An econometric model of the iron ore industry

An EconometricModel of the Iron Ore Industry TheophilosPnovolos  World Bank Staff Comrnodity IVorking Papers  WORLD BANK STAFF COMMODITY WORKING PAPERS Number 19 AnEconometricModel ofthe Iron Ore Industry Theophilos Priovolos The World Bank Washington, D.C.  The Intcrn.~tionalHank for Keion\truct I<):\ and C)e\.t.lr)p!~~c.:~t r ;!t .'.,'./::' 3 -;\i IP18I-lStrctt S11' Llhsh~nl;tnn,T) C 20-133 L'S .4 r i l l rrst:!s rcsc.r~*c.il \lar\uf,~cturt.dIn the Un1tc.dSt'j!cs of :'in>t~r~ca F~r\t~rr!ltrnk;i'ctliber I i P - C c ~ r ~ ! r ~ ~ ,\l'ork.~ngP3pt,r\ .xC:jot !c>rr~~i~~ik3!~c.~tt~~ns ~ , ! ~ : ! ~ . ~ ! c d :he lj'orld Bank, .~ndarc clrc.~~I,~tc*jto c.r>cour.igcbLi~\cus\~orian,i ~\)rnnlcntanLito conlmunicate the resui~sof thc Bank'%\\.orL q u ~ c kt;o~the d e c-lopn~entc.on~rnunrty.cttat~onand the use of these ~ pJpt2'S 41cxli,i take . \ C C O U ~ ~ a! !hr.rr Frc)\ 151c)naIcharacter. The flndlngs. interpretattons. and conclub I L > ~ \c\presseJ rn t h ~ papcr arc cntlrely chose of the authods) and should s not t~ ,ittrli~utcclIn &In).manner to the lC>rldBank. to ~ taffiliated organlzationz. or s to mcrn\\crs of ~ t ,Board of Exc-zut~vcD~rcctorsor the coilntrlcs they represent. Any maps th,~taccc3rnpany the text ha\ e btwn prt-pared solcly for the convenience of readtrs t hc Jc\it;nat ion5 and prcwnt at lc)nof n~aterialtn them do not Imply the cxprcfi~~>nof any opnton r, hatsocvcr on thc part of the iVor1d Bank, tts afftliatcs. or its Board c>r rr~rnlbercountries concerning the legal status of any country, territory, crty, or area or o i the ,~u!hor~tlt.st herrof or conccrnlng the delim~tat~onof its boundar~csor rts natlonal afi~l~a!ion Because of !he informai~tyand to present t:le results of research with the least posstbie delay. thc t).pcscript has not bccn prcpa,ed in accordance \*-ith the procedures appropnatc to formal printed texts. and the i\'orld Bank accepts n o responsibility for error3 The most recent \%SrldBank pub~rcatronsare described In the catalog hrca A4blt~rlft0tl~.htch is issued ir, the spnns and fall of cach year. The complete backlist r\ of publ~cat~onsshorvn in the annual Ir-fcr of Rtblicnho~rr,which is of value principally IS to libraries and tnst~tutional~urchasersThe latest edition of each is available free of charge from the Publ*:,.~ons Sales un~t.The World Bank. 1818 H Street, N.W., Ll'ashington. D C. 20433. LS A , or from Publications, The World Bank. 66. avenue d'lena, 75 116 Pans, France Theoph~losPriovolos is an economist in the International Commodity Markets Division of thc Iz'orld Bank's International Economics Department. Library of CongressCataloging-in-PublicationData Prlovolos. Theophllos. An econonetric model of the iron ore industry / Theophllos Priovolos. p. cm. -- (World Bank staff comaodity norklng papers, ISSN 0253- 3537 ; no. 19) Btbllography: p. ISBN 0-8213-0970-6 1 . Iron Industry and trade-- Econometric models. 2. Iron ores- -Prices--Ecoroaetrlc models. I. Internatlonal Bank for R e c o n s t r u c t f o n and Development. 11. T ~ t l e . 111. Serles: World Bank staff commodity working paper ; no. 19. HD9510.5.P75 1987 338.2'73--dc19 87-29542 CI?  ABSTRACT T h i s p a p e r p r e s e n t s a model of t h e world i r o n o r e i n d u s t r y t h a t u s e s game t h e o r y p r i n c i p l e s t o d e t e r m i n e i r o n o r e p r i c e s . The boundaries o f t h e r a n g e of p r i c e n e g o t i a t i o n s a r e s p e c i f i e d through b i i ~ t e r a lo l i g o p o l i s t i c t h e a r y end a r e f u r t h e r c o n s t r a i n e d s o t h a t t h e n e g o t i a t i n s p a r t i e s a r e n o t put o u t of b u s i n e s s . The v a l i d a t i o n of t h e model ~ r r d i c a r e s t h a t it is s u i t a b l e f o r p o l i c y a n a l y s i s a s w e l l . M u l t i p l i e r a n a l y s i s i s used t o t r a c e t h e c h a n n e l s of t r a n s m i s s i o n o f exogenous shccks i n t h e i r o n o r e markets. The s i m u l a t i o n s show t h a t a n i n c r e a s e i n B r a z i l i a n i r o n o r e c a p a c i t y w i l l r e d u c e i r o n o r e p r i c e s and l e a d t o a r e d i s t r i b u t i o n of market s h a r e s among t h e producers. I n c r e a s e s i n EEC crude s t e e l production and exogenous i n c r e a e e a i n s c r a p p r i c e s o r i n t h e i n f l a t i o n index w i l l tend t o i n c r e a s e i r o n o r e p r i c e s . The s i m u l a t i o n s a l s o i n d i c a t e t h a t d e p r e c i a t i o n of t h e U.S. d o l l a r r e l a t i v e t o European and J a p a n e s e c u r r e n c i s s w i l l have a n e g a t i v e e f f e c t on i r o n o r e p r i c e s i n t h e f i r s t e i g h t y e a r s and a p o s i t i v e e f f e c t i n t h e n e x t too. But t h e o v e r a l l e f f e c t of t h e U.S. d o l l a r d e p r e c i a t i o n is found t o be v e r y s m e l l o v e r a t e n - y e a r p e r i o d .  I acknowledge my great i n t e l l e c t u a l debt t o Ron Duncan and my Commodities D i v i s i o n c o l l e a g u e s f o r t h e i r c r i t i c a l l y important c o n t r i b u t i o n s t o t h e paper. I note p a r t i c u l a r l y t h e support of I'. Akiyma, B . J . Choe, X. Gbetibouo, C. G i l b e r t , ti. Imran, D. H i t c h e l l , F. Najmabadi, and J. Strongmen, a s w e l l a s two anonyinous reviewers. The persons, however, who a s s i s t e d me t h e most i n p u t t i n g t o g e t h e r t h i s model a r e T. Dunietz and H. Buchinsky. Also, I acknowledge with many thanks t h e g r e a t support of J. Raulin who proofread, typed and e d i t e d f o r s t y l e t h i s manuscript. Any e r r o r s t h a t remain may suggest t h a t I have not f u l l y taken advantage of t h e suggestions made by t h e people l i s t e d above and t h e r e s p o n s i b i l i t y f o r t h a t remains f u l l y mine.  TABLE OF cowmTs ABSTRACT .......................................................... ... 1 1 1 I. INTRODUCTION ...................................................1 11, THE IRON ORE INDUSTRY ..........................................3 ..............m....................6 ./ 11.1 Background and Definitions.. 3 11.2 Production and Apparent Consumption of I r o n Ore 11.3 I n t e r n a t i o n a l Trade ....................................11 a 11.4 P r i c e S t r u c t u r e.................m..................... 11.5 Government Role .......................................1622 .........24 111.1 An Overview of t h e Hain Features of t h e Model ........................................31 111.2 Model Linkagee ..................................3843 I V . 1 I r o n Ore Production ....em.........m................... ..................................*46 IV.2 Apparent Consumption IV.3 Exports and Imports IV.4 P r i c e s ................................................47 HODEL VALIDATION LW XULTIPLIER ANALYSIS ......................56 ......................................56 V 1 . Hodel V a l i d a t i o n ...................................58 .....59 V.2 M u l t i p l i e r Analysis V.3 Sustained I n c r e a s e i n B r a z i l i a n I r o n Ore Capacity V.4 Sustained I n c r e a s e i n EEC-7 Crude S t e e l Production ....61 V.5 Sustained I n c r e a s e i n Scrap P r i c e s ....................63 V .6 Sustained I n c r e a s e i n t h e XUV D e f l a t o r .............,.. 65 V 7 . Sustained Depreciation of t h e US D o l l a r vi c-a-vi s t h e European Currencies and t h e Japanese Yen ..........65 ANNEX I Index of V a r i a b l e s .......................................7 1 ANNEX I1 L i s t of Equations ........................................73  Table 1, world Iron Ore Capacity - 1983 and 1984 . . a . . . . . . . . . ~ . ~ . . . ~ e . . o o . . 5 2 . I r o n Ore Production... . . . . . . . . . . . . ~ ~ ~ . ~ ~ . . . . . ~ . ~ . . . . . ~ . . . . . . . . . . . 7 3. S i n t e r Pines Production Cost5 f o r S e l e c t e d World I r o n Ore S u r f a c e Hines and &posits..,.. . . . . . . . . . . . . . . . . . . . . . . b . . . . . . e . e e . 9 4. Operating, R a i l and Ocean Freight Costs f o r S i n t e r Finer and P e l l e t s . ..............~..e.e...~.....e.....e.~..........e...~O 5 I r o n Ore Apparent Consmption.. .................................12 6. I r o n Ore Export~................~.............~.........~..~~...l4 7 , Uorld Trade of I r o n Ore by Area of O r i g i n , 1984.................20 8. The S t r u c t u r e of t h e I r o n Ore ~0del...............~..~~....