OREANDA-NEWS. September 16, 2015. Following launch on 31 Aug 2015, iron ore lump derivatives have seen a strong start with 340,000 metric tonnes traded in the opening ten days. This period has seen 46 individual trades among a pool of 20 participants, with activity concentrated in the front four months of the forward curve. To put this into context, compared to the launch of the benchmark 62% Fe iron ore fines product in 2009, iron ore lump has seen 33% more volume cleared in the first ten days post-launch.


 

Bringing Down Basis Risk

As shown below in exhibit 2, iron ore lump is to some extent subject to its own seasonality and market dynamics. As a result, the correlation between lump premiums and the underlying fines price is on average very low. Furthermore, over the past two years lump premiums have remained relatively resilient compared to the benchmark iron ore fines price, which has fallen by more than half over the period. The consequence of this is that the lump premium as a proportion of the underlying fines price has generally risen, in turn increasing basis risk for physical market participants seeking to hedge their iron ore lump exposures with just the benchmark 62% Fe iron ore fines products alone. The new SGX iron ore lump derivative contracts provide the solution, significantly reducing basis risk and providing more effective hedging tools for iron ore lump market participants.


 

Robust Demand Outlook

Iron ore lump has a robust demand outlook both in the near-term and, perhaps more importantly, in the medium to long-term as well. Demand for lump imports into China is typically stronger heading into year-end. Seasonally, cold winter temperatures across northern China lead to reduced domestic iron ore concentrate supply (which can be pelletized). With reduced availability of domestic concentrate supply, the demand for imported iron ore lump, a mutual substitute for pellets, can be expected to increase. This seasonality may be observed by the strong contango in the front months of the forward curve (see exhibit 4 below).

In the medium to long-term, market dynamics may also be supportive of seaborne lump demand. With iron ore prices falling substantially in recent years, a growing portion of domestic Chinese iron ore capacity has become uncompetitive and some higher-cost output has been curbed. Our analysis indicates that domestic Chinese iron ore concentrate (on a 62% Fe-equivalent basis) has on average been declining since 2013. In the event that imported iron ore continues to take market share from domestic Chinese output, this may lead to structural growth in the country’s demand for imported iron ore lump. Over the longer-term, depletion of high-grade hematite lump resources may also be supportive of lump premiums, particularly if environmental pressures remain prevalent.