Contract killer

Chinese steel output at new highs

Refer to Iron Man and many will think of the superhero played by Robert Downey Jr in the Marvel movies. But the Chinese press has been speculating that another ‘Iron Man’ is operating closer to home, hard at work manipulating iron ore futures on the Dalian Commodity Exchange (DCE).

Prices have shot through the roof since the Chinese economy started to bounce back from the Covid-19 pandemic. In November, the country’s PMI Index hit 54.9, its highest level in 10 years, as industrial and manufacturing activity picked up pace. And something similar has been happening in the price of iron ore. The quoted price for the DCE’s dominant I2101 futures contract has soared from a low of Rmb511 ($78.18) per tonne in mid-April to Rmb993 last Friday. Prices are now at an all-time high.

However, the surge has also stirred concerns that the futures prices may have lost touch with the realities of physical supply and demand. “Iron ore prices have gone up way too fast. There’s hardly ever been a rise like this before,” one trader told the 21CN Herald, with Caixin, another business magazine, also calling on the regulator to intervene in a recent editorial.

In large part, this reflects the financialisation of the industry. A decade ago there were annual but opaque price negotiations between the iron ore miners and their (mostly Chinese) customers. The Chinese were unhappy with the prices that were set, but largely failed to get together as buyers to negotiate a better offer. The situation started to change in 2013 when the DCE launched its first futures contract in a bid to give domestic steelmakers more leverage over negotiations. Today, it’s estimated that about 10% of futures trading comes from steelmakers hedging their physical exposure. But the rest comes from financial traders.

Both the Chinese press and the country’s regulators worry that the futures prices are too open to manipulation, with the media hinting that at least one multinational is holding a huge position for that purpose. On December 3, the exchange in Dalian responded by imposing a trading limit on the I2105 contract for non-futures companies in a bid to protect retail investors from the bursting of a speculative bubble. Three days later it published a WeChat post highlighting its policy of “zero tolerance” for irregular trading.

Yet few disagree that there are fundamental reasons why iron ore prices should be rising. Demand in China is strong, with steel output expected to top 1 billion tonnes for the first time in history this year as the government targets another round of infrastructure projects to buoy growth. Chinese buyers of iron ore are now in greater competition with international ones as economies around the world start to revive as well. This started to show up in October, when shipments to China from Brazilian mines fell from 84.2% of the overall iron ore exported by the South American nation to 74.2%.

Activity is also picking up at a time when supply is under pressure. It is rainy season in Brazil and output there still hasn’t fully recovered since a tailings dam collapsed in January, killing nearly 250 people. Then there is the political row with Australia. Relations between the two countries are fraught (see WiC521), with China slapping tariffs on Australian wine in late November, adding that to other Aussie commodities on the embargo list.

Iron ore looks unlikely to be next, despite constituting Australia’s largest export to China by far in value terms. The reason? China is much in need of it, relying on Western Australia for as much as two-thirds of its imported ore this year.

For the moment, both countries are dependent on one another. Probably of more concern for the Australian miners over the longer term is how the Chinese are looking for alternative suppliers, however. The world’s largest undeveloped deposits lie in Guinea’s Simandou mining project, owned by a Singaporean, Brazilian and Chinese consortium. But the project is said to be a minimum of five years from production, encouraging major Australian producers like BHP, Rio Tinto and Fortescue Metals to invest billions of dollars in new mines, which will come into operation over the next few months. As that additional supply ships perhaps that will see futures prices fall in 2021.

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