~....33 9. E l a s t i c i t i e s of I r o n Ore Supply ...............e.e........e...0..41 10. E l a s t i c i t i e s of Iron Ore Apparent Consuarption. ........e.ee......45 11. Error S t a t i s t i c s f o r Major Variables: H i s t o r i c a l Simulation (197'-84)...........e...e...C....e......e......e..e..57 12. Dynamic M u l t i p l i e r Analysis: A Sustained I n c r e a s e i n B r a z i l i a n I r o n Ore Capacity ~ ~ ~ ~ ~ e e ~ . ~ e ~ . ~ ~ e ~ ~ ~ e 13. Dynamic M u l t i p l i e r Analysis: A Sustained I n c r e a s e i n EEC-7 Crude S t e e l Produ~tion......................~~.~............~...62 14. Dynamic M u l t i p l i e r Analysis: A Sustained I n c r e a s e i n Scrap Prices.. ..............e.........e...............e...............6 4 15. Dynamic M u l t i p l i e r Analysis: .........................................66 A Sustained I n c r e a s e i n t h e WUV I)eflat~r...~........... 16. Dynamic U u l t i p l i e r Analysis: A Sustained 33.3% Depreciation of t h e U.S. D o l l a r vis- a- vis all European Currencies and Yen....67 F i g u r e 1. Flowchart f o r I r o n Ore ~odel....................e..eee.e........32  I. - ImoWCTION Previous e f f o r t s t o model :he i r o n o r e i n d u s t r y were not independent of e f f o r t s t o m d e l t h e s t e e l industry. A review of t h e s e e a r l i e r i r o n o r e and s t e e l s t u d i e s shows t h a t t h e y focused on e s t i m a t i n g t h e demand f o r i r o n o r e . l / I n most c a s e s i r o n o r e p r i c e s were determined exogenously. In a d d i t i o n , e f f e c t i v e c a p a c i t y , production, e x p o r t s , imports and apparent consumption of i r o n o r e by country were not e x p l i c i t l y s p e c i f i e d ; t h e i r i n t e r r e l a t i o n s h i p s were a l s o not modeled. Furthermore, s i m p l i f y i n g g e n e r a l i z a t i o n s regarding t h e c o m p e t i t i v e n e s s of t h e i n d u a t r y were u s u a l l y made. Chapter 11 d e s c r i b e s some o f t h e unique c h a r a c t e r i s t i c s of t h e i r o n o r e i n d u s t r y . I t was o u r o b j e c t i v e t o b u i l d a model t h a t r e f l e c t s most of t h e s e c h a r a c t e r i s t i c s ; a amdel t h a t simultaneously e s t i m a t e s an4 s p e c i f i e s p r i c e s a s w e l l a s volumes and t h a t answers a number of p e r t i n e n t p o l i c y q u e s t i o n s r e g a r d i n g t h e s t a t e of t h e i n d u s t r y today. Examples include: t h e impact of i n c r e a s e s i n i r o n o r e c a p a c i t y i n Brazil on p r i c e s ; t h e impact of changes i n t h e US d o l l a r exchange r a t e vis- a- vis o t h e r c u r r e n c i e s on production, consumption and p r i c e s of i r o n ore; t h e impact of changes i n p r i c e s of u n i t f a c t o r c o s t s on t h e iron o r e production process o r t h e impact of changes i n p r i c e s of s u b s t i t u t e s t o i r o n o r e (such a s s c r a p ) on production, consumption and i r o n o r e p r i c e s e t c . Chapter I11 presents t h e s t r u c t u r e of t h e model. The r e l a t i v e b a r g a i n i n g pover of n e g o t i a t i n g p a r t i e s i s quantified and game theory p r i n c i p l e s a r e used t o model t h e determination of i r o n o r e p r i c e s . Chapter I V - 11 For a review of these models see H. Hashimoto, "A World I r o n and S t e e l Economy Xodel: t h e WISE ~ o d e l "i n World Bank c&dity Models, World Bank S t a f f Comrrodity Working Paper No. 6, June 1981, Washington, D.C.  analyzes the specification of most behavioral equations of the model. Chapter V discusses the validation of the model and shows hov well the dynamic simulation path replicates the historical data. In addition, multiplier analysis is used to answer policy questions and to d e t ~ i lthe impact on the iron ore industry of exogenous shocks.  11.1 Background and Definitions I r o n (Fe) i s one of t h e most abundant and most widely d i s t r i b u t e d elements i n t h e world and probably c m g t i t u t e s upwards of 5% of t h e e a r t h ' s weight. I t i s estimated t h a t world resources of i r o n o r e exceed 800 b i l l i o n t o n s of crude o r e , c o n t a i n i n g more than 250 b i l l i o n t o n s of iron. The iron- b e a r i n g minzrals a r e by f a r mostly i r o n s i l i c a t e s . Rarely a r e t h e r e considered "iron ore" because "ore" i n f e r s an iron- bearing substance t h a t is an econo- m i c a l l y v i a b l e m a t e r i a l . The d e r i g n a t i o n "ore" i s dependent on many f a c t o r s such a s l o c a t ion, knowledge of i t s cornposit ion and e x t e n t , technology and * .*' a c c e s s i b i l i t y . The r r c j ~ r forms of i r o n vorltdvide, a s c l a s s i f i e d by t h e i r chemical composition, a r e a s follows: ( a ) Magnetite (Fe304) which i n its pure form c o n t a i n s 72% i r o n ; ( b ) Hematite (Fe203) which when pure c o n t a i n s about 70% i r o n ( h e m a t i t e i s :\e most comnon o r e of i r o n ) ; ( c ) T a c o n i t e c o n t a i n i n g 15-35% i r o n ; ( d ) Limonite, r e f e r r e d t o a s brown hematite, is a hydrous f e r r i c oxide; ( e l S i d e r i t e (PeC03) conraining about 48% iron; ( f ) P y r i t e (FeS*) c o n t a i n i n g 47% i r o n ; and ( g ) P y r r h o t i t e which c o n t a i n s 60% i r o n , I r o n o r e is t h e source of primary i r o n f o r t h e world's s t e e l indus- t r y . I n o r d e r t o produce m e t a l l i c i r o n f o r s t e e l making, it i c necessary t o mine s u i t a b l e iron- bearing minere. - and t r e a t them through a s e r i e ~of pro- c e s s e s . The final process is some form of chemical " reduction" d u r i n g which a "reducing agentu combines with unwanted chemical elements i n the mineral and  r e l e a s e s the iron a s a metal. More than 90X of the world's present new supply of metal1 i c i r o n i s produced each year as pig iron, from iron o r e s t h a t a r e smelted i n b l a s t farnaces. Pig iron i s defined as r high- carbon iron made by reduction of iron ore in the blast furnace. i r c n ore as n i n e d in i t s natural s t a t e i s called crude ore. Crude o r e may be r , ~ r c h a n t e b l ewithout processing o r uich minimal processing such a s crushing and screening, in which case i t i s called direct- shipping ore. The f i n a l ore product of a ntining operation, vbether direct- shipping ore o r the product of extensive processing, i s c a l l e d usable ore o r marketable ore. Usable ore includes lump ore, f i n e s , concentrates and agglomerateo. Lump o r e c o n s i s t s of p a r t i c l e s one- quarter inch o r larger. Fines a r e p a r t i c l e s l e s s than one- quarter inch ;n diameter; s i n t e r feed c o n s i s t s mostly of f i c e s l a r g e r than 100 mesh, vh:!e f i n e s smaller than 100 mesh may be classed a s p e l l e t feed. The product:; a f jeneficiation plants a r e called concentrates and a r e c l a s s i f i e d a s coarse (p:us one- quarter inch) o r f i n e (minus one- quarter inch) as indicated above. Fine concentrates o r natural ores a r e agglomerated t o f a c i l i t a t e transportation and smelting; these products a r e called p e l l e t s , s i n t e r , briquets, etc., depending on the agglomerating pror. -s used. 11 According t o the US Bureau of nines' s t a t i s t i c s , vorid i r o n o r e nominal capacity i s estimated t o be close t o 639.6 million metric tons i n i r o n content i n 1984. 11 Of t h i s capacity 171 and 19%a r e considered t o be i n North America and South America, respectively, 32% and 8% a r e considered t o be i n -11 See Bureau of Nines, U.S. Department of t h e I n t e r i o r , "1ron Ore," preprint from B u l l e t i n 675, 1985 edition, Washington, D.C. -21 See Table 1.  T a b l e 1: WORLD IRON ORE CAPACITY - 1983 AND 1984 EFFECTIVE CAPACITY /A --------------------m 1983 1984 ---------( m i l l i o n metric t o n s i r o n content)--------- NORTH AMERICA CANADA UNITED STATES SOUTH A!!ER ICA BRAZI L VENEZUELA EUROPE /B FRANCE SWEDEN USSR AFRICA LI BERIA 13.6 SOUTH AFRICA, REP. OF 22.7 ASIA INDIA 30.8 31.7 27.4 27.5 CHINA & OTHER 45 .4 45.4 42.3 /C 43.1 /C WORLD TOTAL 641 -4 639.6 544.5 543.1 /A EFFECTIVE CAE'ACITY I S CALCULATED USIlIC PEAK PRODUCTION RATES. THE EFFEC- TIVE CAPACITY FICLJRES COULD BE INCBEASED SUBSTANTIALLY IF MARKET CONDITIONS WARRANTED. /B INCLUDES CPEs. /C CHINA ONLY. SOURCES: NOMINAL CAPACITY FIGURES: BUBeAU OF *TNi?S, US DEPARTMENT OF INTERIOR; EFFECTIVE CAPACITY FIGURES: LIXpbL3 c;V, INTERNATIONAL ECONOHICS DEPARTXWT.  