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Tickers in this Article: AKS, NUE, RTP, BHP, X, RIO
Pricing negotiations between steel companies and iron ore producers will take on a different tone this year as six consecutive years of price increases will certainly end. The only remaining question is: How low will the prices go?

Annual Event
Every year, steel companies negotiate supply contracts with representatives of some of the largest mining companies in the world, including BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RTP) and Brazil-based Companhia Vale do Rio Doce, (NYSE:RIO). These three companies control much of the world supply of iron ore. The most recent talks determined prices for the shipping year starting April 1.

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Estimates concerning the degree to which prices will decline vary wildly. In early March, a survey of sell-side analysts called for a 30% decline in prices. Some steel manufacturers in Europe predicted a 50% reduction, while the China Iron and Steel Association has publicly called for a 40% price cut, which would return prices to the level seen in 2007 and 2008. Representing 40% of steel capacity, China has a particularly strong influence in world markets.

During its earnings conference call in late January, AK Steel (NYSE:AKS) stated that prices for iron ore pellets could "decline by as much as 50% or more in 2009". CEO James Wainscott cited industry-operating rates in the 50% range as the reason for the prediction.

Prices in the spot market for iron ore currently are at $67-68 per metric ton, down considerably from the $111 per metric ton prices that were negotiated at this time last year.

Recession-Era Effects
The fall in prices for iron ore was precipitated by the plunge in demand for steel, which has dropped sharply due to the recession. World steel production declined 22% in February, as measured on a year-over-year basis. In Japan, the drop was more severe, down 44% year-over-year. (For further reading on the relationship between demand and prices, be sure to read the Demand and Supply section of our Economic Basics Tutorial.)

Miners, however, are still talking a good game maintaining a united front. An executive at Rio Tinto said at an industry conference that an eventual return of industrial demand would mitigate the most pessimistic predictions on pricing.

Another argument in support of higher steel production is inventory levels, which, in some categories, are low considering the state of demand. John Surma, CEO of U.S. Steel (NYSE:X), cited inventories of flat rolled steel as an example of low inventory.

The drop in demand has hurt the U.S. domestic steel industry. Nucor (NYSE:NUE) surprised the Street last week when it announced a loss for 2009 of 55 cents to 65 cents per diluted share. Management cited "continued deterioration in economic and market conditions".

Bottom Line
Over the last few years, mining companies used annual negotiations to dictate prices to their customers. Little more than a sham, customers were forced to pay the prices that were demanded. But the leverage miners once had over customers has ended because of the recession. Only time will tell the real cost to the industry.

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