July 2012 could be a record breaking month for iron ore derivatives as market players look to cope with freefall in spot prices
July 26, 2012. Freight Investor Services, one of the pioneers of iron ore swaps and iron ore options, analyses the recent price movements in the physical iron ore market and their effect on iron ore derivatives.
What is happening to iron ore prices?
Over the past two weeks, iron ore spot prices (62% Fe content, delivery China) have slumped by over 13 per cent to stand at $117.30/tonne (according to The Steel Index), the lowest level for nine months.
Why is this happening?
Steel demand from users such as the construction sector in China has slowed and steel prices have fallen as the hot summer and a challenging economic environment take their toll on the market. A record volume of almost 102 million tonnes of iron ore inventory has built up at China’s ports.
How has this affected the swaps market?
Swaps trading volumes have increased dramatically, with swaps cleared via the Singapore Exchange reaching 7,210,000 tonnes so far in July. High volume trading for the rest of this week should ensure a new monthly record, which currently stands at 7,676,500 tonnes via SGX for May 2012.
How low could prices go?
At the end of October 2011, prices fell below USD 117 per tonne before rebounding. Current levels appear to represent a point where some Chinese production becomes uncompetitive, and in the past this has led to import substitution, causing international prices to stabilise. However with an apparent oversupply of steel in China and weak demand elsewhere, this is not guaranteed.
Chinese steel production totaled 356.2 million tonnes in the 1H12, a rise of just 3.4 Mt over the 1H11. Any further falls in steel prices over the next few months could see China struggle to reach recent estimates by US consultancy World Steel Dynamics of 715-725 million tonnes for the whole of 2012.
What can I do about it?
Margins for both steel mills and iron ore miners are under severe pressure from falling steel and iron ore prices. There has never been a better time to use derivatives to protect against price risk. Using iron ore swaps enables traders to secure prices in the forward market to hedge their physical exposure, even though swaps are cash-settled with no physical delivery. Contracts may be traded on the FIS CLICK screen with broker support and straight-through processing to clearing houses NOS, LCH and SGX.
Source - FIS
(www.steelguru.com)