Europe (incl\i:r:t: -Ye C P E s ) and A f r i c a , r e s p e c t i v e l y , and 12% and 13% a r e c o n s i d e r e d t o be - A Asia and Oceania, r e s p e c t i v e l y . A t p r e s e n t , t h e USSR, B r a z i l and A u s t r a l i a account f o r 53% of world nominal c a p a c i t y o r 51% of world e f f e c t i v e c a p a c i t y . The I n t e r n a t i o n a l Iron Ore and S t e e l r n s t i t u t e (IISI) and t h e World Bank i! p r o j e c t t h a t i n t h e next 15 y e a r s , world i r o n o r e c a p a c i t y will expand by aboat 37 m i l l i o n tons i n Fe content. Brazil, China, A ~ s t r a l i a , Canada and I n d i a a r e expected t o i n c r e a s e t h e i r i r o n o r e c a p a c i t y by about 53 m i l l i o n tons. Other producing c o u n t r i e s i n A f r i c a , Europe and North America a r e expected, however, t o have t h e i r c a p a c i t y c u t a s t h e i r high- quality, l o r c o s t r e s e r v e s are depleted. 11.2 production and Apparent C o n r u p t i o n of I r o n Ore Ninety- five percent of a l l i r o n o r e production is consumed by t h e w o r l d ' s steel- making i n d u s t r y . Annual world i r o n o r e production ( i n a c t u a l weight! u s u a l l y exceeds 800 m i l l i o n tons of which about 90% is produced by 12 c o u n t r i e s . Uorld i r o n o r e production i n Fe content was 515 m i l l i o n t o n s i n 1985 ( s e e Table 2). The USSR, the United States, France and Sweden were t h e major i r o n o r e producers i n 1960. The combined production of B r a z i l and A u s t r a l i a accounted f o r only 2.52 of world production i n 1960. Twenty- five y e a r s l a t e r , B r a z i l and A u s t r a l i a accounted f o r c l o s e t o 25% of world productior.. The United S t a t e s , Prance and Sweden have, however, seen t h e i r combined s h a r e of world production f a l l Zrom 42.5% i n 1960 t o 9.9% i n 1985. D i f f e r e n c e s i n production c o s t accounted f o r t h e s e changes i n t h e geographical -11 See Report 814186, P r i c e Prospects f o r Hajor Primary Commodities, The World Bank, I n t e r n a t i o n a l Ec~nomicsDepartment, October 1986.  ---------------------------------------------------------------------------------------------------------------------------------------------- .................................. LEVEL (r PROWCTlON ............................... G?WW RATE ------------------------- SHARE OF TOTAL FEFiROUS CONTENT ----------------- COUNTRY 1960 1970 1980 1985 1960-85 /A 1960-69 /A 1970-79 /A 1960 1970 1980 1985 1960 1980 ---------*------------------------------------------------------------------------------------------------------------------------------------ -----------------------------------------------g---------------------------------- CANAOA UNlTED STATES FRANCE S E E N AUSTRAL lA L I E R I A MAURITANIA INDIA BRAZIL CHILE V E N Z NLA PERU SOUTH AFRICA USSR W l N A WORLD 251.91 425.10 540.53 515.72 3.2 5.7 1.9 100.00 100.00 IOOe00 100.00 46-55 58-15 /A ESTIMATED ON 1HE BASIS OF LEAST SQUARES T E N D FITTING. /B 1961-1985. /C 1961-1969. /D I N 1961. /E I N 1978. SOUR(TS: UNCTAD, 1p85 Y f w OF I-lTY STAT, 1986, JULY, GEEEVA, AN> WORLD BAH( ESTIMATES.  l o c a t i o n of i r o n o r e mines d u r i n g t h e 1960-85 period. Table 3 shows t h a t i n 1381, o p e r a t i n g c o s t s w e r e s u b s t a n t i a l l y lower i n B r a z i l and A u s t r a l i a t h a n , f o r example, i n L i b e r i a o r t h e United S t a t e s . The World Bank e s t i m a t e s t h a t i n terms of investment c o s t s p e r annual t o n of new c a p a c i t y ( g r o s s o r a c t u a l w e i g h t ) expansion p r o j e c t s can be c o s t e d a s low ab u ~ $ Z O / t o n , whereas r e p l a c e - ment p r o j e c t s have c a p i t a l c o s t s of USS25-75/ton and g r e e n f i e l d p r o j e c t s ~ ~ $ 1 0 0 / t oand above. The l e v e l of i n t e r e s t r a t e s can t h u s g r e a t l y a f f e c t t h e n p r o f i t a b i l i t y of o p e r a t i o n s i n t h e i r o n o r e i n d u s t r y . T o t a l c o s t s v a r y s u b s t a n t i a l l y among c o u n t r i e s . B r a z i l and A u s t r a l i a a r e t h e lowest c o s t producers of s i n t e r f i n e s and p e l l e t s . P e l l e t p l a n t s a r e more c o s t l y t o o p e r a t e t h a n p l a n t s producing s i n t e r f i n e r . P e l l e t i z i n g i e a n e n e r g y - i n t e n s i v e o p e r a t i o n v h i c h is d i r e c t l y r e l a t e d t o t h e t y p e o f o r e b e i n g p r o c e s s e d . The amount of f u e l used h e n t h e o r e is of t h e h e m a t i t e t y p e is 28 l i t e r s l t o n ; when t h e o r e is of t h e m a g n e t i t e t y p e it i r 15 l i t e r s / t o n . T a b l e 4 p r o v i d e s d e t a i l s on r a i 1 and ocean f r e i g h t t r a n s p o r t a t i o n c o s t s . These c o s t s vary enormously between mines and c o u n t r i e s . I n a n t i c i p a t i o n o f h i g h e r i r o n o r e demand and t h e s e a r c h f o r new r e s o u r c e s of high- grade o r e , t h e w o r l d ' s o r e r e s o u r c e s were augmented c o n s i d e r a b l y i n t h e 1960-85 period. Furthermore, t h e development of improved benef i c i a t i n g methods made numeroue l o r g r a d e d e p o s i t s e c o n o m i c a l l y v i a b l e i n s p i t e o f a n abundance o f h i g h e r q u a l i t y o r e . C o n c u r r e n t l y w i t h t h e s e developments two o t h e r important developments p r o f o u n d l y i n f l u e n c e d a t e e l production and demand f o r i r o n o r e . Foremost was t h e r a p i d development of computerized c o n t i n u o u s c a s t i n g t e c h n i q u e s and e l e c t r i c a r c f u r n a c e s ( t h a t may u s e 100% s c r e p ) ; t h e s e t e c h n i q u e s i n c r e a s e t h e o u t p u t o f f i n i s h e d steel from a s p e c i f i c amount of raw steel. The n e t e f f e c t is t h a t less i r o n o r e is now required f o r t h e production  Table 3: SIHrER F l a S PRtDJCT ION COSTS FOR SELECTED W L D IR3H WE S W A E MINES lvJD OEPOSITS /A _______________-------------------------------------------------------------------------------------------- ----------- RATING COSTS------------- No. @ -----------1984 A W A L W US$/LT ORE------------- WTRY ~ R T I E S CAPACITY GUS WINE RAI L BEMEF ICI ATION (WT) ( K T ________________-----------------------------------------------------------------------~------------ .------ AFRICA PR000(rRS /B 7 2.2-24.6 63-65 1,lG-3.40 0.25-1 5.76 /C 0.60-2.30 MMVtCWCERS 1'0 12 4 5 - 2 5 56-67 1 -80-3.20 0 .90-3 -00 AUSTRAL lA PROOUCERS HOrPROOUCERS OTHER SOUTH M R l C A PROaKTRS n; ruMTmuxfiS /H UNITED STATES LAKE SG~RIUR HCUKEKS / I 9 8.261.7 63-66 2.00-4.50 0.25-4.80 3.25-5.00 L A C SUPERlORNONPRDOUCZRS /J 12 2.2-28.7 62-65 2.50-4.50 3.50-9.00 O M R NOWWaKERS /K 20 0.7-8.9 42-69 3.50-15.50 2.00-6.75 NAp = NOT APPLICABLE, Y = WIT)+1ELD. LT = LONG TW (EQUAL 1,016 e T R I C TON). PROOWERS INCLtJO W K H T L Y PROOOCING MINES; MWRXWERS INCLUE PAST FWWXftS, E W L M D W EVELOPING EPOSITS. AFRICAN PROOO(=ERS INCLUE ALGERIA, LIBERIA, MALRITANIA, REPUBLIC Of SOUTH AFRICA AN0 SlEWU LEONE. SOUTH AFRICA. AFRICAN -RS INCLUT ALGERIA, -WON, GABON, LIBYA, IVORY COAST, LIBERIA, (XIIIEA AND MAURITANIA, . EURDeEAN PROaKTRS IWME NORYAY, SPAIN AH) SUDEN. =DEN OTHER SOUTH M R l C A N fWMXf6 INCLUE WILE, PERU AM2 VENZUELA. O M R SOUTH N E R I C M -RS INClUOE E N E M L A . LAKE SWERIOR PFZOOOCEB IHCLUl MIHES IN TI MSABI AH) W?@JETrE RANGES. LAKE SUPERIOR NO)(PFMOUCERS IWCLUOE MINES AM3 MPOSITS IN M WSABI, -TI, AM) GOGEBIC RANGES. O n f R MWRUNEFLS INCLWE CALIFOfNIA, MISSOURI, WONTANA, NEVADA, NEW JERSEY, NEW Y W , TEXAS, UTAH AH) YTOMING* W:THEUSBUREAUOf WIHES, 1987, If04OfE AVAlUBlLlTY -W W T ECONOLI'I CWdlRIES: A MINERALS AVAILABILITY APPRAISAL, BY J,L, BOLIS AM J.A. BEKKALA, WAWIW;TW, W.  -Table 4: - OPEUTINC, RAIL AND OCEAN FREICHT COSTS FOR SIHTER FINES AND PELLETS _ _ _ _ _ _ _ _ _ _ _--_----.................................................... ---------------------- SIHTER FINES PeLLMS RAIL OCEAN REGION/ OPERATING OPERATING TRAHSPORTATIOt* FREICHT COUNTilY COSTS COSTS OST COST _ _ _ _ _ _ _ _ _ _ ___-- ----.------------------------------------------------------------------- ------ BHAZ I L PRODUCERS CANADA PRODUCERS /B EUROPE PRODUCERS HEX1CO PRODUCERS UNITED STATES LAKE SUPERIOR PRODUCERS 5.25-9.50 6.00-10.60 0.25-4.80 LAKE SUPERIOR WONPRODUCERS 6.00-13.50 7.30-12.90 0.25-4.80 OTHER NONPRODUCERS 5.5-22.25 6.50-14.00 0.25-4.80 / A TO WESTERN EUROPE. /B CANADIAN PRODUCERS INCLUDE MINES PROCESSING ONLY HWATITE ORES. /C TO WESTERN EUROPE. / D SWEDEN. /E FRW NORWAY TO WESTERN EUROPE. SOURCE: THE US BUREAU OF MINES. 