TSI 62% Fe benchmark usage in Iron Ore physical linkage rising, helping hedging

UNITED KINGDOM July 20 2016 7:06 PM     

LONDON (Scrap Register): The TSI  62% Fe iron ore index is being used exclusively for index-linked spot deals of  Jimblebar Fines, a 61.3% Fe ore produced by Australian miner BHP Billiton,  several market sources have confirmed, said The Steel Index.

Prior to  July, the product was reportedly sold in the spot market based on an average of  TSI 62% Fe and an index for 62% Fe fines produced by Argus Media. The first news  of the exclusive use of TSI’s index for physical linkage came via the two  leading electronic trading platforms (COREX and GlobalORE).

The decision  to trial sales based purely on the TSI 62% Fe index, rather than an average, is  believed to be based on increased requests from customers who hedge their  physical exposure in futures markets. The TSI 62% Fe benchmark is used to settle  more than 99% of all US$- denominated iron ore derivatives.

As yet, it  is unclear whether this will also be extended to long-term contracts for  Jimblebar. One Chinese steel mill located along the Yangzi River who buys the  product said their current oneyear contract has not yet ended, but that they  would be willing to switch to a “TSI only” arrangement when it comes up for  renewal. “It would be more convenient for us when hedging in the derivatives  market, and would lower our basis risk,” said a purchasing manager at the mill.  

While much iron ore in the physical market is purchased against a range  of other indices, using different indices for physical and financial contracts  creates basis risk for anyone who wishes to offset risk in financial markets  cleared against the TSI 62% Fe price. This is because monthend averages between  physical and financial settlement can be variable and unpredictable.  

Using the same index for both the physical and financial sides of the  deal removes this basis risk by ensuring the two legs match. The  unpredictability of basis risk has long been an unwanted “wild card” element in  any hedge, but is becoming more of a headache as trading margins come under  pressure. The purpose of hedging is after all to remove risk.

There has  also long been strong demand from end-users and traders for linkage to higher  volume ‘mainstream’ ore grades too, not just Jimblebar, for the exact same  reason: more effective hedging.

Meanwhile, liquidity risk for “hedgers”  has become a thing of the past as volumes of derivatives continue to soar.  Preliminary data for the first half of 2016 (H1) shows volumes of cleared  derivatives settled against the TSI 62% Fe number to be 101% above the level of  H1 2015. Indeed, liquidity across exchanges was just shy of a billion tonnes  (976,083,800 tonnes) between January and June this year.

To put this in  context, last year those volumes weren’t achieved until sometime in November.  Annualizing the preliminary exchange data now puts the ‘paper’ trade of iron ore  at two times the underlying physical Chinese market reference, as well as  comfortably over the size of the total global seaborne market for the first  time.