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Tuesday, December 13, 2011

Iron ore contract move may boost paper hedges for clients: Vale

Tuesday, 13 December 2011

Brazil's Vale expects that a move to price iron ore using spot prices in the same period of shipments could boost paper hedging by clients, but the world's biggest supplier will refrain, for now.
Vale is seeing how the swaps market is evolving, while it agrees to move most customers away from the quarterly lag price system for term contracts.

Trading company analysts point out that the pricing shift would need more risk management, and increase administration as a known fixed price for a three-month period is lost.
"We don't hedge," Jose Carlos Martins, Vale's executive director of iron ore and strategy, told reporters in London on Wednesday. "If the market becomes liquid and you have financial will be mainly played by customers."

The new contracts switched from a fixed price accord based on the previous quarter with one-month lag system, that, for example, used June to August values to price Q4.
Vale said there is no going back for customers switching to price basis current quarter from the quarterly lag system.

Vale CFO Tito Martins said he didn't think there was enough liquidity in the short term to allow it to happen on a grand scale, as up to 80% of Vale's customers switch to pricing iron ore on current quarter average and even shorter benchmarks such as monthly and pure spot-based pricing.
The executives pointed out the difficulties of hedging a range of different iron ore products around a set marker, which would ensure greater liquidity.

Vale produces many higher iron content products than the 62%-Fe fines concentrate grade used as a benchmark in the physical market Platts and others publish.
One market analyst said that current quarter pricing would encourage more participants into the paper trading market. He also pointed out that it is more difficult for steel mills and miners to issue letters of credit for trade based on a floating price until settlement at the end of each quarter. Another source agreed, and said he expected more paperwork as a result.
The analyst said as Vale is the largest and more conservative than BHP Billiton and Rio Tinto that make up the top three global suppliers, the pricing mechanism change with large steel mills would likely lead smaller players in the industry to follow.
That means the "whole iron ore pricing system is based on a uncertain/floating value," he said.

Vale executives admitted it would be hit by a 20% or so lower price based on the quarterly average to date for newly revised contracts. This switch is likely to result in well over $1 billion in lost revenue, based on expected shipment volume and prices to date.

Vale's Q4 prices under the old system should have stayed flat to Q3, based on analysis by Platts.
However, if prices rise in Q1 2012 by more than the $155.794/dmt CFR North China average generated by benchmark Platts IODEX prices between September to November that would be used under the old system, Vale is betting it can recoup at least part of the loss from customers making the switch. Platts assessed IODEX 62%-Fe at $141.25/dmt CFR North China on Thursday.
Jose Carlos Martins said the market may stay in the $140-150/dmt CFR North China range for the time being, but believes the price will move up in the future.

The analyst said that even after the loss by the structural price change, Vale still makes large profits compared to mills in China that are losing money or at just breakeven.
He forecast Vale's iron ore fines and pellet export volume at around 68 million mt in Q4.
For Rio Tinto, the world's No. 2 iron ore miner and largest supplier from Australia, it too has already moved more towards spot prices. A November 28 company presentation shows about a third of sales remaining on the previous quarter with one month lag pricing basis, with the rest a mix of current quarter, monthly-prior and monthly actual, and spot.
In October, Rio Tinto said 86% of sales in the third quarter were based on historic "quarterly lagged" prices.
Rio Tinto's iron ore sales in Q3 totaled 60 million mt on a 100% project basis, based on the group's operational review.

As for BHP Billiton, the miner has been the most aggressive in pushing for short-term spot-based pricing in iron ore, as well as coking coal and other commodities. While the miners captured a change in pricing helped by China's expanded appetite for imports, it has increased volatility as Japanese-led benchmark pricing now becomes the exception.
Source: Platts

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