>COMMODITY HEAP (CITI)

Iron Ore – Closing the Circle

■ Chinese Iron Ore Imports Surge — Iron ore imports are up 25% YTD. Yet steel production is up a more modest 3%. The explanation is falling domestic production and inventory accumulation.

■ Supply Demand Reconciliation Only Partial — The supply demand balance for the first five months highlights two concerns. Firstly annualized crude steel production (510Mt) is well above our forecast for the year of 485Mt. Secondly, reported domestic iron ore production (677 Mt) and required supply of iron units (after imports and stock changes) implies a further fall in ore grade to 20% from 23% in 2008. However, it would be reasonable to believe that grade is increasing, given the 100 Mt production cut. We conclude that unreported inventory continues to build, perhaps by 30Mt.

■ Contract Price Settlements; China Will Probably Follow — We think it most likely that China’s steel mills will follow the contract benchmark settlements agreed between Rio Tinto, the JSM and Posco, although perhaps only following further drawn out negotiations.

■ China’s Options — As we see it China’s steel mills (led by Baosteel, with CISA as a strong voice) have four options: 1) settle in line with the JSM; 2) no settlement – as much as half China’s imports are priced on spot anyway; 3) negotiate a lower price – this would put Rio Tinto in an untenable position; 4) agree but on a short-term basis, with the provision to renegotiate quarterly. We would attach the highest probability to option 1.

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