SINGAPORE July 31 2015 4:30 PM
SINGAPORE (Scrap Register): Singapore Exchange (SGX) and the CME Group together cleared over 118 million tons of iron ore swaps, options and futures by the 29th of July. SGX had cleared over 105 million tons, making it the highest trading volume month on record for the Asia-based bourse. This record volume was recorded in a month which saw significant price volatility for this key steelmaking raw material.
Iron ore derivatives were introduced by the Singapore Exchange in April 2009 and the contracts have seen rapid uptake and continual growth in annual volumes traded during every calendar year. It was only by January of this year that Open Interest at the Singapore Exchange breached the 100 million ton mark for the first time.
By July 29th, SGX had cleared over 105.7 million tons, whilst CME had cleared 12.8 million tons of swaps, options and futures. Their combined volume (exceeding 118.5 million tons) is significant as it annualizes to a figure in excess of 1.4 billion tons, which is the approximate size of the physical global seaborne iron ore market. Many commodities markets see traded derivatives volumes many multiples of the size of the physical market, reflecting the number of times that material changes hands, as well as downstream or adjacent market exposure to the commodity being traded.
Open interest at SGX on the 29th was over 172 million tons, though this typically wanes towards month-end as positions close out.
Option futures stand out as the fastest growing part of SGX’s total volumes, having more than doubled since January (they were only introduced in August 2014). 12 months after launch, volumes are already rivalling those of swaps – the original instrument launched in 2009.
The exchange, which uses The Steel Index (TSI) price benchmark for 62% Fe iron ore fines shipped to China for cash settlement of its iron ore contracts, serves as the leading venue for price risk management for the global iron ore market. Since launch in 2009, the volume of derivatives traded on SGX and other offshore exchanges entering the market in later years, including the CME Group, has more than doubled annually. In 2014, almost 600 million tons of swaps, options and futures were cleared globally, equivalent to almost half of all seaborne physical trade worldwide, and two-thirds of Chinese imports.
“The growing utility of iron ore derivative contracts is a boon to physical actor’s ability to hedge against price volatility for traded cargoes, stock inventory and guard against price erosion for finished steel products” says Tim Hard, TSI Director in Singapore. “However, for the larger ferrous industry to benefit across-the-board, it is crucial that both coking coal and finished steel derivative markets grow in tandem with those of iron ore. Liquid markets for these products will provide the flexibility for steelmakers to properly hedge margins as the global steel industry is entering an uncertain period of shake-out, restructuring and consolidation”.
Miners and hedging
During July’s torrid price movements, one Australian iron ore miner explicitly revealed their ongoing options hedging strategy in an investor note. During the commodity supercycle of recent years, miners have maintained a corporate position of being ‘unhedged’, in order to provide shareholders with direct exposure to commodity price movements. But with prices now falling amid oversupply, bringing spot prices closer to breakeven levels for some miners, and hedging strategies are now increasingly important – not just for the producers, but also banks financing them.
With derivatives volumes rising so that the physical market can be hedged ton for ton, it will be interesting to see whether hedging moves beyond a strategy primarily employed by traders and end-users. If it does, there is an opportunity for basis risk to be negated along the supply-chain. International traders and Chinese steel mills have been increasingly vocal in asking for TSI-linked physical supply contracts in recent months.