The FT’s Javier Blas is at the forefront of commodities commentary, and every once in a while, his observations that come across our desk (ok, desktop) make themselves worthy of mention.
In this column, Blas spotlights the newest version of a commodities yearbook in which the structural changes in the iron ore and steel markets take center stage. “Cyclope’s World Commodity Yearbook, edited by professor Philippe Chalmin, has been around for more than 25 years. Chalmin, an economics professor at the University of Paris- Dauphine who’s better versed in studying and writing about agricultural commodities and the global food supply, nevertheless makes important points:
“On iron ore, the commodity used for steelmaking, Cyclope’s World Commodity Yearbook calls the changes in the pricing system, from secretive negotiations and annual contracts, to prices linked to the spot market and quarterly contracts, a Ëœtrue revolution,’ Blas writes. He continues, “it also highlights that although many ignore the commodity on the belief that the world emerged from the ËœIron Age’ some time ago, iron ore is important.
For all you steel buyers out there, the above sentiment is one that you know all too well. While this “commodities Bible stands “bullish-to-neutral on metals, the question for all of us becomes how to play the markets to suit buying needs, i.e. hedging against risk and volatility. This hinges on the “true revolution, as the Yearbook puts it, of the contract pricing system change.
Indeed, price volatility is at the center of how iron ore contracts have and continue to evolve. The consensus on the quarterly pricing system (on the steel producers and buyers side) seems to be that although they accept it, they do so grudgingly. Steelmakers worldwide have consistently voiced their opinion that the more frequent pricing schedule simply contributes to Vale/Rio/BHP’s profits and allows them to keep renegotiating (read: raising) premiums.
Although there’s been talk of the Big Three miners switching over to monthly contracts, Vale’s come out and said recently that they’ll stick to quarterly although they are creating a new pellet premium pricing formula, which serves as a conversion premium.
The general iron ore price forecast looks like it may remain on the high side, as per Stuart’s recent assessment on Chinese iron ore consumption:
“Much of the case for falling prices seems to center around rising supply, but many analysts are beginning to question whether firms are going to be able to raise supply that much that fast. Vale has recently reduced its production forecast for 2015 by 10 percent due to new project delays.
So with raw material prices rising and mining delays getting longer/more frequent/more widespread, is there anything that can be done to remedy the elements of quarterly contract pricing that aren’t working?
If one is to take Brad Clark’s recent argument on these virtual pages, there are more opportunities now than ever to hedge against risk in every aspect of the steelmaking process via derivatives and swaps. For those with exposure to iron ore or coking coal buys, he writes, you can lock in your input costs via these specific swaps. (Credit Suisse and Deutsche Bank released Iron Ore Swaps in spring 2008, Goldman Sachs began trading them earlier this year, while the CME just released the Australian Coking Coal Swaps contract on July 25.)
In terms of iron ore, will the Big Three move to monthly contracts next? Only time will tell, but in the mean, there are more tools and solutions being introduced every day to help companies cope with market price volatility and risk. We’ll keep eyes and ears peeled, and you should do the same.