1987, IRON ORE AVAILABILITY - XARKET ECONOMY COUKTRJ ES: A HIN~RALS~AVAIU\BILITYJ.L.APPRAISAL, BY BOLIS AND J.A. BI~KKALA, YASHIWCTON, DC.  of one t o n of crude s t e e l . About 1.2 t o n s of i r o n o r e i s r e q u i r e d per ton of s t e e l u s i n g t h e s e processes, compared t o 1.6 tons f o r t h e almost economical ly- obsol e t e open h e s r t h furnace systems. Second, there were important changes i n t h e type of s t e e l being consumed and technological improvements i n s t e e l u t i l i z a t i o n . The use of high- s t r e n g t h s t e e l i n t h e automobile i n d u s t r y l e d t o weight savings and s m a l l e r c a r s . The evolvement of new techniques i n b u i l d i n g and c i v i l c o n s t r u c t i o n p e r m i t t e d g r e a t e r use of concrete and h i g h - t e n s i l e s t e e l s . These examples and o t h e r s , such a s t h e use o f s u b s t i t u t e m a t e r i a l a (e.g., aluminum f o r s t e e l i n a u t o m o b i l e s ) , o r improved manufacturing techniques (e.g., i n household d u r a b l e s ) have l e d t o decreased s t e e l u s e and u l t i m a t e l y reduced i r o n o r e demand. P a r t l y a s a r e s u l t t h e growth of i r o n o r e consumption slowed from 5.5% p.a. i n t h e 1960-69 period t o 1.8% p.a. i n t h e 1970-79 period; consumption d e c l i n e d by 1.2% p.a. i n t h e 1980-85 period ( s e e Table 5 ) . The development of t h e s t e e l i n d u s t r y i n Japan, B r a z i l , t h e Republic of Korea and China coincided w i t h t h e d e c l i n e of t h e s t e e l i n d u s t r y i n t h e United S t a t e s and t h e EEC. As a r e s u l t , t h e demand f o r i r o n c r e changed considerably among c o u n t r i e s i n t h e 1960-85 period. The s h a r e of apparent consumption held by t h e United S t a t e r d e c l i n e d from 26% i n 1960 t o 7.3% i n 1985. On t h e o t h e r hand, Japan's s h a r e i n c r e a s e d from 4.12 t o 15.1%. The demand f o r i r o n o r e i n c r e a s e d f a s t e s t i n Japan, Canada, B r a z i l , t h e Republic of Korea, India, South A f r i c a , Mexico, China and Spain. 11.3 International Trade The percentage of wcrld iron ore production traded i n t e r n a t i o n a l l y h a s r o s e from 302 i n 1961 t o 46% i n 1985. I n t e r n a t i o n a l t r a d e volume reached a peak o f about 234 m i l l i o n tons ( i n i r o n c o n t e n t ) i n 1985.  Tabla: lROCJ OfE APPAPfNT COIJSWTION (FE CONTENT IN MILLION T W ) ---LEVEL ----------------------- -------- Of APfMNT CONSWTIW .................................. CROYTH RATE SHARE ff TOTAL. F C W S CONTENT -------- *- - - -- - --------------I-------------- CANAOA UNITED STATES G W Y , F.R. FMr(CE BELGIUM-LUX. SWEDEN SPAIN UNITED KINGOOC( JAPAN AUSTRALlA SOUTH M R lCA I W I A ' M I L C(EXIC0 USSR CZECHOSLOVAKI A CHINA /A ESTIMATED ON THE BAS S Of LEAST S W M S TEND FITTING. /B 1961. K 1960-1983. /D 1960-1969, /E ESTIMATED.  I n 1985, s i x c o u n t r i e s ~ c c o u n t e d f o r more than 75% of i r o n o r e e x p o r t s . 'rncoe g r w p s , Japan, t h e EEC and t h e United S t a t e s , consumed about 70% of t h e i r o n o r e traded on the international market ( s e e Table 6). The Japanese s t e e l industry i s based on imported o r e because t h e r e are v i r t u a l l y no domestic i r o n o r e r*qources. The Western European s t e e l i n d u s t r y was e s t a b l i s h e d on t h e b a s i s ' domestic ores. Due to the present marginal q u a l i t y of t h e s e o r e s , with grades between 30-40% i r o n , and t h e a s s o c i a t e d increased c o s t s f o r pig-i ron product ion, t h e EEC c o u n t r i e s now import about 80% of t h e i r i r o n o r e requirelrants. There a r e a number of d i s t i n c t d i f f e r e n c e s betveen i n d u s t r i a l and developing c o u n t r i e s w i t h r e s p e c t t o i r o n o r e t r a d e . As an example, i n 1975, developing c o u n t r i e s furnished 952 of t h e i r e x p o r t s t o t h e i n d u s t r i a l c o u n t r i e s . T h i s c o n s t i t u t e d almost SOX of t h e t o t a l import needs of i r o n o r e of t h e i n d u s t r i a l c o u n t r i e s . The developing c o u n t r i e s a r e g e n e r a l l y l o c a t e d f a r t h e r avay from t h e i r markets than a r e t h e i n d u s t r i a l c o u n t r i e s vhich export i r o n o r e , Developing c o u n t r i e s , however, have increased steel production r a p i d l y , a s r e f l e c t e d i n t h e 5.7 p.a. i n c r e a s e i n i r o n o r e consumption during t h e 1970s. In c o n t r a s t , t h e consumption of i r o n o r e i n t h e i n d u s t r i a l c o u n t r i e s decreased a t a n annual r a t e of 0.7% during t h e same period. Long-term c o n t r a c t s cover t h e major p a r t of a l l i r o n o r e t r a n s a c t i o n s between t h e s t e e l m i l l s and t h e i r c a p t i v e mines a s well a s between t h e i r o n o r e producers and s t e e l mills i n general. A t p r e s e n t , t h e Japanese s t e e l i n d u s t r y meets 90% of its import requirements under t h i s t y p e of arrangement, -11 Exports a r e presented i r Table 6 i n terms of i r o n o r e c o n t e n t ,  Tabla: I f W O ( i E EXWRTS (FE CONTENT IN MILLION TONS) -------------------------------------------------------------------------------------------------------------------..----------..--------------- .................................. LEVEL Of EXPORTS GROWTH RATE ---------------------------- SItARf OF TOTAL fEfWOUS CONTCNT ----me------------------------- --------------f cNwA UNITED STATES FRANa SWEEN AUSTRAL lA SOUTH M RlCA L I E R I A MAURITANIA I W I A BRAZIL CHILE VEFEZlELA USSR fJf*!!u /A ESTIMATED ON THE BASIS OF LEAST SQUARS TRENO FITTING, /B 1965-1983. I C 1965-1069, /O I N 1965, /E 1963-1983. /F 1963-1969. X; IN 1963, SOURCES: W T A D , 1985 1-1 m T Y S m , JULY, 1986, GENEVA, MI M)RLD BAM ESTIMATES,  whereas t h e European c o u n t r i e s receive 40% of t h e i r imports under long- tern c o n t r a c t s . The balance r e p r e s e n t s s a l e s on t h e spo: market o r under short-term c o n t r a c t s . The s t e e l producers have e s t a b l i s h e d very c l o s e r e l a t i o n s h i p e w i t h most i r o n o r e mines that began producing in the e a r l y 1969s. Examples include mines i n can ad^ and Western Africa which have p a r t i a l ownership by s t e e l companies, and t h e n i n e s i n A u s t r a l i a vhich v e r e e s t a b l i s h e d under long- term c o n t r a c t s t o Japanese s t e e l m i l l s . These r e l a t i o n s h i p s a s s u r e t h e s t e e l producers of a s t a b l e source and p r i c e f o r t h e i r ore. In t h e l a s t decade, l a r g e consumers have reduced t h e i r supply r i s k f u r t h e r through d i r e c t investment i n a d d i t i o n a l mines and/or long-tern c o n t r a c t s with o t h e r mines, r e s u l t i n g i n a d i v e r s i f i c a t i o n of sources f o r i r o n ore. I n a d d i t i o n , buyers have a s s u r e d themselves of a more- than- adequate supply of i r o n o r e by o f f e r i n g i n c e n t i v e s t o open new mines with long- term c o n t r a c t s o r w i t h p a r t i a l ownership. A l t e r n a t i v e l y , such guaranteed markets a r e necessary f o r t h e mine owners and t h e i r f i n a n c i a l backers t o j u s t i f y t h e l a r g e i n v e s t e n t s needed t o develop t h e mines. I n t h e p a s t , under t h e umbrella of long- term supply c o n t r a c t s , t h e i r o n o r e i n d u s t r y and t r a d e develop along a f a i r l y s t a b l e growth p a s t . However, i n r e c e n t y e a r s , a gradual r e d u c t i o n of t h e s t a b i l i t y provided by t h e s e long- term arrangemeyts has been witnessed. The breach of c o n t r a c t e d b a s i c q u a n t i t y couxnitments has become more t h e norm r a t h e r than t h e i r f u l f i l l m e n t . I n many c a s e s , s t e e l mills have accepted only 60%-70%of b a s i c ~ o n t r a c t u a ltonnages, making t h e usual 10% q u a n t i t y v a r i a t i o n c l a u s e s appear meaningless.  This contractual breakdown has increased t h e tendency towards wider quantity margins and s h o r t e r contract durations. Pereistence of t h i s trend, coupled with the apparent l a t i t u d e in approach t o t h e quantity margina, v i l l g r e e t l y diminish t,he value of these contracts and can only r e s u l t i n increased competitiveness in iron ore mining o per at ions and in the shipping industry operations. 