Iron Ore

Emerging Arbitrage? Iron Ore Swaps vs. Ore Producers

07/15/2009 by Research Reloaded

The iron ore market has been going through some pretty intense growing pains, exemplified by contentious negotiations between companies such as Vale(VALE)/Rio Tinto(RTP)/BHP(BHP) and chinese steel producers, and the actual dentention of some BHP employees by Chinese authorities, on spying charges. More on the sector here.

Nevertheless, it is developing in fits and spurts, away from long term fixed contracts and more towards shorter term market-based repricing. One force in this trend has been the development of iron ore swaps by UK-based shipping broker FIS. Most recently, SteelGuru reported that FIS had broked its first China Iron Ore swaps, aimed at breaking the traditional fixed-price negotiation system which recently has been causing so many problems.

“We are pleased to trade the first ever LCH.Clearnet iron ore swap. We believe that given the rapidly changing iron ore market, more companies will phase out their use of the benchmark price and trade spot, driving the greater use of risk management with derivatives. With only 15% of the 2009 iron ore requirement fixed so far, we are urging the China Iron and Steel Association to scrap the benchmark and embrace greater spot fixing.”

While an early pioneer, FIS is not alone either. Credit Suisse and Deutsche bank set up iron ore swaps last year, and more have joined since.

Obviously this nascent derivatives market has a lot of good uses for industry players. But I think it could open up some interesting potential arbitrage opportunities for institutional investors as well. Any nascent market, especially if difficult to access and with relatively low liquidity, plus volatile pricing swings, is bound to have inefficiencies. For example, going forward an interesting trade to watch would be pricing between iron ore swaps and the stock prices for major iron ore producers such as CVRD, Rio, BHP mentioned above. Something similar might be possible for bulk shipping companies as well.

The Sharp Steel Slowdown in 2009 and Iron Ore Overcapacity 2009-2011

06/29/2009 by Research Reloaded

UNCTAD recently released report forecasting a 15% decline in global steel demand, which comes after a 1.4% decline in 2008. While most of the world is expected to experience sharp declines in demand, even China is expected to see a 5% decline, though in 1Q09 China still eked out 0.8% of demand growth.

 

The global contraction in demand has resulted in extremely low May 2009 capacity utilization levels of 43%, 49%, and 55% for the steel industries in the US, Europe, and Japan. Again, even China, despite its growth, was recently about 78% utlization as per the UNCTAD piece, and via other sources is expected to see capacity utilization in the 70% range this year due to over expansion of steel capacity.

What does the YTD data vs. forecasts tell us? We haven't seen the worst yet out of China. The UNCTAD report implies that most of the 5% decline in Chinese demand should be weighted towards the second half of 2009. The worst is yet to come from China in terms of steel demand, and keep in mind UNCTAD takes note of Chinese government stimulus plans. Falling capacity utilization forecasts fro YTD vs. full year 2009 imply the same.

Understanding the Impact of China on Iron Ore

06/27/2009 by Research Reloaded

In 1990, China imported 14.2 million tonnes of iron ore.

In 2002 it was taking in 112 million tonnes and last year it consumed 443 million tonnes -- about 45 per cent of the world total. That figure is widely expected to be exceeded this year.

While I was first introduced to the massive impact of China on the ore trade back when I first started researching shipping, I thought posting this was a useful factoid to keep in mind. More to come on this later.

Higher Chinese Iron Ore Imports Are Not Necessarily Green Shoots

06/11/2009 by Research Reloaded

I pulled an interesting point from Citi's latest June 10th Iron Ore piece by Alan Heap regarding BHP, Rio Tinto, and CVRD. It is a warning signal for those who see a higher BDI and higher Chinese iron ore imports as a "green shoot".

At one point he explains in the piece, that while Chinese imports of iron ore have been up 25% YTD, Chinese steel production has only been up 3%. What makes up the difference? Falling domestic iron ore production plus some inventory build. Note I have provided links to online sources with similar numbers to what Citi has, just to give some verification beyond the report. 

My addition to the Citi point is that it shows that an increase in Chinese demand for seaborne iron ore doesn't necessarily mean an increase in total Chinese demand. You would want to see steel production increasing in a similar fashion in order to claim that higher Chinese ore imports were a sign of growth. So while other green shoots may exist in the world, higher Chinese seaborne iron ore imports YTD isn't one of them. This also sheds some light on the recent BDI rally and why it may be a fake-out.

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