Historically, the commodity cycle follows the economic cycle and this time is no different. The liquidity crisis and its cascading effect on real economies across the world have pulled down prices of commodities, including iron ore and coking coal. Both these commodities are crucial inputs for steel-making and any fundamental change related to these raw materials is bound to affect the financials of its producers (mining companies) and consumers (steel companies).

Iron ore and coking coal account for 50-60% of the cash cost of production for non-integrated steel firms, which do not have captive mines of these raw materials. The recent decline in steel prices, a result of tapering global demand, in turn pulled down prices of the inputs. Spot iron ore prices have fallen by one-third to $67 per tonne from their year-ago levels. Likewise for coking coal. Prices seem to have hit bottom and the possibility of a further decline is limited.

Prices are largely driven by demand from China, which is the largest consumer of steel. China’s crude steel production dropped by 14% during the December 2008 quarter compared to the previous three-month period. However, it has been recovering since January ‘09 and crude steel output during April has been around 15% higher than in December. The higher production of steel has improved the import of iron ore.

The monthly import of iron ore from India to China for March rose by 26% compared to December ‘08. These factors, coupled with signs of overall macroeconomic revival, send some positive signals about improvement in demand for these two commodities.

Most large steelmakers around the world buy iron ore and coking coal on long-term contracts which are renewed every year. Currently such negotiations, for both price as well as volume, are underway. If the early indications are to be believed, the contract prices for coking coal for the next one year are expected to be settled between $100 and $130 per tonne.

Similarly, long-term iron ore prices might get contracted in the range of $50-65 per ton. Even spot prices are not expected to fluctuate much during the current fiscal and would remain range-bound at $45-75. Such developments can have varying implications on Indian companies like Sesa Goa, National Mineral Development Corporation (NMDC) and JSW Steel.

Sesa Goa derives around 90% of its revenue from exports of iron ore to China and other countries. The bulk of its net sales are from the spot market rather than long-term contracts. Spot prices are unlikely to see any significant upside in the near term and Sesa Goa’s export-oriented model increases demand risk. This is mainly due to two factors: slack in demand from other countries compared to India and higher competition from global players. Also, the Indian rupee is not expected to depreciate further against the US dollar.

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