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FOCUS: Liquidity begets liquidity, with SGX's 65% Fe iron ore contract seeing record open interest, traded volume.

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August 05, 2019  

The 65% Fe iron ore derivative contract offered by the Singapore Exchange (SGX) registered record levels of open interest and monthly traded volumes in July 2019, with the contract seeing participation from a diverse set of physical and financial stakeholders in the iron ore value chain. 

Open interest for the contract, which is settled on the basis of Fastmarkets’ index for iron ore 65% Fe Brazil-origin fines, cfr Qingdao, was 1.95 million tonnes on Tuesday July 30, with traded volumes reaching 2.12 million tonnes in July, according to SGX data. 
The traded volume and the open interest were at their highest levels since the contract was launched on December 3, 2018. 
The contract has been traded by more than 50 market participants since launch. These include physical hedgers, bank traders and financial market participants, according to the SGX. 
The contract was launched amid calls from the market for efficient risk mitigation tools for the iron ore market. The SGX sees the contract’s popularity lying in its ability to serve as a tool providing a more precise hedge for the high-grade ore segment. 
SGX also offers the market an ability to hedge their exposure to other grades and segments of the iron ore market, through its mid-grade, low-grade and lump derivative contracts. 
“Market participants have been trading the 65%-62% Fe iron ore spread as a proxy to [Chinese] steel mills’ margins, which have been volatile on strong iron ore prices,” the SGX said. 
“The contract also serves as a tool for those who wish to express their views about the effects of environmental controls in China on the grade differentials,” the bourse added. 
The contract is the world’s first high-grade iron ore derivative, and the improving volumes and open interest associated with it augur well for its adoption by the wider iron ore market, according to market participants. "The recent spike in trading interest for the 65%-62% Fe spread has come on the back of increased volatility after the premiums fell by 30% through July," Sidharth Aggarwal, Anglo American's manager for market analysis and strategy, told Fastmarkets. 
Long-term prospects for high-grade iron ore demand from China remains positive, he said.  
"While the near-term upside may be limited on looser production cuts in China, long-term prospects remain positive on structural flight to quality. The Chinese steel industry continues to transition toward bigger blast furnaces amid rising capacity utilization levels. Further, the industry consolidation will see the share of the top 10 steelmakers nearly double to 60%, and the implementation of supply-side reforms in the Chinese coke sector will drive up demand for premium metallurgical coal, boosting consumption of high-grade iron ore," he said.  
“There is no question about the usefulness of such a contract in providing a clean hedge for those with exposure to the high-grade segment, and in providing a transparent forward curve to the iron ore market,” Sashi Kiran Anumula, managing director for metals and bulk commodities at Macquarie, told Fastmarkets. 
The rise in traded volumes followed a period of supply tightness for the iron ore market amid suspension of some mining operations by Brazilian producer Vale and disruption to Australian shipments following the effects of Cyclone Veronica. 
Some of the supply concerns eased in June, however, when Vale announced the resumption of its Brucutu operations and the partial return of dry processing at its Vargem Grande complex, accounting for around 35 million tonnes per year of production. 
Around 93 million tonnes of the miner’s production was affected by the suspension of some of its operations earlier in the year. 
Vale said recently that, of the 50 million tpy of its production that is currently under suspension, it expects that about 20 million tpy of dry processing production will be resumed before the end of this year. 
The remaining 30 million tpy, which includes wet processing, is estimated to return to normal operations in about two or three years’ time, it added. 
The narrowing of grade spreads has been the standout trend for the iron ore market over the past two months, amid persistent tight availability of mid-grade ores and mills’ cost-consciousness. 
The narrowing of grade spreads has resulted in many steel mills opting for a blend of high-grade Brazilian ore and lowgrade ores from Australia and India, for efficient blast furnace operations and cost benefits, according to market sources. 
This preference among some Chinese buyers has fueled the uptake of low-grade Indian iron ore fines by the Chinese market, they added. 
“A lot of iron ore was sold from the [Indian] state of Odisha to China over the past two months, [because of] Chinese buyers’ blending requirements and favorable prices for low-grade Indian ore, given the general rise in iron ore prices this year due to the supply disruptions,” a seller source from India said. 
Even while many market participants acknowledged the value of using a high- and low-grade blend as a cost-effective combination in the current market, some said that Chinese mills were still showing inertia in terms of replacing the midgrade ores in their blast furnaces. 
“There is always resistance among Chinese mills to replace or lower the proportion of Pilbara Blend [PB] fines in their blast furnace burden, and the stocks of PB and even Newman fines are not that high at the ports,” a trader source said. 
Much of the iron ore market is now focused on production restrictions that affect steelmaking operations in China, especially in the weeks leading up to celebrations of the country’s 70th anniversary in October. 
October-March is also the period when Chinese policy dictates the severity of the steel production cuts in the country in response to pollution levels. 
The market is abuzz with rumors that the winter cuts will be lighter this year because of the government’s decision to roll out restrictions on a case-by-case basis rather than taking a broad-brush approach, as was seen in 2017. 
The China Iron & Steel Association (Cisa) told Fastmarkets last month that steel production growth rates will slow down in the second half of this year, amid a narrowing of mills’ profit margins, the Chinese government’s intensified measures to protect the environment, and its sustained focus on steel supply-side reforms. 
Cisa also thinks that the government is unlikely to maintain the fixed-asset investment levels seen in the first half of 2019 over the closing six months of the year. 
Uncertainty about policy and Chinese mills’ response to it will continue to be an important driver of grade spreads in the coming months, assuming that this year’s quota of supply disruptions has been exhausted. 
Deepali Sharma