Marius Kloppers, who will leave BHP Billiton after five years as its chief executive, was loved and hated equally by investors for his many bold – and failed – takeover bids. But whatever his M&A record, Mr Kloppers will leave an important legacy in the mining industry and commodities markets: the reform of iron ore pricing.
The overhaul not only created a real market for iron ore, but also triggered a windfall of billions of dollars for the world’s top iron ore miners, including BHP.
For more than 40 years until early 2010, iron ore prices were settled in secretive – and more than often acrimonious – negotiations between steelmakers and miners. The system was called “the benchmark” because the first price deal, usually between Nippon Steel of Japan or Baosteel of China, on the one side, and the Australian miners on the other, would set the price for the rest of the industry.
Because the cost of iron ore directly filters into steel prices and, ultimately, the cost of everyday goods, from washing machines to cars, the iron ore benchmark talks were one of the most important commodity price negotiations.
It all changed two years ago, thanks to the tenacity of Mr Kloppers. Almost overnight, the price of iron ore was no longer set once a year in secretive meetings, but rather steelmakers and miners would track the price of the nascent spot market. The radical reform was similar to the one witnessed in the oil market in the late 1970s when posted, or fixed, prices were abandoned in favour of the spot market.
As the prices in the spot market, which largely reflected the trade between India and China, was much higher than under benchmark annual deals, prices rose. The price received by the miners moved from about $60 a tonne in early 2009, before the benchmark system collapsed, to more than $150 a tonne by the middle of the following year, and to a record of $200 a tonne in 2011.
Vale of Brazil, the world’s largest iron ore miner, posted record profits of $22.8bn in 2011, nearly double the $11.8bn that it earned five years before when the benchmark system was still in place and, hence, iron ore prices were much lower.
Mr Kloppers pushed for several years for a system that reflected what he called “the price of the day”, rather than an annual deal. In part, he was replicating in iron ore its own experience in the reform of the coal market, which started to move away from fixed prices in the early 2000s.
BHP first tried to move away from the iron ore benchmark price system in 2007, but failed. There was a split among miners. BHP, the third largest ore producer, strongly favoured prices based on the spot market. But Rio Tinto, the world’s second-largest producer, supported the benchmark system, although it had indicated it was open to a negotiated reform with the steelmakers. Vale, on the other hand, was strongly opposed to any reform and supported the benchmark.
But at the end, Mr Kloppers found an unexpected ally: China. Beijing had resisted the shift from benchmark to spot pricing because it feared higher prices. But a series of industry changes during the global financial crisis in 2008-09 softened the resistance. BHP got its way in March 2010, when it convinced a group of Chinese and Japanese steelmakers to drop the annual contracts.
The Commodities Note is a regular online commentary on the industry from the Financial Times
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