New tools offer steel, iron ore price cushion

- Banks and major exchanges are racing to develop financial instruments to trade steel and iron ore as extreme price volatility prompts producers and consumers to seek a fixed price.

The price of iron ore, a key steelmaking raw material has shot up in the past few months while in annual contract talks major miners such as Rio Tinto secured up to 96.5 percent price hike from China's Baosteel.

A major raw material for the $800 billion steel industry, iron ore remains one of the few non-exchange traded commodities.

However, experts say the tide is about to turn.

"Producers and consumers are faced with much greater volatility in commodity prices than before...Whether that be steel, iron ore, coking coal or freight," said Kamal Naqvi, head of fund coverage of commodities at Credit Suisse.

"Given the sheer extent of recent volatility, market participants are looking much more closely at strategies to manage the price risks," he said.

In May, Credit Suisse and Deutsche Bank co-launched an over-the-counter market, where investors can trade cash-settled swaps in iron ore across a range of maturities.

Naqvi said Credit Suisse traded around 1.6 million tonnes in the OTC iron ore market since the launch on May 23, and that participants included miners, steel producers, physical merchants and funds.

Such instruments seem to have support from miners, too.

Marius Kloppers, the Chief Executive of the world's largest miner BHP Billiton last week said that BHP would be a participant. "...We'll continue to be a participant. We see that as a very important development."

Rio Tinto was more cautious.

"We need to know more before deciding whether alternative mechanisms might better reflect supply-demand factors of the market," a spokesman for Rio Tinto told Reuters.

"In the meantime, we will keep an open mind on the various proposals..," he said.

Several experts say a number of exchanges will be looking into a possible iron ore contract. An industry source told Reuters this week that a major Asian exchange planned a launch.

"They're looking to make an announcement in the third quarter," the source said. Earlier, analysts tipped the Singapore Exchange as most likely to be first to carry an over-the-counter iron ore contract.

MARKET TURNAROUND

The sky-high cost of iron ore, coupled with the expensive price of another key steelmaking raw material, coking coal, have pushed world steel prices to record highs.

This volatility prompted major exchanges to develop futures products for the $800 billion steel industry, where the new contracts were shunned by some major steelmakers who enjoy big profits as they are able pass on costs to their customers.

But smaller steel-mills, who don't enjoy the pricing power that majors such as ArcelorMittal, and steel consumers such as construction companies and funds who seek juicy returns are likely to support these new instruments.

"A fixed forward price is something our consumers have been asking us for a long time," said the head of a Turkish mini-mill, which produces around 1.5 million tonnes of steel annually. "We're looking at ways to use these contracts."

However, participation by larger producers might require a market turnaround.

"In a steeply rising price market, primary producers of steel do not want to be selling long term fixed steel priced products via exchanges," said David Paul, director, global financial risk management at Barclays Capital.

"Currently producers know that each month they can increase prices, hence why fix forward selling prices. However, this can change when the market looks to have peaked, and forward prices look as though they may decline," Paul said.

Steel futures are currently offered by the London Metal Exchange, Dubai Gold and Commodities Exchange and India's National Commodity and Derivatives Exchange.

The New York Mercantile Exchange (NYMEX) is planning to launch its futures contracts later this year.

"At the moment the exchanges are only addressing 50 percent of the total market audience as all the exchange users are on the buy side," Paul said.