The annual battle to settle iron ore prices appears to be heading towards deadlock, but exchanges are quietly looking at developing contracts that could change the way the industry sets prices.
Analysts tipped the Singapore Exchange as most likely to be first to carry an over the counter iron ore contract, which would create a more transparent pricing mechanism for the more than $200 billion industry and let some of the heat out of what some see as over-inflated spot prices.
"The dynamic in the iron ore market is changing from one dominated by long-term supply contracts, to the point today where rampant demand has created a viable spot market," ANZ's senior commodities analyst Mark Pervan said. "What has accentuated the need for a contract, especially in Asia, is the increase in freight spreads for iron ore from producers in different parts of the world," he added. Earlier this year, Chinese steelmills settled annual contracts with Brazilian miner Vale at levels 67 to 71 percent up from last year.
But they are yet to settle with Australian miners who argue that the lower cost of freight from Australia to China, versus Brazil to China, should be reflected in higher prices for Australian material, a sticking point for the Chinese.
The freight differential has always been there, but has been given extra prominence by a 1,100 percent rise in the Baltic Dry Cargo Index in the past six years.
Last month Deutsche Bank launched an over-the-counter iron ore contract and the bank said exchanges were looking at developing their own.
"A number of exchanges will be looking into some form of iron ore contract. There is a lot of demand for this kind of product, which we are already seeing in our newly launched OTC iron ore product," Raymond Key, Global Head of Metals Trading at Deutsche Bank said.
Traders in London, Sydney, Singapore and Hong Kong report talk that an Asian exchange may announce something late in the third quarter, and although there is no definite word, Singapore is the hot pick to be first.
"Singapore seems like a viable centre. It's the gateway between Asia and the Pacific basin. The Australians will want a stable and well-developed exchange and importantly, Singapore is also BHP's big marketing hub in Asia," a trader in Sydney said. Other exchanges mentioned that might be interested in iron ore contracts included Hong Kong and Mumbai.
"Hong Kong may be sniffing at iron ore, but it's Singapore that I think is probably furthest along," a source at an international trading house based in the city-state said.
"They already offer a freight contract and it wouldn't be too hard to develop iron ore, and even coal contracts along similar lines," he added.
A spokesman at the Singapore Exchange would not confirm that the organisation was considering iron ore.
"As and when we have new products, we will make the announcements," he said
India's National Commodity and Derivatives Exchange seemed to rule itself out.
"Launching iron ore contracts in India may not be fruitful. The iron ore exported from India has different specifications so standardising a contract for futures trade is very difficult," said Ramesh Iyer, vice president, metals at the Mumbai exchange,
And the London Metal Exchange also seemed an unlikely winner.
Deutsche's Key said: "I don't think the LME is in the running. The system they use with its physical warehouse delivery points isn't well suited. This product will need to be cash settled."
He also noted a contract in Sydney would receive a lukewarm response from Chinese buyers, already worried about Australia's dominance in iron ore production.
Irrespective of who wins, a contract is likely to find broad interest from hedge funds, who want to try and cash in on the spectacular run up in iron ore prices, as well as producers.
"In principle, we support transparent market pricing mechanisms and we will evaluate their use as they are developed," BHP Billiton spokeswoman Samantha Evans said.
The steel industry has show little interest in exchange traded contracts. The LME's recently-launched steel contracts have seen turnover stall at around 10 lots a day for the three-month benchmark Mediterranean and Far East contracts.
ANZ's Pervan said that an exchange contract would benefit Chinese steelmakers, who worry that the dominance of the iron ore market by three players, Vale, BHP Billiton and Rio Tinto gives miners an unfair advantage.
"A contract would quickly narrow the spread between the spot and long term prices and that would benefit the Chinese and result in more sensible prices," Pervan said.
But an official at China's number one steel maker, Baosteel, said the company was not interested.
"Baosteel will not trade there, especially in the early stages. But small mills might consider it," he said.
Source: Reuters
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