Iron resolution




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Anybody interested in the iron ore market should be watching the development of the Belinga mine in Gabon. It promises to be huge both in terms of iron ore output and environmental damage. Here’s a link to an older story about it.


Another bilateral deal, but in this case it looks as though the consumer will effectively become the producer.

One factor that seems never to be discussed in all the punditry about rising oil prices is the effects of the current wars.

How much pressure would be taken off world markets if the US was not fighting in Iraq and Afghanistan? I’m not just thinking of the actual fuel use need to run the day to day operations (and the long supply chains), but all the use which in incorporated in materiel replacement, training, foreign base support and the like.

The DoD is the world’s largest single purchaser of fuel.

Then add in all the other pressures that come from reactive actions. Every military item that Saudi Arabia buys, or every “training” flight they make with their fighter planes adds to demand. Extend this to Syria and the rest of the Middle East and then to Russia, China and other worried states.

A bit of real analysis might be revealing – demand can’t all be due to US SUV’s.

The inputs to iron ore, mainly energy, are soaring, therefore iron ore prices must increase. I can’t imagine prices *not* rising.

I think your arguments about oil and speculation are iron-clad. But I think your arguments about iron are exactly backwards: it’s precisely the lack of an easy way to speculate in a commodity like iron that allows speculation to drive up the price in such commodities in a way they can’t in oil.

Long-term bilateral contracts are essentially future contracts where the buyers have already agreed to take delivery. That means that when those futures become the present, each of those contracts will have taken product off future spot market, constricting its supply without ever increasing an inventory — what it has done is diverted new production away from the spot market. And it is perfectly possible for competitors in such a non-transparent market to get caught up in a leapfrog competition where they bid up long-term bilateral contracts and agree to longer terms.

The difference between markets like this and the oil market is that in these markets, the spot market is the residual market. It doesn’t govern the price of most transactions; it is the price of the leftover commodity that isn’t already secured. In oil, by contrast, not only is a sizeable amount of oil bought through it, but it governs the price of all other long term contracts which are usually tied to the spot market price at the time of delivery.

So if people panic and tie up more and more of a commodity in long-term bilateral contracts, less and less product will get to the spot market in succeeding years. This is how the spot market price can be driven up by speculation and can be kept up at an artifically high level for several years because of the long term nature of the contracts and the non-transparent nature of the “futures” (i.e., long-term bilateral contract) market.

Eventually of course this all has tp unwind as the increasing supply eventually made its way onto the market. But that unwinding could take years.

This is largely precisely what happened in the 1979 oil shock. The oil spot market then was a lot like other commodity spot markets now, secondary and residual compared with long-term bilateral contracts. And unlike the 1973 oil price spike, which was based on a tight market, the 1979 price spike was caused entirely by panic buying in long term bilateral contracts. When it eventually unwound in the mid 1980s, there was a precipitous collapse. But it took that long to unwind.

Dr. Krugman,

Would you then say that there is no merit to the idea that there is a premium on the price of oil due to Middle East Instability, which is often mentioned as contributing as much as 20% to the price of oil. It would seem that all your arguments against a speculative premium would apply equally to this idea as well. I too have no dog in this fight and was never convinced one way or the other of this argument.

Paul, The fact that Australian ore prices have to be jacked up by bi-lateral agreement, is evidence FOR the inflation of commodity, housing, oil and other prices by speculation-not against it. Frankly, I don’t think the world can afford the involvement of non-value added, trade market casino speculation skimming to the extent we have seen in the past, if at all. Call it a correction.

Wouldn’t these bilateral deals involve commissions and fees? The larger the sums, the more all the top feeders can skim on either side of the transaction.

Does China subsidize their steel industry?

Mr Krugman, what accounts for the fact that those pumping sweet crude from the Dakotas are only being paid $65/ barrel, if speculation isn’t a big deal? In your column, you admit that that “could” be a cause. Why not repeal the “Enron Loophole” and find out. There is no other reason for the loophole.