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SGX launched the world’s first high-grade iron ore derivative contract, settled against the daily MB 65% Fe Iron Ore Index published by Fastmarkets MB, on Monday December 3.
The launch followed wide calls from the industry for a suitable mechanism to manage high-grade segment exposure, with grade differentials in iron ore more volatile amid strong mills’ margins and the Chinese government’s targets to reduce emissions.
“If someone sells a [high-grade iron ore] fixed price cargo, and you go hedge that on the 62% [derivative], you are exposed to the premium differential between the 62% and the 65% [prices], and the best you can pretty much do with that is cross your fingers and hope,” Glass said.
“You have already floated the major component, which is better than nothing, but the differentials we have seen this year have been somewhat catastrophic to some participants in the marketplace. Now that we have the ability to go in and hedge on that 65% [derivative contract], you can mitigate so much more of that risk,” Glass said at the 22nd Fastmarkets MB Middle East Iron and Steel conference in Dubai this week.
Alona Yunda, senior analyst with Fastmarkets MB Research, highlighted the increasingly divergent pricing trends of 62% and 65% iron ore fines.
While prices for the different iron ore grades were less volatile in 2017/18 than in 2015/16, they were also more divergent, Yunda told conference delegates.
“Prices for high-grade material and for low-grade material more often moved in different directions…we can see that’s been happening more often recently on a weekly average basis and, notably, pellet prices correlate much more with the 65% Fe benchmark,” Yunda said.
This divergence increases the inherent basis risk that is taken on if hedging a 65% cargo against a 62% contract.
“The more of that basis risk that you can remove, the more stable your business can be as a result,” Glass said, adding that the closer correlation makes the 65% contract the better financial vehicle on which to hedge other high-grade products such as pellets.
The introduction of the high-grade contract is an important step in protecting the entire steel-making industry, Glass said.
“We are extremely passionate about the 65% contract getting listed because it’s something for the whole industry, not just for us, not just for a producer and not just for the mills, it allows us to mitigate that risk away,” Glass concluded.