at 15:39 GMT, Sunday, 4 July 2010 16:39 UK

Could rising iron ore prices halt recovery?

By Tim Bowler
Business reporter, BBC World Service

Molten iron ore
Iron ore prices have risen rapidly this year

Are the world's iron ore mining companies putting the world recovery in jeopardy, by forcing up prices?

Iron ore is a key component in the manufacture of steel, and is used in construction and heavy industry everywhere.

It may not have the immediate glamour of a precious metal, like gold, but is nevertheless vital for economic growth.

Steel itself is used in a myriad of everyday products - from household items such as fridges and washing machines, to cars, buses, trains and the steel girders used in most office buildings.

Three big mining companies, Rio Tinto, Vale and BHP Billiton, dominate the global market in iron ore.

According to their customers, the steelmakers, they are putting up the price of iron ore unfairly. It's a charge the mining companies deny.

Pricing switch

In the past, the mining firms used to fix the price of iron ore once a year. But this year they have switched to three month contracts, and iron ore prices have risen steeply.

The steelmakers argue that higher raw material costs could push up costs for manufacturers and consumers, and thus threaten the global recovery.

A labourer welds steel frames at a steel factory in Huaibei
Could higher iron ore prices eventually mean higher steel prices too?

Europe's steelmakers have already formally complained to the European Commission about what they say are "possible anti-competitive practices" by the main iron ore suppliers.

Eurofer, the European Confederation of Iron and Steel Industries, which represents Europe's steelmakers, says the price rises of up to 100% this year are not justified.

"We are obliged to turn to the main miners to source iron ore, we have no alternative, and they have the ability to impose price increases," Gordon Moffat, director general of Eurofer, told BBC World Service's Business Daily programme.

"We have written to the European Commission to complain and to indicate we believe there are clear indications that there is something amiss in the way the iron ore market is working."

"There is nothing fundamental in the market in terms of demand which would drive those prices increases," he said.

Eurofer, in a joint statement with Orgalime, the European Engineering Industries Association, said: "If economic access to iron ore is hampered through unjustifiable pricing this would have severe consequences for millions of jobs in the sectors concerned."

The European Commission, has confirmed it is looking into various complaints about the iron ore industry.

Higher demand

The big mining firms have robustly defended the new pricing arrangements, and say that the reason prices are higher is because demand is picking up.

Roger Agnelli, CEO of Brazil's Vale, said: "Vale is not fixing prices - prices are established in the market. We're merely reflecting in our contracts what is happening today in the market."

"Iron ore prices are following market demand and supply."

Vale said the new price system would actually benefit the steelmakers, because it would enable them to know in advance the price to be paid in the following quarter, making cost control easier.

A joint ThyssenKrupp and Vale steel plant in Brazil
The big mining firms say rising demand is pushing prices higher

Rio Tinto said its position reflected the recent shift in the iron ore market away from annual pricing to three month contracts.

"We have recently signed agreements with the majority of our Asian customers which to date account for close to 40% of our total iron ore sales volumes."

The old yearly pricing system was certainly not perfect.

When the spot, or open market, price fell below the set annual price, customers complained, and when it rose above it, it was the miners that were unhappy.

Profits squeeze

So what are the effects of higher prices? The global motor industry has to pay the going price for steel, and that's directly affected by the price of iron ore.

Carl-Peter Forster is group chief executive of Tata Motors, India's biggest car firm. which makes the small car the Nano, and also owns the British brands Jaguar and Land Rover.

Tata Motors chairman Ratan Tata looks at the Tata Nano car at a ceremony in Mumbai
The price of Tata's Nano could rise because higher iron ore costs

"Steel costs are an important input cost, but the share of the total cost depends heavily whether you're talking about as small vehicle or a premium vehicle."

"It's more of an issue for our Indian operations - and our Tata brand vehicles."

"It does increase the cost of our vehicles a few percentage points, depending on the vehicle. It squeezes our margins, it definitely does."

Returning profit

Yet while iron ore prices may now be rising, mining firms have previously had to deal with years of low prices. As a result, many of them merged in order to survive - leaving three giant firms.

Michael Tamvakis, professor of commodity economics and finance at Cass Business School, London, said: "I don't necessarily believe the claims of gloom and doom that higher iron ore prices will bring about economic collapse."

"What we are experiencing is undersupply of iron ore - which leads to very high prices - and this undersupply is because of years of under-investment in mining."

"Ultimately it is about coming closer to market-related pricing, and returning some of the profitability to the mining sector," he told Business Daily.

"I don't think its going to create long-lasting damage. Ultimately the most competitive steelmakers will adjust."

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