In the early days of iron ore’s derivatives market development, the Singapore Mercantile Exchange (SMX) was one of the first exchanges to offer a futures contract, based on Metal Bulletin’s 62% Fe index in 2011.
The Singapore Exchange (SGX) also launched a low-grade iron ore contract settled against Metal Bulletin’s 58% Fe Premium Index in 2015 to complement its established mid-grade offering.
Major Brazilian iron ore miner Vale recently announced that it would move to base 100% of its Carajas fines exports on Metal Bulletin’s 65% Fe Brazilian Index (MBIOI-65-BZ), having already been pricing the majority of its volumes this way for several years. The company is also a key user of Metal Bulletin’s 62% Fe Iron Ore Index (MBIOI-62) for its mid-grade products.
The days of the annual “mating season” - when steelmakers and major iron ore miners would play brinkmanship over who would give way first over setting an annual iron ore price - are long over.
New spot market indices that reflect the “price of the day” are the new reality, and have also opened up the opportunity for price-risk management through exchange-based, and sometimes over-the-counter, contracts and swaps.
For example, the daily, weekly and monthly indices are listed because of the varied liquidity displayed by different parts of the market.
Sinter fines and lumps make up the bulk of the seaborne iron ore market, and are the products most frequently traded on a spot basis, so daily pricing is used for the key 62% Fe, 58% Fe and 65% Fe fines, and lump premium references.
By contrast, the beneficiated ore segment - comprising pellet and concentrate - is smaller in terms of both volume and liquidity, and weekly indices are therefore more appropriate.
Iron ore is a non-fungible commodity, and its quality varies. To help facilitate price adjustment for differences between expected and delivered product specifications, PRAs have developed value-in-use (VIU) indices for the key price-affecting chemical components of iron ore - iron, silica, alumina and phosphorus.
Metal Bulletin’s VIU indices are calculated by analyzing price and specification data of spot market transactions over the course of a month, so they are published on a monthly basis.
Metal Bulletin’s iron ore indices are all tonnage-weighted average calculations of observed and reported market activity within a specified data collection window (e.g. 24 hours, five days, one month).
Being a variable commodity, prices are normalized back to index base specifications by using coefficients derived from statistical analysis of prior index data. Metal Bulletin incorporates a unique sub-index approach in its iron ore indices, which mathematically ensures a balanced impact from all parts of the market - producers, consumers and traders - on its prices.
Different percentages of iron content reflect both the natural variation in iron ore grades found in mine deposits and the degree of processing (if any) employed to upgrade the ore for a certain use. In general, higher purity ores help increase hot metal yields in the blast furnace, and also lower production cost by reducing the amount of coke required. For these reasons, the rule of thumb is “higher Fe grade, higher price.”
Iron ore also differs in physical form. Fines require sintering (agglomeration into crude pellets) prior to use in the blast furnace. Lump ore can bypass this process and be charged directly into the furnace, as can pellets, and both command an associated price premium. Most steel mills use a blend of different grades of ore, and a mix of sinter, lumps and fines, but the quality requirements depend on the circumstances and availability.
For example, ore used in the direct-reduction process to make direct-reduced iron (DRI) or hot-briquetted iron (HBI) destined for melting in an electric-arc furnace (EAF) needs to be of much higher grade than that fed into a blast furnace. Prices vary accordingly.
The relative preference for different ore types depends on market conditions, and the differentials between the various iron ore indices are very dynamic. Perhaps the biggest driver of all is the profit margin that steelmakers are achieving - defined by the price at which they sell their steel minus the costs of their raw materials inputs.
When margins are high and mills are profiting from each tonne they produce, they prefer to use high-purity ores to maximize their blast furnace yield. Inter-grade price spreads tend to expand during these times, and high-grade indices such as the MBIOI-65-BZ and Metal Bulletin 66% Fe Concentrate Index (MBIOI-CO) usually extend their premiums to the MBIOI-62 and Metal Bulletin 58% Fe Iron Ore Index (MBIOI-58). Conversely, when margins fall away, mills look to the cheaper low-grade ores to reduce costs and minimize their production rates.
Blast furnaces cannot easily be switched on and off, so a shrewd approach to iron ore purchasing is needed to optimize their operating rates for different market conditions.
