An almost doubling of iron ore prices over the past six months led Chinese steelmakers last week to call for a change in the current pricing mechanism.
Miners have reportedly indicated an openness to work towards improvements. The industry should grasp this opportunity to consider enhancements to the way iron ore prices are formed and assessed, but should also be wary of the possibility of inadvertently taking steps backwards, at a cost to the whole market.
The mechanism functions...
Iron ore boasts a deeply liquid spot market, with around 680 transactions (about 85 million mt) concluded so far this year for the main medium-grade fines used in benchmark 62% Fe assessments, or an average of about two and a half transactions every working day, according to data reported to S&P Global Platts. Such volumes make it very difficult for spot price assessments to diverge significantly from market fundamentals, partly explaining their attractiveness as a mechanism for settling long-term contracts.
Critics may point to the recent price surge as a sign that something is wrong and that prices have divorced from fundamentals. Looking at the last six years, that might seem a reasonable assertion: never have prices moved so much, so fast.
But cast your eye further back in time and you will find that such volatility is entirely consistent with history. Prices shrunk by two thirds from $170/dmt to $57/dmt in just three months during the 2008 Global Financial Crisis, then doubled between October 2009 and April 2010, before again shedding 47% in the following three months. In late 2012, they spiked by 74% in four months. With global steel markets seeing their sharpest uptrend in over a decade thanks to post-COVID infrastructure spend, it should really come as no surprise to see iron ore prices surging to the current extent.
Interestingly, all these volatile periods occurred before the establishment of liquid derivative contracts.
Around ten million tons were trading monthly on SGX by late 2012, or just about 5% of current liquidity, while Dalian Commodity Exchange only launched its iron ore futures in 2013.
This seemingly undermines the argument that speculative futures trading is responsible for abnormal volatility.
...but can be significantly improved
Iron ore is currently caught in a middle stage of its market evolution. On one hand, deep spot liquidity and some degree of transparency ensures that price assessments remain broadly reflective of market values. But on the other hand, the market is in some ways let down by the quality of spot pricing data made available to pricing agencies, resulting in diminished trust in indices, and ongoing squabbling over pricing.
About two thirds of 2020 spot transactions were concluded via broker screens such as globalORE, COREX and the Ore Supermarket, according to Platts data. These brokerages are understandably driven by the commercial need to maximize screen liquidity rather than create high-quality price points for indices. So naturally, data from these venues suffer from a range of issues, when considered for the purpose of use in price assessments. These include issues with timeliness of information presented, a lack of incremental price testing and the fact that "pre-brokering" often masks real value as a function of time. They also include the fact that bids and offers can be put on screen despite a company having a very limited number of potential counterparties, and, last but not least, the fact that all screen activity is anonymous.
Price reporting agencies have been dealing with this lower-quality data in two different ways. For Platts, this has meant critically analyzing every data point and prioritizing higher-quality information for which more dimensions of a trade are known. Many, however, have taken a statistical approach by providing a rough average. The latter is arguably akin to giving up on market evolution and being satisfied with a broadly indicative price instead of pursuing further refinement and precision.
Recent debates around pricing mechanisms show that there is appetite in the iron ore industry for a better solution than the status quo. All major market participants, when speaking in public, advocate for transparency – and this is entirely right, since transparency encourages responsible behavior and builds confidence in price benchmarks. The Platts Market on Close process, which is widely used in many of the largest commodity markets, offers a pathway towards absolute transparency and the removal of the shortcomings mentioned above, inherent in sourcing data from commercially driven brokering screens. The net result for the industry would be to gain a price assessment mechanism which is fairer, open to all, and in particular, beyond doubt, as all market participants would share a common understanding of which information contributed to the assessment and how it was arrived at every day.
Frequently asked questions about Platts Market on Close
What is Platts Market on Close?
Platts Market-on-Close (MOC) is the process Platts editors use to assess prices of iron ore and other commodities. The MOC approach to methodology operates on the principle that price is a function of time. Structured and highly transparent, the MOC is a process in which bids, offers and transactions are submitted by participants to Platts editors and published in real time throughout the day until the market close. Following the close, Platts editors examine the data gathered through the day, conduct their analysis and develop price assessments that reflect an end-of-day value.
Who can participate in the MOC?
MOC participants are buyers and sellers of iron ore. They include, but are not limited to, miners, steel mills, independent trading houses, or entities acting on their behalf.
Any active market participant may submit bids, offers and transactions to Platts as part of the MOC process. Participation in the MOC is voluntary. However, Platts is selective as to which companies are permitted to participate in its price assessment process. As a publisher, Platts will only accept data provided by reputable companies that meet counterparty acceptance criteria and comply with the guidelines Platts has set to govern the MOC process.
Entities that wish to participate in the iron ore MOC should complete this form. spglobal.com/platts/en/our-methodology/participation-review. Platts' Price Group then conducts a participation review to establish that the company is credible, creditworthy and an active participant in the broader market for that commodity. The entities can also request more information on how MOC works and Platts guidelines governing the process. Entities must be reviewed for each specific market and evaluated against the editorial criteria for that market. For more information on the participation review process, please contact Price Group.
How is performance ensured?
Platts expects trades reported in the iron ore MOC to be physically performed. Participants should not unreasonably withhold substitutions or hamper the established delivery process. Platts reviews the performance of trades reported in the iron ore MOC to maintain the integrity of the assessment process. Platts reserves the right to not publish bids, offers and trade information from a company that fails to perform as per standard industry practice and Platts guidelines.
How does Platts conduct counterparty acceptance review?
Platts applies objective criteria to review companies that wish to participate in the MOC. All companies need to demonstrate that they are acceptable counterparties to a critical mass of active market participants on typical terms and in accordance with Platts published methodologies. To participate all companies must also demonstrate that they are able to perform as an iron ore buyer and/or seller, providing evidence of trade performance and logistical capability to perform. In the MOC assessment process, Platts specifies that transactions must be at arm's length, meaning not conducted between corporate affiliates, individuals or companies that may be related in such a way that creates the potential for a perceived or actual conflict of interest. As part of the counterparty acceptance review, Platts verifies companies' financial standing and creditworthiness as well as understanding of the Platts editorial guidelines.
Where is daily MOC information published?
Firm bids, offers and trades from companies are published in real time on Page 700 of Platts Steel Alert (STL), on the Platts iron ore MOC microsite, as well as on Platts Platform and Platts Market center.