Australia’s mining sector has done extremely well, largely from exports to a rapidly growing China, especially for commodities like iron ore and coal. This rising wealth helped Australia emerge from recession earlier than most other developed economies and prodded the Reserve Bank of Australia to hike interest rates multiple times.
This amazing growth has come with costs, primarily in the form of higher labor costs. In “Lovesick Miners Raise Costs for Rio, BHP,” Bloomberg describes how the isolation of work in the remote mining areas makes these jobs very unattractive. Mining companies like BHP Biliton (BHP) and Rio Tinto (RIO) not only have to pay extremely high wages as compensation, but they also must include other perks to help miners deal with the isolation. For example, work schedules for miners can include extended trips to major cities in between extended shifts. Still, major shortages of labor exist in many skills. Australia will likely need to rely more and more on foreign workers to do these jobs – the isolation THOSE workers will feel will likely be many times what Australian miners feel. So, this dynamic will be important to watch.
Overall, this article is a fascinating look into the lives of Australian miners and how their work impacts their ability to gain and maintain relationships.
The Financial Times reports that analysts expect iron ore prices to rise as much as 25% from the first to the second quarter.
One of several examples of increasing price pressures:
“Contract prices for the second quarter, which are based on the average spot market price from December to February, are set to rise to about $170 a tonne for Australian iron ore, excluding freight costs. That is 40-45 per cent higher than the same quarter in 2010 and nearly triple the $61 price in place until March 2010 under the old annual benchmark pricing system.”
See “Record iron ore prices loom” for more details.
Talk to any steel company, and you will quickly discover the impact of commodity inflation. Steel companies in general have struggled to keep up with the soaring prices of coking coal and iron ore. It seems it is only a matter of time before these price pressures begin to push their way into the rest of the economy.
For example, in its latest earnings report, AK Steel (AKS) announced its plans for achieving greater pricing power by passing on input prices more quickly to its customers. We have also chronicled many of AK Steel’s price increases over the past year.
In “Steel-Price Increases Creep Into Supply Chain“, The Wall Street Journal demonstrates how steel companies are responding to higher input costs by passing along these costs to their customers:
“Steelmakers have increased prices six times, for a total increase of 20% to 30%, since November on basic flat-rolled steel, used in everything from cars to toasters, to offset higher input costs of raw materials, such as iron ore and coal. Higher costs for steel, which are expected to continue well into this year, are hitting bottom lines of companies and prompting additional price increases.”
The general expectation seems to insist that these pricing pressures will not percolate into final end consumer prices. However, I believe this thinking is just the lingering aura of the deflationary mindset of the last recession, and it will fade as surely as commodity prices have soared.
Disclosure: Author owns shares in AK Steel
While governments in several emerging markets are rushing to contain inflation pressures, governments in developed economies in Europe and North America are idling in the hopes that external inflation pressures are not bad tidings of things to come. Germany could become a prime example of the mounting pressure between the need to maintain stimulative monetary policy for one part of the economy (the periphery of Europe) even while other parts heat up.
On Wednesday, Bloomberg reported: “German Import-Price Inflation Accelerates to Fastest in More Than 29 Years.” The various statistics on inflation in Germany are eye-popping:
- Import-price inflation accelerated to 12 percent, the highest rate since October 1981, from 10 percent in November
- In the month, prices increased 2.3 percent, almost double the 1.2 percent forecast by economists
- Energy was 34.2 percent more expensive in December than a year earlier
- Iron ore prices soared 98.4 percent
- Non-iron ore metals cost 37.9 percent more
- German consumer-price inflation accelerated to 1.9 percent last month, pushing the euro-area rate to 2.2 percent, the first time it has breached the ECB’s 2 percent limit in more than two years
For those of us who never believed that deflation was a serious threat given the monetary actions of central banks across the globe, we must now wonder how much longer will it take for inflation to start hitting consumers across a broad array of purchased goods.
A common theme has connected the earnings reports of most steel companies: lower prices for many steel products and higher input costs. This margin squeeze has produced poor earnings, and steel companies are providing very cautious outlooks. While pricing for steel products varies – some strong, some weak – the increasing cost pressures are near universal. Inflation is very real for these companies.
Arcelor Mittal (MT), AK Steel (AKS), and U.S. Steel (X) all reported this week. I have included some quotes from their earnings report to provide some examples of the pressures that these companies face.
“In Q3 the business performed towards the lower end of our expectations against a background of seasonally lower volumes, weakening spot prices and higher costs. Our outlook for Q4 remains cautious as the expected higher input prices continue to work through the business and demand remains muted, though with some regional differences.”
