Beijing, 4 June 2010

The end of iron ore benchmark pricing will lead to higher costs for the entire Chinese steel industry, but it might not hurt smaller players already used to scrapping for supplies on the spot market, a senior industry executive told Reuters. Henry Yu, chief executive of the U.S.-listed General Steel Holdings , said in an interview that while the heavy price hikes were unfair, private operators would not suffer as much as their state-owned counterparts.

"China is hugely dependent on imported iron ore, so the cost increase is not fair for the industry as a whole, but there are problems internally in the Chinese steel industry, including the unequal status of small companies unable to secure benchmark prices," he said.

The old benchmark system allowed large-scale steel enterprises to sign long-term supply contracts with big miners Rio Tinto , BHP Billiton and Vale at a discount price. The three mining giants have already decided to abandon the system in favour of quarterly index-based pricing.

Some small and medium-sized mills, long used to paying a premium of around $50 a tonne for iron ore on the spot market, have said privately that killing off the benchmark will help create a level playing field in an industry long skewed in favour of state-owned giants like Baosteel .

"This adjustment will have a bigger impact on those enterprises that were previously able to get the benchmark," Yu said. "As far as those companies relying on the spot market are concerned, the impact isn't that pronounced."

Reports suggest that Vale will demand $160 per tonne for its iron ore in the third quarter, and while the hike will be bad news for the smallest minnows, it could actually help with China's restructuring efforts, Yu said.

"For the companies with capacity lower than 1 million tonnes a year, the rise in raw material costs, plus overcapacity in the industry, will create serious operational difficulties this year. So that could benefit the whole industry in terms of consolidation."

Rio Tinto Fall-Out

It was the distortions brought about by the benchmark system that eventually led to the conviction in China of four employees of Rio Tinto earlier this year. The four, including Australian citizen Stern Hu, were sentenced to between seven and 14 years after accepting bribes from smaller steel mills desperate to get access to cheaper benchmark ore supplies.

Yu said the market was already being regulated more strictly as a result. Some analysts suggested China's strict licensing rules were to blame for the chaos in the sector, with smaller mills turning to illegal tactics in order to compete with big statebacked rivals for cheap benchmark supplies -- but Yu said responsibility rested with the big miners rather than Chinese regulators.

"The big problem has been that the big miners wouldn't sign benchmark agreements (with the smaller players) – this wasn't China stopping them."

He said General Steel itself was one of just a handful of firms granted an import license, and had also bought a fraction of its iron ore on benchmark terms, getting the rest either from long-term deals with smaller suppliers in Chile and elsewhere or from domestic sources.

The company, born two decades ago in the steel heartland of Daqiuzhuang near Tianjin in northern China, sold 3.8 million tonnes of steel products from its four subsidiaries last year.

Yu said the strong position currently enjoyed by the dominant three global iron ore suppliers was unlikely to last. "The only companies using iron ore in such large quantities are Chinese -- European and U.S. steel mills use scrap," he said.

"This is temporary and the high prices aren't permanent. Previously, prices were always very low. These high prices are unreasonable and actually can't be sustained."

Ends --

By David Stanway and Lucy Hornby, Reuters - for Commodities Now.