1 4 Price Structure Iron ore presently accounts f o r only 10-15% of the cost of a ton of s t e e l even though i t takes about 1.2 tons of iron ore t o produce one ton of steel. The p r i c e of iron o r e does not f l u c t u a t e automatically with the p r i c e of i r o n / s t e e l . The market f o r i r o n ore is essentially a bilateral oligopolimtic market, with r e l a t i v e l y few producers s e l l i n g t h e i r product t o r e l a t i v e l y f e w buyers, On t h e demand s i d e , Japanese and European s t e e l mskers dominate t h e market f o r i r o n ore, and, t o a great extent, control i r o n ore prices. However, individual s t e e l makers normally do not negotiate t h e i r own contracts: most negotiations a r e done through industry- oriented buying organizations. The majority of Japaneae purchases and shipping contracts a r e handled concurrently by t h e buying companies. The Federal Republic of Germany has two cooperating agencies t h a t a r e commissioned with t h e buying and transporting of raw m a t e r i a l s f o r t h e s t e e l industry, I n t h e United Kingdom and I t a l y , purchares of i r o n o r e a r e negotiated horizontally by industry-owned organization^. Because of t h e i r geographic and ownership relationships, Australia is t h e producer leader f o r o r e imports i n t o Japan, and Brazil (previously it was Sweden) i s t h e producer leader f o r i r o n o r e imported i n t o Western Europe.  Host i r o n o r e is s o l d on an annual o r multi- year t e r n c o n t r a c t on a tonnage b a s i s , v i t h an gnnual o r s m e t imes semi- annual r e n e g o t i a t i o n of p r i c e s . These annual n e g o t i a t i o n s have a wide impact on t h e i r o n o r e i n d u s t r y; p r i c e s t h a t a r e n e g o t i a t e d y e a r l y by B r a z i l and Australia, the l a r g e s t e x p o r t e r s , a r e construed as t h e benchmark p r i c e s f o r t h e o t h e r a r e exp,, t e r s and consumers during t h e i r n e g o t i a t i o n s . S t e e l mills a r e involved i n t h e development of many i r o n o r e mine8 e i t h e r through v e r t i c a l i n t e g r a t i o n , p a r t i a l ownership, o r through f i n a n c i a l and t e c h n i c a l a s s i s t a n c e . Hany of t h e c o n t r a c t s a r e intercompany t r a n s a c t i o n s ; t r a d i t i o r r a l l y , t h e supply of i r o n o r e t o t h e s t e e l i n d u s t r y i n t h e United S t a t e s and Canada h a s been from c a p t i v e mines. US s t e e l companies c o n t i n u e t o i n v e s t i n o r e production f a c i l i t i e s and d e r i v e up t o 80% of t h e i r requirements through such t r a n s a c t i o n s . The European s t e e l i n d u s t r y h a s s i m i l a r ownership ties with mines i n West Africa and Latin America. Hwever, s e v e r a l of t h e mines i n t h e s e r e g i o n s have been n a t i o n a l i z e d and t h e supply of o r e through t h e s e t i e s h a s been s i g n i f i c a n t l y reduced. I r o n o r e is not a homogenous commodity with r e s p e c t t o contained i r o n , s i z e , cr d e l e t e r i o u s material. Consequently, t h e p r i c e s t r u c t u r e is complex; s a l e s of t h e d i f f e r e n t q u a l i t i e s of o r e s r e q u i r e a v e s t range of p r i c e s t o account f o r t h e s e q u a l i t y d i f f e r e n c e s . The p r i c e f o r i r o n o r e paid t o t h e mine, w i t h t h e exception of d o n e s t i c o r e s , is t h e c a l c u l a t e d FOB p r i c e . However, t h e FOB p r i c e is d e r i v e d from t h e CXP p r i c e which i s t h e p r i c e with which t h e s t e e l producerr a r e i n i t i a l l y concerned. CIF o r C+P p r i c e s f o r f u l l y comparable products tend t o be equal i n a given market. T h i s is because i r o n o r e buyers w i l l g e n e r a l l y n e g o t i a t e c o n t r a c t s s o that p r i c e s f o r i r o n o r e of t h z same q u a l i t y a r e a l l  equal on a d e l i v e r e d b a s i s . The FOB p r i c e i s determined by s u b t r a c t i n g t h e e s t i m a t e d ocean f r e i g h t c o s t from t h e CIP p r i c e . The r e s u l t i n g FOB p r i c e is used a s a b a s i s f o r reimbursement t o t h e mine. Diffezences i n CIP p r i c e s between v a r i ~ u si r o n ores d e l i v e r e d t o a p a r t i c u l a r s t e e l m i l l a r e , t h e r e f o r e , due e i t h e r t o d i f f e r e n c e s in q u a l i t y o r type of t h e o r e o r t o d i f f e r e n c e s i n t h e type of c o r ~ t r a c tand d a t e of i t s n e g o t i a t i o n . 6asir.g t h e s a l e p r i c e of i r o n o r e on t h e FOB vblue has made t h e o t c e l mills responsible f o r p ~ y i n gocean f r e i g h t c o s t s and f o r price f l u c t u a t i o n r i n f r e i g h t r a t e s . S t e e l producers p r e f e r t o be r e s p o n s i b l e f o r ocean f r e i g h t c o s t s ; indeed, i t has been d i f f i c u l t f o r i r o n ore producers t o n e g o t i a t e c o n t r a c t s i n which t h e y a r e r e s p o n s i b l e f o r shipping d r r a n g e w n t s . Since ocean f r e i g h t r a t e s have been s t e a d i l y d e c l i n i n g f o r t h e past two decades, t h e a t e e l not t h e i r o n o r e producers, have b e n e f i t t e d ~ r o mreduced r a t e r though some af t h e b e n e f i t must accrue t o t h e exporter?. Although t h e buyers b e n e f i t from t h e r e d u c t i o n i n t r a n s p o r t c o s t s , t h e e x p o r t e r s i n v e s t t h e c a p i t a l f o r t h e p o r t f a c i l i t i e s t h a t have made t h e lower ocean t r a n s p o r t c o s t s p o s s i b l e through a c c o m d a t i n g l a r g e r v e s s e l s . The i n c r e l s e d abundance of i r o n o r e worldwide, over time, has placed t h e producers a t a g r e a t e r disadvantage during p r i c e n e g o t i a t i o n s . The oversupply of i r o n o r e c a p a c i t y i n t h e l a s t decade h a s made t h e market i n c r e a s i n g l y competitive and h a s c o n t r i b u t e d s i g n i f i c a n t l y t o d e c l i n i n g i n t e r n a t i o n a l p r i c e s i n r e a l tercra. I n c r e a s i n g l y s t r i n g e n t c o n d i t i o n s have been imposed upon t h e o r e producers by t h e s t e e l makers. Although steel companies have d i v e r s i f i e d t h e i r markets while a t t h e same time d i v e r s i f y i n g t h e i r i r o n o r e s u p p l i e s , i r o n o r e e x p o r t e r s have not been s u c c e s s f u l i n  d i v e r s i f y i n g t h e i r markets ( s e e Table 7 ) . Each of t h e major e x p o r t i n g c o u n t r i e s r e l y mainly on one market, which weakens t h e i r p o s i t i o n with r e s ? e c t t o t h e o t h e r p o t e n t i a l buyers. Examples of t h i s dependency i n e x p o r t s a r e Canada t o t h e United S t a t e s , Sweden Lo Western Europe and A u s t r a l i a t o Japan. The f o r m t i o n of t h e Association of I r o n Ore Exporting Countries (APEF) has o n l y m a r g i c a l l y improved t h e n e g o t i a t i n g posture of t h e i r o n o r e producers. I t has not been very e f f e c t i v e s i n c e both Brazil and Canada have opted not t o j o i n . Although t h e determination of p r i c e s during t h e c o n t r a c t u a l n e g o t i a t i o n s remains r a t h e r complex, some b a s i c rr 'anisms have been e s t a b l i s h e d and i n gerreral a p p l i e d through t h e years. Up t o a few y e a r s ago, t h e annual European i r o n o r e p r i c e n e g o t i a t i o n s n o r m l l y s t a r t e d i n October/Hovember a ~ dended before Christmas. 3/ In some r e c e n t y e a r s t h e n e g o t i a t i o n s have had a tendency t o d r a g on w e l l i n t o t h e new year. I n c a s e s where no p r i c e agreenwrt had been reached before t h e end of t h e d e l i v e r y y e a r , t h e p a r t i e s normally agreed on a p r o v i s i o n a l p r i c e f o r shipments i n t h e new year. I n v i e u of t h e l a r g e o r e q u a n t i t i e s received v i a Rotterdam, it h a s f o r v e r y many y e a r s been t h e p r a c t i c e t o t a k e the CI? Rotterdam price as a r e f e r e n c e p r i c e f o r n e g o t i a t i o n s i n Europe. The p r i c e s f o r i r o n o r e d e l i v e r e d -11 The APEP was formed i n 1975 and c o n s i s t s of Algeria, A u s t r a l i a , C h i l e , I n d i a , L i b e r i a , Hauri t a n i a , Peru: Si errs Leone, Sweden, Trrnisia and Venezuela. The s t a t e d purpose of t h e APEF is t o improve information, marketing cooperation, and t o o b t a i n more s a t i s f a c t o r y p r i c i n g p o l i c i e s f o r i r o n o r e . -21 I n Europe t h e " iron o r e year" is t h e c a l e n d a r year whereas i n Japan i t is t h e f i s c a l y e a r (April 1 t o Harch 31).  