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Iron Ore Peak with Designs on a 30% Decline

Commodity Critic: Where Is the Iron Ore Price Heading?

Commodities Trading - Credit Risk

Alan Chong

Commodities

The Chinese government has recently allowed foreign investors to trade iron ore futures on Dalian Commodity Exchange (DCE) in May 2018 and deployed a senior official from the China Iron and Steel Association (CISA) to advocate the use of more index based pricing (DCE being one of the few) for fairness and transparency (at the Singapore Exchange iron ore week conference two weeks ago). According to market sources (Argus and Platts), CISA has been in negotiations with the world top four mining companies ( BHP, Vale, Rio Tinto and Fortescue) to bring about a change in the way iron ore is priced. These signals lead us to believe the government plans to assert more control over iron ore pricing.If only demand and supply can easily determine the direction of iron ore prices, China, being the largest seaborn iron ore importer would have been able to steer prices in their favour. China has long objected to the pricing strength enjoyed by the large global mining companies, with steel mills largely accepting long-term contracts based on a dominant reference index.We argue that a state-led market economy is the largest obstacle for international market to adopt and accept a China-based index. The success is not just about the volume of iron ore China consumed annually but we think investors would rather be cautious with the following about China:(1) Lack of policy transparency;(2) FX risk, as iron ore traded on DCE is RMB denominated and settled;(3) Stability of the trading/reporting system; and(4) The dominance of a few individual speculators in the derivatives market that could result in speculative trading and huge price swings (as reported in Nikkei Asia Review on 1 May 2018).

The Chinese government has recently allowed foreign investors to trade iron ore futures on Dalian Commodity Exchange (DCE) in May 2018 and deployed a senior official from the China Iron and Steel Association (CISA) to advocate the use of more index based pricing (DCE being one of the few) for fairness and transparency (at the Singapore Exchange iron ore week conference two weeks ago). According to market sources (Argus and Platts), CISA has been in negotiations with the world top four mining companies ( BHP, Vale, Rio Tinto and Fortescue) to bring about a change in the way iron ore is priced. These signals lead us to believe the government plans to assert more control over iron ore pricing.If only demand and supply can easily determine the direction of iron ore prices, China, being the largest seaborn iron ore importer would have been able to steer prices in their favour. China has long objected to the pricing strength enjoyed by the large global mining companies, with steel mills largely accepting long-term contracts based on a dominant reference index.We argue that a state-led market economy is the largest obstacle for international market to adopt and accept a China-based index. The success is not just about the volume of iron ore China consumed annually but we think investors would rather be cautious with the following about China:(1) Lack of policy transparency;(2) FX risk, as iron ore traded on DCE is RMB denominated and settled;(3) Stability of the trading/reporting system; and(4) The dominance of a few individual speculators in the derivatives market that could result in speculative trading and huge price swings (as reported in Nikkei Asia Review on 1 May 2018).

Commodity Critic:  China’s Power Assertion over Iron Ore Pricing