Consumption of iron ore products can also be constrained by the end-use application that the steel producer is designing its product for. Typically, higher-grade flat steel products require higher-quality raw material inputs with lower impurities to ensure that they are applicable to the end-product they are used in.
Therefore, although some steel mills have become experienced in adapting their melt mix to accommodate for volatility in raw materials markets, others are more constrained by their customers as to how much they can mitigate severe market volatility.
More recently, at least in China, environmental policy has become a key driver of prices across the iron-ore grade spectrum.
Again, as a rule of thumb, lower-grade ores with higher fractions of impurities such as silica and alumina require increased consumption of coke, which can raise emissions of controlled gases and particulates.
The sintering of fine ores can also be a polluting process, and mills under environmental constraints may favor direct-charge ore such as lumps or pellets.
China’s 2016 update to its Environmental Protection Law enforces stricter caps on industrial pollution, and has increased the appetite for higher purity ores.
To put these drivers into perspective, the higher mill profit margins and increased environmental restrictions that have come with China’s recent industrial reforms have driven the gap between the MBIOI-62 and the MBIOI-58 to experience a fourfold expansion in percentage terms (sevenfold in dollar terms) between the start of 2016 and the start of 2018.
Over the same period, the premiums commanded by the 65% Fe and 66% Fe indices over the MBIOI-62 have also risen to record highs.
China’s aforementioned industrial reforms post-2016 have encompassed capacity reductions, elimination of illegal substandard steel and tougher restrictions on pollution.
The result has seen much wider and more volatile differentials between iron ore indices of different grades, and companies exposed to prices such as the high-grade MBIOI-65-BZ and MBIOI-CO are now calling for exchanges to list contracts settled against those indices to help manage price risk, with the basis risk to the 62% Fe financial benchmark deemed unmanageable.
The shift to indexation following the final demise of the annual benchmark pricing system in 2010 came with an implicit expectation that iron ore might be able to become a more commoditized traded product - represented by the composite 62% Fe index as a market mid-point.
But it soon became obvious that the 62% Fe index could not serve to reflect the incredibly varied range of products. Negotiating premiums and discounts to this benchmark mid-grade index is like aiming at a moving target, with spot prices for different grade segments marching to the beat of their own drums.
One after another, indices for lower grades, higher grades, concentrate, pellets etc. were launched to facilitate product-aligned pricing.
Today’s iron ore market participants trade their products with a wider array of indices than ever before, and this trend in index diversification is still progressing.
In a more recent innovation aimed at facilitating simpler, more accurate valuation of individual products relative to indices, Metal Bulletin is looking to publish differentials that represent the value that particular iron ore brands achieve relative to the MBIOI-62 on a daily basis.
The implementation of product differentials depends on the frequency that each product trades on the spot market on a transparent basis. Metal Bulletin considers transparent trades to be those done on trading platforms such as Global Ore and the Beijing Iron Ore Trading Center Corp (Corex), or by tender.
Based on the number of transparent transactions seen in the spot market, Metal Bulletin has decided to start publishing the differential that 62% Fe Pilbara Blend fines achieves on a spot basis relative to the MBIOI-62. Metal Bulletin will also seek to replicate this for other more liquid spot market products.
The calculation of the differential is the tonnage-weighted average of transparent transactions of the particular product on a given day, minus the MBIOI-62 on that day.
The MBIOI-62, with the published differential, would represent the actual value of products traded in the spot market on that day.
In the absence of trade, the product differential is maintained until another transparent trade is observed. When the differential remains unchanged, the implied product value will continue to move with the underlying movement in the MBIOI-62.
Looking forward, Metal Bulletin aims to continue providing the market with the necessary tools to achieve fair and transparent iron ore valuation, and to link long-term contract volumes to spot market price demonstration.
As market forces have driven wider spreads and lower correlation between prices for different grades of iron ore, Metal Bulletin expects that the trend toward increased granularity and product-aligned pricing will continue - particularly at the high end of the grade spectrum.
Metal Bulletin recognizes that the evolution of the iron ore market’s pricing mechanisms following the end of the annual benchmark system are still ongoing, and remains committed to its role of providing price transparency where possible in response to market demand.
This article was first published in the June issue of Metal Market Magazine, which carries in-depth feature articles, analyses and reviews of metal and steel markets.