Tsble 7: VCIRLO T M C6 I K W CRE BY AREA 06 ORIGIN, 1984 ( a i l l l o n tons, a c t u a l w e i g h t ) --------------------------------------lrnTS------------------------------------- O W R XrEiOplrC; IMAJSTRIAL IrOvSTRIAL EASTERN OTHER ~ L ,awTYtES D OOUHTRlES USA JAPM EEC (XXHvRIES EUROeE C U M R I E S EXPWTS _________________-------------------------*----------------------------- - - ------ -- ---- --- - -- --- - - WORLD 338.7 22.4 278.9 7.4 125.4 118.8 17.3 53.9 3.5 DEVELOPIN(; COUNTRIES 57.6 13.0 1 32.3 6.0 55.9 64.4 600 11.8 0.5 BRAZIL CHILE I M l A L18ERIA MAURITANIA PERU V E N M L A O M R S AUSTRAL lA 66.0 8.5 74.5 - M.4 15.6 0.5 - 3a0 CANADA 29 .2 - 2 11.3 3.1 13.5 1.3 - - s - - -- -- EEC 4 05 4 -5 4.5 - SWEEN 14.5 0.5 13.0 0.1 - 10.9 2.O 1.0 O M R S 24.0 0.4 23.3 - 8.0 9.8 5.5 0.3 - EASTERN E U R C E Am USSR 42.9 - 2.1 - - 0.1 2a0 40m - a SOURCE: Tt YORLD E M , I N T E W T I W A L ECXXMICS OEPARMNT,  t o small European p o r t s have been determined i n r e l a t i o n t o CIP p r i c e Rotterdam a f t e r t a k i n g i n t o account s e a f r e i g h t and p o r t c o s t d i f f e r e n c e s between Rotterdam and t h e port i n q u e s t i o n . \ Up t o 1974-75 t h e C!F Rotterdam r e f e r e n c e p r i c e was decided i n n e g o t i a t i o n s betvccn t h e Swedish i r o n o r e s e l l e r s and t h e s t e e l m i l l s of t h e F e d e r a l Republic of Germany. I n subsequent years, t h i s r e f e r e n c e p r i c e was n e g o t i a t e d between t h e same s t e e l mills and t h e t r a z i l i a n company CVRD. The p r i c e i s defined i n US$ per Fe u n i t / D M ~ (dry m e t r i c t o n ) . The p r i c e d i f f e r e n t i a l s f o r o r e q u a l i t y d i f f e r e n c e s a r e expressed a9 premia o r d i s c o u n t s on t h e c a l c u l a t e d g e n e r a l FOB p r i c e i n U S ~ / Pu n~i t . A/ I n Japan, p r i c e is defined i n US$ per Fe unit/^^^ ( d r y long ton). 2 1 - In t h z p a s t , Japanese s t e e l m i l l s agreed t o pay f o r " ~ t l a n t i c " Barin o r e s t h e FOB p r i c c v a l i d f o r d e l i v e r y t o European buyers, p l u s t h e f r e i g h t f o r t r a n s p o r t t o Japan. A s t h e expansion o f s t e e l c a p a c i t y slowed down i n Japan, Japanese s t e e l m i l l s f e l t more s e c u r e i n t h e i r s u p p l i e s of i r o n o r e . The p r i c i n g p o l i c y was g r a d u a l l y replaced by a " f r e i g h t sharing" system under which t h e s e l l e r and t h e buyer shared t h e d i f f e r e n c e between t h e f r e i g h t c o s t s t o Europe and Japan on an equal basis. Japanese s t e e l m i l l s now seem t o be i n c l i n e d t o change t h i s " f r e i g h t sharing" system and t o f o l l o w t h e European system with equal CIF p r i c e s f o r t h e v a r i o u s imported i r o n o r e s . In view of t h e oversupply and t h e r e l a t i v e s i m p l i c i t y of r e p l a c i n g one source of supply -1/ I r o n o r e products a r e s o l d on a n " iron u n i t basis." For example, a c o n c e n t r a t e of 66% c o n t a i n r 66 i r o n u n i t s . -21 One long t o n = 1.016 m e t r i c ton.  with a n o t h e r , i r o n ore markets have become q u i t e competitive and i n c r e a s i n g l y i r o n o r e i s traded o n a spot b a s i s . . ' 11.5 Government Role I n many of t h e producing c o u n t r i e s , governments f u l l y o r p a r t i a l l y own i r o n ore p l a n t s . B r a z i l , C h i l e , France, India, L i b e r i a , Mauritania, Mexico, Norway, Peru, S i e r r a Leone, South A f r i c a , Sweden and Venezuela a r e some of t h e c o u n t r i c e where t h i s -occurs. I r o n o r e i s a major source of f o r e i g n exchange and an important source of t a x revenue f o r many c o u n t r i e s . In view of t h e perceived economic and s t r a t e g i c importance of t h e i r o n o r e i n d u s t r y through i t s l i n k t o t h e s t e e l i n d u s t r y , governments o f t e n choose t o p r o t e c t and i n t e r v e n e i n its o p e r a t i o n s , p a r t i c u l a r l y i n p e r i o d s of r e s t r u c t u r i n g and change such aa a t present. Governmental i n t e r v e n t i o n s appear i n many forms. f o r example, t h e Swedish i r o n o r e mines, which have teen i n s e r i o u s f i n a n c i a l t r o u b l e f o r a number of y e a r s , a r e being supported by t h e C ~ v e r n m e n t through monetary payouts. Sydvaranger, a Norwegian i r o n o r e company, has been r e c e i v i n g g r a n t s from t h e Government f o r t h e p a s t few years. I n France, most i r o n o r e mines a r e a s s i s t e d by t h e Covernment, based on t h e r a t i o n a l e of e n s u r i n g a supply of feedstock f o r t h e doarestic s t e e l i n d u s t r y and t o provide employment. The Peruvian Covernment, i n t h e l a t t e r p a r t cf 1980, provided e x p o r t t a x r e l i e f on s a l e s by g r a n t i n g exemption from t h e 17.5% e x p o r t t a x . Trade i n i r o n o r e b e n e f i t s from duty- free treatment under two major p r e t e r e n c e systems. F i r s t , t h e r e i s t h e g e n e r a l i z e d system of p r e f e r e n c e s (CSP) which h a s suspended t a r i f f b a r r i e r s f o r imports from developing c o u n t r i e s i n i n d i v i d u a l country p r e f e r e n t i a l schemes. Second, t h e s p e c i a l p r e f e r e n c e s o f f e r e d by t h e EEC t o African, Caribbean and P a c i f i c (ACP) S t a t e s  under t h e om& Convention which a c c o r d s d u t y - f r e e t r e a t m e n t t o some primary and i n d u s t r i a l p r c d u c t s i n c l u d i n g i r o n o r e . N o n t a r i f f b a r r i e r s a r e r e l a t i v e l y few and g e n e r a l l y apply t o s t e e l products r a t h e r than i r o n ore. Scch n o n t a r i f f b a r r i e r s i n c l u d e import l i c e n s e s , s u r c h a r g e s , v a l u a t i o n procedures, custorna fees and d e p o s i t s . L/ A t p r e s e n t such i n t e r v e n t inns are s p o r a d i c and l i m i t e d t o v e r y few c o u n t r i e s . -I/ See United Nations, he Iron Ore and Steel industry," ~ ~ / ~ / 6 . 2 / 1 7 6 / ~ e v . l , S a l e s No. E.78.II.D.1, 1978, New York.  111.1 An O v e r v i w of t h e b i n Features of t h e Model For a very long time t h e n e g o t i a t e d p r i c e between r e p r e s e n t a t i v e s of Swedish and 1a t e r B r ~ z i li a n i r o n ore c o m p & ~ i o sand representative^ of a t e e l mills o f Continental Europe (mainly of t h e F e d e r a l Republic of Germany) h a s been c o n s i d e r e d r h e g e n e r a l r e f e r e n c e i r o n o r e p r i c e on t h e b a s i s of which or-her i r o n o r e and steel producers n e g o t i a t e d t h e i r c o n t r a c t s . Over t h e l a s t few y e a r s , however, c o m p e t i t i o n h a s i n c r e a s e d . Consumers and amall p r o d u c e r s have s t a r t e d t o n e g o t i a t e p r i c e s and q u a n t i t i e s b e f o r e t h e c o n c l u s i o n of t h e n e g o t i a t i o n s between t h e r e p r e s e n t a t i v e s of C o n t i n e n t a l Europe and B r a z i l . The aim of consumers i n doing oo i a t o i n f l u e n c e t h e outcome of negotiation11 w i t h B r a z i l , A u s t r a l i a and o t h e r major producers, v h e r e a s t h e aim o f amall p r o d u c e r s is t o l o c k i n t h e i r s h a r e of e x p o r t s e a r l y i n t h e year. I n t h e p a s t , based on t h e p r i n c i p l e o f e q u a l t r e a t a w n t f o r a l l customers, J a p a n e s e s t e e l m i l l s succeeded i n s e c u r i n g agreement on p r i c e changes w i t h B r a z i l i a n and A u s t r a l i a n supp1:ers s i m i l a r t o t h o s e n e g o t i a t e d between C o n t i n e n t a l I!urope and B r a z i l . I n t h e f u t u r e , however, Japanese steel mills a r e expected t o a c t more i n d e p e n d e n t l y w h i l e t a k i n g i n t o c o n s i d e r a t i o n t h e outcome o f n e g o t i a . t i o n r between B r a z i l and C o n t i n e n t a l Europe. We w i l l assume h e r e t h a t f o r a l l p r a c t i c a l purposes t h e g e n e r a l r e f e r e n c e i r o n o r e p r i c e ( t h e CIF North Sea f o r B r a z i l i a n 65% Fe s i n t e r f i n e s ) is being negotiated and s e t between representatives of Brazil and Continental  Europe. l-/ T h i s r e f e r e n c e p r i c e i