“Sales were lower during the third quarter of 2010 as compared to the second quarter of 2010 due to seasonally lower volumes (-8%), partly offset by higher average steel selling prices (+4%).”
“Sales in the Stainless Steel segment were $1.4 billion for the three months ended September 30, 2010, a decrease of 12% as compared to $1.5 billion for the three months ended June 30, 2010. Sales declined primarily due to lower steel shipments (-8%) as discussed above and lower average steel selling prices (-5%) due to a weak market environment and pressure from imports.”
“The company said its average selling price for the third quarter of 2010 was $1,075 per ton, a 2% decrease from the $1,101 per-ton price in the second quarter of 2010, and approximately 8% higher than the $994 per-ton average price realized in the third quarter of 2009.”
“2010 Iron Ore Price Increase Impacts Third Quarter:
AK Steel said that it has agreed with two of its three primary iron ore suppliers that the requirements for the establishment of the annual benchmark price of iron ore for 2010 have been met. That 2010 benchmark is an increase of 98.65% over the 2009 benchmark, and is higher than the 65% increase the company had previously estimated for the first half and for its third quarter guidance. The third primary supplier of iron ore to the company has not acknowledged yet that an annual benchmark price has been established. Instead, that supplier continues to seek a price increase in excess of the 98.65% annual benchmark price. The company does not agree that this supplier has a right under the parties’ contract to charge based on other than an annual benchmark price and, for purposes of the iron ore purchased from this supplier, the company has used an estimated benchmark price increase of 98.65% in its third quarter financial results.”
“The company’s third quarter 2010 financial results reflect the year-to-date impact of the higher iron ore price, which increased the company’s third quarter operating loss by approximately $76.0 million, or $52 per ton.”
“AK Steel said it expects shipments of approximately 1,300,000 to 1,350,000 tons for the fourth quarter, with an average selling price per ton decrease of approximately 4% from the third quarter. While the company expects fourth-quarter maintenance costs to decrease by about $20 million from the third quarter, it nonetheless expects to incur an operating loss of approximately $80 per ton for the fourth quarter of 2010, largely due to the lower shipments and selling prices combined with continued high iron ore and other raw material costs.”
(Quotes transcribed and paraphrased)
“Results declined in 3rd quarter from 2nd from lower flat-rolled average prices, higher raw material costs in flat-rolled segment and European operations: decreased shipments and production volumes, decreased average realized prices, increased costs for facility repair and maintenance (higher activity, not input costs), and consumption of higher cost coal, coke and iron ore purchased to support earlier facility restarts. Decreased spot prices more than compensated for increased contract prices.”
“In 4th quarter, expect lower average realized prices, lower spot and contract.”
“Tubular operations had higher average prices for fifth quarter in a row. Decreased costs for steel substrate. Not expecting same price performance in 4th quarter but costs should continue down.”
Disclosure: author owns X and AKS
Yesterday, AK Steel (AKS) warned investors that earnings would be lower than expected partly due to increasing material costs (mainly iron ore). Today, AK Steel told its customers that prices will increase as part of an effort to recoup some of those rising material costs. These price hikes are also enabled by strong demand for stainless steel products.
AKS will raise prices for specialty flat-rolled stainless steel products by about 5% to 10%. These products include “…tensilized, bright annealed and special finishes, along with special mechanical requirements.”
Full disclosure: author owns shares of AKS
In early May, the World Steel Association (worldsteel) repeated its worries about “the recent unprecedented rises in the price of iron ore and metallurgical coal.” The industry warned that these prices are pressuring margins and are threatening to increase inflation pressures in various countries. The industry also worries that price volatility will increase with the change from annual to three-month spot pricing.
See “The steel industry repeats alarm over recent developments in raw materials markets” for more details.
Dow Jones Commodity News reports that “Morgan Stanley has raised its forecast for a 2010 benchmark iron ore price rise to 60% from 20% previously. Morgan Stanley also sees a further 20% increase in ore prices in 2011, a bank analyst report released Friday said.”
According to Wikipedia, “iron ore is the raw material used to make pig iron, which is one of the main raw materials to make steel.”
Reuters reported that Australian miners are seeking a 40% increase in contracted iron ore prices for 2010. This is in stark contrast to the 20-30% increase that the China Iron and Steel Association expected for 2010. The differential could lead to more contentious price negotiations – similar to what occurred at the beginning of 2009 – especially given some nervousness about whether steel demand will continue to increase robustly this year.
Bloomberg: “Forecasts for annual contract prices for iron ore, a $160 billion-a year-global market, were raised by Macquarie Group Ltd. and JPMorgan Chase & Co. after a surge in demand from China.” Economists attribute the expected price increase to strong demand from China. Iron ore is used in steel production, so look for higher steel prices down the road.