“Iron ore quality depends a lot on geological factors and, unlike copper, it is not a homogenous [product] so therefore it makes sense to have different derivatives for different iron-ore grades,” Shawn Teo, general manager of ferrous raw materials at Mitsubishi Corporation RTM International said.
Although the copper market has some degree of variability with location premiums, the different kinds and grades of iron ore warrant different derivatives’ contracts, Eric Bretting, executive director and senior bulks trader at JP Morgan said.
Much of the conversation surrounding iron ore demand in China - the world’s largest consumer of iron ore - is tied to the country’s macroeconomic health.
Market participants consider copper and iron ore to be proxies for China’s macroeconomic conditions and outlook, although, volumes involving copper derivatives constitute a much bigger proportion of the physical market compared with the ratios in iron ore.
“In the oil market also there are many different qualities and locations where the contracts trade but they are still successful, so I don’t see any reason why [multiple contracts] would not work in the ferrous market,” Bretting added.
The executives made the comments during a panel discussion moderated by Fastmarkets chief executive officer Raju Daswani on Thursday May 9 in Singapore.
Siddharth Aggarwal, manager market analysis iron ore and ferrous trading, Anglo American, also endorsed the need for multiple derivative contracts.
The divergent views regarding grade differentials in the iron ore market is what drives interest in the derivatives’ contracts and makes it more interesting than a more commoditized product like copper, Aggarwal said.
“At the moment, the [SGX] 65% Fe contract has a $15 [per tonne] backwardation, which mirrors the backwardation in the 62% Fe contract, but then there is a structural side of the story in China with regard to the Chinese steel industry,” Aggarwal added.
Aggarwal was referring to market participants’ expectations of Chinese steel mills’ structural preference for higher-grade ore. This would be in line with the government’s environmental protection measures and the steel industry’s consolidation over the last few years while the government attempts to check overcapacity.
China’s supply-side reforms in the coke sector to eradicate smaller-size coke ovens will also support demand for higher-grade iron ore in the future, Aggarwal added.
Aggarwal and Teo commented that the 65% derivative contract is useful for market participants exposed to high-grade segments such as pellets, pellet feed, concentrates and even lump products, with Aggarwal adding that the launch of the 65% derivative had widened the user base of derivatives' contracts.
“Value determination has become more complex in the iron ore market for the different segments and, hence, the 65% and 62% contracts are both needed and are complimentary,” Teo said.
Basis risks often outweigh liquidity risks for participants, Janice Kan, senior vice president and head of derivative products, SGX said while explaining the rationale behind the exchange’s launch of the 65% derivative contract last year despite the wide use of the SGX’s 62% iron ore derivative that launched nearly 10 years ago.
The 65% Fe iron-ore derivative contract launched on December 3 and is settled based on Fastmarkets MB 65% Fe iron ore derivative contract.
The contract has had over five million tonnes traded so far, with open interest breaching one million tonnes
Physical demand for high-grade iron ore will also be a function of mills’ profitability, besides environmental factors, in the future, Ji Chao, assistant general manager of Baoshan Iron and Steel said.
“If the Chinese steel industry plans to achieve 80% utilization levels on installed steel capacity, then that capacity utilization is co-related to the [earnings before interest, tax, depreciation and amortization] margins and those margins are co-related to how the premium-grade prices’ move,” Aggarwal said.
Teo agreed with Aggarwal, adding that there was scope for even more consolidation in the Chinese steel industry, which would further the need for efficiency and support high-grade iron ore demand in the long term.
The settlement of the SGX’s derivative contracts basis indices - based on physical market prices - ensures that they are strong tools to use for risk management, Teo added.