s assumed t o a f f e c t t h e n e g o t i a t i o n s of a l l o t h e r i r o n o r e p r i c e e ( i n a nonhomgenous way). Under t h e s e n e g o t i a t i o n s we assurne t h a t market p a r t i c i p a n t s recognize t h e i r mutual interdependence and r e a c h mutually r a t i s f a c t o r y agreement ( c o n t r a c t ) a s t o t h e r e f e r e n c e p r i c e and t h e q u a n t i t y t h a t Brazil w i l l export t o most EEC c o u n t r i e s (namely, t h e F e d e r a l Republic of Germany, France, United Kingdom, I t a l y , Belgium, Luxembourg and t h e Netherlands). The procers of s e t t i n g p r i c e s and q u a n t i t i e s is r e p a r a t e d i n t o two s t e p s . Thc f i r s t r t e p i s t h e p r e p a r a t i o n f o r t h e n e g o t i a t i o n s by t h e two p a r t i e s . During t h i s r t e p , the i r o n o r e producers and s t e e l mills s p e c i f y t h e i r d e s i r e d p r i c e m d q u a n t i t y l e v e l s and t h e i r n e g o t i a t i n g s t r a t e g i e s independently of each o t h e r . The second s t e p involves t h e bargaining process. I t is assumed t h a t t h e p a r t i c i p a n t s n e g o t i a t e t h e d i s t r i b u t i o n of t h e i r j o i n t p r o f i t s v i t h t h e corrmon o b j e c t i v e of a g r e e i n g on a p r i c e t h a t w i l l n o t put e i t h e r p a r t i c i p a n t out of business. The preparation f o r n e g o t i a t i o n by B r a z i l i a n i r o n o r e producers i n v o l v e s e s t i m a t i n g t h e p r i c e and q u a n t i t y of i r o n o r e t h a t w i l l maximize t h e i r p r o f i t s . The producers know well t h e demand f o r t h e i r products and t h e c o s t i m p l i c a t i o n s of t h e i r operations. To s a t i s f y t h e f i r s t - o r d e r c o n d i t i o n of t h e p r o f i t maximization problem, t h e i r o n ore producers w i l l have t o e q u a t e marginal revenue w i t h marginal c o s t . The s o l u t i o n of t h i s problem (which i s -I/ The l o g i c t h a t a p p l i e s i n t h e determination of iron o r e p r i c e s between Brazil and Continental Europe may be a l s o applied t o other i r o n o r e c o n t r a c t u a l n e g o t i a t i o n s , such a s n e g o t i a t i o n s between B r a z i l and Japan, A u s t r a l i a and Japan, e t c .  that of a discriminating monopolist) will provide a price and a quantity for each market that will maximize iron ore ~roducers'profite. The pre-negotiation preparation by Continental Europe's steel mills is assumed to be similar to that of Brazil. It involves estimating the price and qsantity of iron ore that will minimize their cost of production or that will maximize their profits from operating the mills. The steel producers knov well their productioll and cost functions. The first order condition of the profit maximization problem involves equating marginal revenue with respect to iron ore with the marginal cost. The solution of this pr~blem(which is that of a discriminating monopsonist) vill provide a price and quantity of iron ore for each market that maximizes the profits of the steel producers. Both participants in the negotiations know that their desired price and quantity maximize their own profit but not the profit of the otk.zr party. During the negotiations they will apply their bargaining power in order to achieve an outcome (i.e., a set of price and quantity) as favorable au possible to their operations. The participants agree first on the quantity to be traded. Usually the allotment is greater than the actual traded quantity. The agreed quantity is not binding on either party. The existence of a spot market makes the quantities of iron ore competitively determined. Moreover, the competitive determination of the output results from the theory of bilateral amnopoly and the analysis of the collusion and bargaining process of negotiating parties. 11 Under this theory, the participants first negotiate a -11 The analysis here follows that of J. Henderson and R. Quandt, Hicroeconomic Theory, McGraw Hill, New York, 1971, pp 244-249. The same notation is used here as in Henderson and Quandt.  q u a n t i t y t h a r maximizer t h e i r j o i n t p r o f i t and they determine a p r i c e that d i s t r i b u t e s t h e i r j o i n t p r o f i t among them. The buyer (i.e., t h e steel producer) uses q2 ( i . e m , i r o n o r e ) .a ur i n p u t t o produce q l ( i . e . , s t e e l ) according t o h i s production f u n c t i o n qi=h(q2). He sells t h e ateel q1 a t the fixed price pl. The s e l l e r (i..., th. i r o n o r e producer) uaes a r i n g l e input x f o r t h e production of q2. Ha buy# 8 a t t h e fixed p r i c e r. Ye asaume that h i s production function can be erpre##.d i n i n v e r s e form as x = 8(q2). The j o i n t p r o f i t of t h e buyer and r e l l e r then would be: h e r e r = j o i n t p r o f i t p r o f i t of buyer ( s t e e l producer) xb = t = p r o f i t of reller ( i r o n o r e producer) 8 a e t t i n g dw/dq2 equal t o z e r o and  Joint p r o f i tis vxinized a t an output a t which the value of the buyer's marginal product e q w l r the s e l l e r ' s marginal coat. This i r t h e aamc solution as t3e conpetitive solution, i.e., a8 i f both buyers and r e l l e r s were p r i c e takers. l h u r ue nay conclude t h a t the o p t i a r l bargaining output level i r * the same a s the competitive output level of q 'Ihe bargaining rolution of the 2 ' b i l a t e r a l monopoly d w r not lead, however, t o t h e competitive price. Ar noted e a r l i e r , f o r t h e prescribed iron ore rupply (q2 ) the iron ore producer d e r i r e r a r hi@ r price a8 posrible and the buyar d r r i r e r a r low a price a r porrible. Thua, i f th. upper lidt of the price i r the price that would f o r c e t h e r t e e l producer'r p r o f i t t o u r o and the lover l i m i t is the p r i c e t h a t vould force t b e i r o n ore producer'r p r o f i t t o zero we would have: Since r negative p r o f i t vould force one of t h e partier t o discontinue operationr, t b t p r i c e cannot k s e t beyond t h e r e l i m i t 8 i f t h e operationr of t h e buyer o r t h e rellrr a r e not r u p p o t t d o t k m t i r e . An alternative i r to I assume t h a t t h e r t e e l producer can do no wrrr than t h e monopoly solution, and t h a t t h e i r o n o r e producar can do no worse thoa t h e mnoprony ~ o l u t i o ni.e., solving each i n e q u a l i t y for p2  * -k * If mgg ( ~ r o f i tof the buyer h e n q2 i s uned) and mSg ( p r o f i t of the * seller when q2 i s produced) are positive then ( 3 ) provides a narrovcr range f o r bargaining than ( 2 ) . In e i t h e r case the determination of a s p e c i f i c price within the bargaining l i m i t s w i l l depend upon the r e l a t i v e bargaining p o w r of t h e i r o n o r e supplier and the s t e e l consumer. Wash, Shapley and p a r t i c u l a r l y tlarsanyi 1/ (who generalizes the S b p l e y approach t o an n-person game without t r a n s f e r a b l e u t i l i t y ) derive equilibrium solutions t h a t a r e functions of t h e fixed point (iota,here t h e two ranges), t h e s e t of weights and s t r a t e g i e s and the associated payoffs. A similar approach is used here t o deternine iron o r e p r i c e r within t h e h r g a i n i c g limits (2) o r ( 3 ) and the derived p r i c e s from t h e s o l u t i o n of t h e p r o b l w of diacriminat ing monopolist and of discriminating We allow the two t'pliyera", i.e., the buyer and t h e s e l l e r of iron ..., o r e t o s e l e c t t h e i r r t r a t e g i e s on a p r o b a b i l i s t i c basis and we l e t ri rrn be t h e p r o b a b i l i t i e s with which the r e l l e r w i l l employ each of h i s m . s t r a t e g i e s where 0 5 ri51 (i-1, ..m) and ri = 1. The buyer can randomize ill hi. s t r a t e p y s e l e c t i o n of assigning t h e p r o b a b i l i t i e s sj, ..., s, t o h i s ..ld n s t r a t e g i e s , where 0 5 s 1 1 , a 1. t W player8 a r e j j.1 j then concerned with expected returns. The return t o the s e l l e r w i l l be equal -11 See JOY. Friedman, 1999, Oligopoly and t h e Theory of Games, North Holland, Amsterdam, -21 I t .may k sham that in -st cases (2) o r (3) provide a narrower range than that provided from t h e s o l u t i ~ nof t h e problem of the discriminating monopolist o r monopaoniat.  