Sunday, July 6, 2008

Iron ore and cold steel markets

With the world obsessed with the rising oil price, steel has not received the same amount of attention it ought to have received. It is in this context that the proposed merger of Australian mining giants BHP Billiton and the Rio Tinto Group, raises important questions about the structure of the market.

Thomas Palley describes the market as a bilateral oligopoly between the ore producers who extract pig iron, and the ore users who make cold steel. Unlike other commodity markets, iron ore prices are set through annual negotiations between the ore producers and the ore users.

On the upstream side, the top three pig iron producers - Vale do Rio Doce, Rio Tinto, and BHP Billiton – account for 75% of total global production. This oligopoly is reinforced by geography, wherein the Brazilian Vale do Rio Doce controls the western hemisphere while the two Australian giants control the East. On the downstream side, thanks to a series of recent mergers and acquisitions, steel market is getting increasingly integrated and dominated by a handful of producers.

As Palley writes, the steel companies have already been making massive profits from the recent spurt in demand from China led emerging economies, and the pig iron producers now want a share in the cake. The Billiton-Rio Tinto merger move is a step in that direction.

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