At first reading, the front-page headline in the Financial Times on Wednesday, ‘Steel prices set to soar,’ struck me as sensationalistic. The story dealt with how iron ore producers and steel companies will now set prices differently, but there was no change in underlying supply or demand. I also know by experience that ‘soar’ is one of the most overused words in business journalism.
But the FT is one of the best newspapers in the English-speaking world and not given to overstatement. Moreover, steel is so ubiquitous in daily life — used in cars, construction and appliances — and steel industries so important in the economies of many nations, that the prediction of soaring prices is worth another look.
Ore prices now will be set by major mining companies and major steel companies on a quarterly basis rather than annually. And price changes will be linked to prevailing spot prices — those from one-time sales outside the global pricing agreement — rather than by drawn-out negotiations.
The old system has been in effect for 40 years. It applied primarily to global trade in ore, especially to exports from countries like Brazil and Australia and imports by China, Korea, Taiwan and other steel-producing countries with limited iron ore reserves. U.S. iron ore from Minnesota and the Upper Peninsula of Michigan has its own pricing practices, some of which involve longer-term contracts.
But ultimately, the market for iron ore is a global one and price increases internationally affect domestic prices, so changes that primarily affect Australia and China have important secondary effects on Minnesota’s Iron Range.
Currently, spot prices are higher than those set in the last annual negotiations. So in the second quarter of this year, global prices are forecast to double from $60 per ton to nearly $120 per ton. That may drive common grades of steel up by a third. Consumers and businesses eventually will feel the pinch.
Moreover, any upward pressure on consumer prices will be unwelcome to the Federal Reserve and other central banks, which are walking a fine line between low interest rates to bolster fragile economies and avoiding inflation from excessive money growth. (The upward rise in many prices already is considerable, but it is masked by sharp declines in calculated housing costs because of falling house prices.)
So in the short run, the new agreement will touch off price increases that are bad news for most households, businesses and governments but great for mining companies, regions and exporting nations.
In the longer run, a change from setting prices annually to setting them quarterly is no big deal. Nothing here changes the underlying cost of producing ore, which is what determines supply. Nor does it change the fundamental demand for steel that drives demand for ore. And a move to pricing that is more responsive to ongoing fluctuations in market fundamentals should increase efficiency of resource use.
One should also recognize that the long-run inflation-adjusted price of steel, just as of other primary commodities like corn or wheat, has drifted downward over time. It varies by type of steel, but most common grades cost less than half as much in inflation-adjusted terms as they did 40 years ago. Steel still is cheap in long-run terms even if demand from Asia is pushing it up from the doldrums of the end of the last century.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.