to t h e sum of the p o s s i b l e outcomes where each outcome i s muLtipLied by t h e p r o b a b i l i t y of i t s occbrrence. I f t h e buy r employs h i s j t h s t r a t e g y with a p r o b a b i l i t y of one and the s e l l e r s e l e c t s t h e p r o b a b i l i t i e s r l , ..., r,, t h e s e l l e r ' s expected r e t u r n i s (where a i , i s the s e l l e r ' s return if a i ~i r i s 1 t h e s e l l e r employs h i s ::h s t r a t e g y ~ n dt h e buyer employs his j t h s t r a t e g y ) . The d e c i s i o n problem cf each player is to s e l e c t an optimal a e r cf p r o b a b i l i t i e s . The s e l t e r f e a r s t h a t t h e buyer v i l l discover h i s s t r a t e g y and t h a t t h e buyer w i l l s e l e c t a strategy of h i s own t h a t w i l l maximize h i s expected outcome, i.e., minimize t h e expected r e t u r n of the s e l l e r . The buyer ha8 s i m i l a r f e a r s about t h e s e l l e r . The p r o b a b i l i t i e s vhich t h e two p l a y e r s employ a r e defined as optimal i f and where V is t h e value of t h e t r a d e between t h e s e l l e r and t h e buyer ( i .e., t h e e x p o r t e a r n i n g s of B r a z i l from t r a d e with t h e EEC). The f i r s t r e l a t i o n s t a t e s t h a t t h e seller's expected r e t u r n is a t l e a s t a s g r e a t a s V if t h e buyer employs any of his pure s t r a t e g i e s v i t h a p r o b a b i l i t y of one. The second r e l a t i o n s t a t e s t h e buyer's expected l o s s is a t l e a s t as small as V i f t h e seller employs any of h i s pure s t r a t e g i e s with a p r o b a b i l i t y of one. A fundamental theorem of game theory s t a t e r t h a t a s o l u t i o n always e x i e t s and  t h a t V i s unique. -1 1 If both "playerr" s e l e c t t h e i r s t r a t e g i e s on a p r o b a b i l i s t i c basis, t h e s e l l e r ' s expected net r e t u r n El and t h e buyer's expected n e t o u t l a y E2 can be shorn t o be which proves t h a t Regardless of t h e o t h e r " p l a ye r ' s w choice, i f t h e buyer O F t h e u e l l e r employs h i s optimal p r o b a b i l i t i e s , hi:^ expected o u t l a y and r e t u r n w i l l not be l e s s o r g r e a t e r than V , r e s p e c t i v e l y . I n the following c h a p t e r we w i l l uue r e l a t i o n ( 4 ) to estimate f u t u r e expected returns. A number of uitnplifying assumptions r e g a r d i n g t h e intertempor.sl fcrm of t h e two p l a y e r s ' p r o b a b i l i t y d e n s i t i e s and t h e i r i n t e r r e l a t i o n s h i p w i l lmake t h e e s t i m a t i o n of expected r e t u r n s and t h e i r o n o r e r e f e r e n c e p r i c e possible. 111.2 Node1 Linbger Figure 1 and Table 8 present t h e flowchart and t h e s t r u c t u r e o f t h e i r o n o r e model, r e s p e c t i v e l y . The i r o n ore p r i c e ( B r a z i l i a n s i n t e r f i n e s 65% Fe CIF otterd dam) is t h e outcome of bargaining between Brazili&-8 and European r e p r e s e n t a t i v e s . Each p a r t i c i p a n t d e s i r e s d i f f e r e n t p r i c e s (P1 and P2). These -11 See, i n t e r a l i a , J. R o s e m u l l e r , 1981, The Theory of Games and Xarkets, North Holland, AMterdam.   Consuape ion C i = f2i(~*i' Pli' eaci Psi, Pni) Prices P1- EH if P1>PJ and P2<P4 then conthued...  I l o g P = a - 2 Log (P3-P4) + B log S Iq* i f P3 2 P1 and P4 5 P2 then I t log P n y - 2 log (P1 - P2) + 6 log S /Qg i r o n o r e nominal o r e f f e c t i v e capacity f o r country i i r o n o r e output f o r country i Brazilian i r o n ore output crude s t e e l output f o r country i crude s t e e l output f o r EEC i r o n o r e reference price . export iron o r e price f o r country i import iron o r e price f o r country i r e n t a l p r i c e of c a p i t a l i n iron o r e operations i n country i petroleum p r i c e i n iron o r e operations i n country i GDP d e f l a t o r of country i p r i c e s of other than i r o n or+ and scrap p r i c e r i n t h e steel product ion process i r o n ore apparent consumption f o r country i continued...  = i r o n o r e apparent consumption f o r EEC CE PSCi = price of scrap in country i e l p o r t s of i r o n cre i n country i 'i = 'i = imports of i r o n ore i n country i ' = e x p o r t s of B r e t i l i a n i r o n o r e 13 'E = imports of i r o n o r e o f EEC c o u n t r i e s = average wholesale s t e e l p r i c e s i n EEC Ps = "desired" iron ore price of Brazilian iron ore producers (rolution P1 of d i s c r i m i n a t i n g monopolist problem) = "desired" iron o r p r i c e of EEC s t e e l mills ( s o l u t i o n of P2 d i s c r i m i n a t i n g monopronist problem) = i r o n o r e p r i c e t h a t w i l l not put (major) i r o n o r e producers o u t of P3 b u s i n e s s % = i r o n o r e p r i c e t h a t w i l l not put Continental Europe's s t e e l mills P4 o u t of business OC = c o s t s of s t e e l production o t h e r than i r o n o r e i n C o n t i n q n ~ 5 1Europe a , f l , y , b , ~ ' , ~ " = parameters r e l a t e d t o p r i c e formation E,H,A = parameters r e l a t e d t o marginal revenue and marginal c o s t of B r a z i l i a n i r o n ore producer N, L = parameters r e l a t e d t c marginal product and marginal c o s t of EEC steel mills Zbi, Z7i= exogenous variables = ei exchange r a t e of t h e currency of country i with r e s p e c t t o t h e US$.  two d e s i r e d p r i c e s a f f e c t t h e outcome of t h e n e g o t i a t i o n s . The agreed s i n t e r f i n e s p r i c e (PI becomes t h e benchmark f o r a d j u s t i n g o t h e r i r o n o r 2 p r i c e s . Export and import i r o n o r e p r i c e s P , P,) a l s o r e f l e c t changes i n t h e r e f e r e n c e p r i c e . Export p r i c e s i n l o c a l currency serve a s proxier f o r producer p r i c e s . The production o f i r o n o r e (Q), constrained by e f f e c t i v e c a p a c i t y , depends on t h e vhole group of u n i t f a c t o r c o s t s and on t h e p r i c e of o u t p u t . The " price- taker" c h a r a c t e r i s t i c of t h e exporter ( a s f a r a s q u a n t i t i e s a r e concerned), i s r e f l e c t e d i n t h e adjustment of e x p o r t r t o production. The f u n c t i o n of apparent consumption of i r o n o r e (C), ref:ecting t h e p r o f i t maximization process of the s t e e l producer, is a function of r t e e l output, i r o n o r e p r i c e and t h e p r i c e of s u b s t i t u t e s such a1 scrap. Imports a r e determined by consumption ( a f t e r a d j u s t i n g f o r domestic production and e x p o r t s , i f any). The e x p o r t s of B r a z i l t o t h e EEC (by d e f i n i t i o n equal t o t h e imports of EEC from B r a z i l ) a r e influenced by not only t h e t r a d e p a t t e r n s of Brazil and t h e EEC but a l s o by the expected demand and supply of iron o r e i n t h e p a r t i c u l a r year. B r a z i l i a n e x p o r t s t o t h e EEC a f f e c t B r a z i l i a n i r o n o r e revenues and c o a t s and EEC s t e e l production c o s t s . The e q u a l i t y between i r o n o r e producers* marginal c o s t and marginal revenue determiner t h e " desired" B r a z i l i a n i r o n o r e p r i c e (PI) and t h e e q u a l i t y between steel producer's marginal revenue of a d d i t i o n a l u n i t e of i r o n o r e and t h e i r marginal c o s t determines Continental Europe's " desired" i r o n o r e p r i c e (PZ). The n e g o t i a t e d i r o n o r e p r i c e (P) is determined w i t h i n t h e boundary p r i c e s , P1 and P2. The p r i c e (P) s a t i s f i e s a l s o t h e c o n s t r a i n t t h a t none of t h e major i r o n o r e  producers nor Continental &mop8 s t e e l producerr w i l lgo out of business, Lee., P4 5 P 5 Pj. With the exception of Brazil m d the neven EEC countries, a l l other countries are treated in the same way. Each country has i t s own potential output, actual output, export#, imports, apparent consumption and price functions. The model recognizer 30 countries and regions.  IV.1 Iron Ore Product ion Actual o u t p u t f o r each country i s derived through p r o f i t m x i m i z a t i o n of t h e i r o n o r e producer s u b j e c t t o h i s production function. Prom t h e theory of t h e f i r m we have: r e a l f a c t o r c o s t ( i t h f a c t o r ) = mdrginal p r o d u c t i v i t y ( i t h f a c t o r ) o u t p u t = f ( e f a c t o r i n p u t s ) where f a c t o r c o s t i 'i = P = producer p r i c e of i r o n o r e hi = i n p u t i Q = i r o n o r e output From ( 1 ) we have 11 and a f t e r a u b a t i t u t i o n of each of t h e xi f u n c t i o n s i n t o t h e production C f u n c t i o n we g e t -1/ The marginal p r o d u c i i v i t y f u n c t i o n s are assumed i n v e r r a b l e .  Q =