Iron ore derivatives traders seek more hedging options

Iron ore derivatives traders on Singapore-based exchange SGX want more hedging tools, including a 65pc Fe contract, and welcome the internationalisation of Chinese futures, which will create more trading opportunities.

UK-South African mining firm Anglo American and its customers would like to have a 65pc Fe contract on SGX that would allow them to manage risk better, Anglo American head of ferrous trading Andrew Glass said at the SGX iron ore conference today.

Most seaborne iron ore derivatives trade is on the SGX and nearly all of it is for 62pc Fe fines, with minor amounts for lump premium products. With high-grade ores becoming more prevalent in the market, 65pc indexation has a future, Glass said, echoing a consensus view at the conference that anti-pollution policies and supply-side reforms in China are supporting long-term demand for high-grade ores. The difference with a previous, failed effort to launch a 58pc contract is that the market did not embrace physical pricing off a 58pc index, Glass said.

Anglo American's options to reduce basis risk for 65pc ores are limited. "Right now there is very limited capability to express your opinion and trade around that," Glass said. "You have to do that onshore through very difficult mechanisms. If we were able to have the SGX embrace a 65pc contract for all of those reasons, it would be very beneficial to the industry."

Generic hedging tools are important but basis risk is growing "so we would like to see a lot more price discovery and reference pricing for penalties and different trades of iron ore", Trafigura bulks derivatives trader Tim Read said. The market has started to pay more attention to quality adjustments for Fe, silica, alumina and phosphorus over the last 12-18 months, he said.

China's portside markets are drawing more attention and in some ways are leading to a more multi-tiered market, SGX head of commodities and derivatives William Chin said. "You see a sort of de-commoditisation happening that leads to a more multifaceted view of where pricing should be," Chin said.

The internationalisation of Dalian Commodity Exchange (DCE) iron ore futures, which are a yuan-denominated onshore iron ore contract, could boost SGX trade rather than compete for volumes, participants said.

"The problem with Dalian is that it is isolated on one particular contract," US bank Citi head of iron ore trading Habib Esfahanian said. The internationalisation of the DCE "is going to blow liquidity up in a really big way because they will be able to come to us for larger strips and strategic hedges into calendar years. We will be able to run the basis risk between Dalian and SGX," Esfahanian said.

DCE participants will bring more non-physical players to the market, but physical and cash settlement support DCE and SGX, respectively, to keep the physical and paper markets linked, Glass said. The non-physical traders create volatility, but "that volatility will always converge and that is where the physical guy [with] a deep understanding of the supply and demand component that underpins the physical can trade the paper and see the convergence and benefit", Glass said.