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Miners’ Iron-Ore Pricing Evolution Curbs Demand for Swaps Trade

Demand for iron-ore swaps has dropped following this year’s shift away from a four-decade old pricing system toward shorter-term contracts and a lack of interest from steelmaking consumers of the ore, analysts said.

“The system has changed, there is no going back and I think the bottleneck is: the steel mills don’t really understand or want to use swaps at the moment,” said Jim Lennon, executive director of commodities and mining research at Macquarie Group Ltd. in London. Uptake of swaps will “take time,” he said.

The world’s biggest iron ore exporters this year scrapped a custom of pricing cargoes in 12-month periods, replacing it with quarterly contracts based on the average price over three months. More iron ore is shipped across oceans than any other dry bulk commodity, with the market forecast by Credit Suisse Group AG to total 1 billion metric tons this year.

Deutsche Bank AG and Credit Suisse started offering iron-ore swaps in 2008 as a means for market participants including producers, mills and consumers to lock in prices, reducing the risk of market fluctuations. Trade in the derivative contracts was 40 percent lower in September than in April, according to data from SGX AsiaClear, the securities and derivatives exchange of Singapore Exchange Ltd.

Missing Liquidity

“What’s missing at the moment on the derivatives market right now is liquidity,” Michael Widmer, head of metal markets research at Bank of America Merrill Lynch in London, said at a conference in the city yesterday. “An evolving pricing system on the physical market is clearly not conducive” to boosting demand for swaps, he said.

Swaps peaked in April with 4,436 lots traded for a volume of 2.2 million tons, according to SGX Asiaclear data posted on its website. The volume for September was 2,682 lots, or 1.3 million tons, the data show.

“We’ve sort of plateaued recently and I guess some people are arguing: is this a sign that there are fundamental issues, and I’d argue definitely not,” Ray Key, Deutsche Bank’s global head of metal trading, who helped develop the swaps product, said yesterday at the same conference. “There is a major battle going on and the psyches of the steel mills, the producers and the end consumers are grappling with these issues.”

Quarterly prices are calculated based on the average price over the preceding three months with a one-month lag. Contract prices fell 11 percent to $129 a ton in the quarter that began Oct. 1 from the previous three months, said Hu Kai, an analyst at, citing Platts index prices.

Raw-Material Costs

The China import price rose 0.2 percent to $141.40 a ton yesterday, according to The Steel Index. Steelmakers use about 1.6 tons of iron ore and 0.5 tons of coking coal to make 1 ton of steel. Raw materials account for as much as 75 percent of production costs for mills, according to JPMorgan Cazenove. Vale SA, Rio Tinto Group and BHP Billiton Ltd. are the three biggest exporters.

The current pricing situation is “a half-way house driven by the desire by the steel mills not to hedge, they don’t want to be involved in it,” Macquarie’s Lennon said yesterday. “We’ve got to get the steel mills and the industry involved in understanding how to use these tools.”

ArcelorMittal, the world’s largest steelmaker, last week said it isn’t relying on forward contracts and is looking to share price volatility with customers. ThyssenKrupp AG, Germany’s biggest steelmaker, said in April it was “developing instruments” to hedge iron ore supplies and reduce the effects of swings in prices.

Enforced Change

“There are fierce debates going on between steel mills, the auto sector,” Deutsche Bank’s Key said. “One way or the other, there is going to be a change forced upon someone. Regardless of how it goes, people are going to start hedging because they need to.”

BHP, the world’s biggest mining company, said last week it expects a shift toward monthly pricing accords as they better reflect the market and the needs of producers and consumers. Rivals Vale and London-based Rio last month voiced different views on a switch to shorter contracts.

“We’ve had really quite an amazing change in the way that the market works, particularly physically and of course we are still within the transformation,” Kamal Naqvi, director of commodities at Credit Suisse, said yesterday. “There really is no other commodity that is embedded in the outlook for industrial demand more broadly than iron ore.”

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