OREANDA-NEWS. Iron ore lump typically commands a price premium over fines, primarily because fines must be sintered before being used by steelmakers. Not only can sintering be costly, but it is also one of the most polluting processes in the steelmaking chain. Lump on the other hand can be loaded directly into the blast furnace. Lump is also easier to handle during wet seasons, while liquefaction can be an issue with fines during periods of wet weather.

To date in 2016, the premium paid for iron ore lump has averaged 17.5% of the underlying benchmark fines price (62% Fe-equivalent, CFR China). This compares to less than 16% in 2015, and just 11.3% on average in 2014. Iron ore lump premiums have on average been on the rise. Furthermore, with the Chinese steel industry’s trend towards larger, more efficient and environmentally-friendly blast furnaces which require higher quality raw materials, the relative increase in lump premiums may be structural.  

Evolving lump market seasonality

In past years, the iron ore lump market has been subject to distinct seasonality. During the winter months in China, weather-related supply constraints generally limit availability of domestic concentrate for pelletisation, reducing substitution optionality and lowering price elasticity for imported lump (which typically comprises around 15-20% of the iron ore fed into blast furnaces). However, since the beginning of Q4 2015, lump premiums have not followed their typical seasonal pattern. Moving forward, as the Chinese steel industry’s reliance on imported iron ore continues to rise, the relative impact of weather-related supply constraints in the domestic iron ore market may be more limited than in the past. Separately, more stringent environmental requirements, periodic mandatory output restrictions and challenging credit conditions in the Chinese steel industry pose potential to drive near-term volatility over price premiums. In short, seasonality in the iron ore lump market is evolving, and short-term price fluctuations are becoming more unpredictable.

Managing basis risk with lump premium derivatives

Rising quality premiums for lump have resulted in higher basis risk between iron ore fines and lump prices. SGX iron ore lump premium derivatives provide effective hedging tools for participants in the global iron ore lump market, particularly in light of rising relative premiums and evolving seasonality. SGX has cleared over five million tonnes in iron ore lump derivatives since launch on 31 Aug 2015.