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Trade Review: Pressures on Asian iron ore to rise after Q2's record highs

Highlights

Fines, lump benchmarks hit record highs in Q2

Preference for premium ores may decline in Q3 amid thinning margins

Chinese mills opt for quayside procurement to manage risks

This report is part of the S&P Global Platts Metals Trade Review series, where we dig through datasets and digest some of the key trends in iron ore, alumina, steel and scrap, and metallurgical coal. We also explore what the next few months could bring, from supply and demand shifts, to new arbitrages, and to quality spread fluctuations.

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The Asian seaborne iron ore market may face a bumpy third quarter, after prices hit record-breaking highs in the second quarter, as China amplifies efforts to curb carbon emissions and steel output.

After Tangshan City, the steel hub of China, more Chinese provinces have begun to plan for cuts in crude steel output amid seasonally weaker steel margins, which had already prompted some mills to carry out plant maintenance, thus reducing iron ore demand.

Last quarter, tight mainstream ore supply and strong global demand propelled prices to unprecedented levels, with the Platts 62% Fe index, or IODEX, and the Platts 65% Fe index both hitting new, all-time highs of $233.10/dmt and $264.20/dmt on May 12. Although seasonally weaker construction activity in China started to dampen steel and subsequently iron ore demand, IODEX remained persistently above $200/dmt in June, underpinned by tight supply.

According to cFlow, Platts trade flow software, both Rio Tinto and BHP had shipped lower volumes in the first half of this year compared with H1 2020. Rio Tinto shipped out even lower volumes in the second quarter than the first. In its Q1 production report, Rio Tinto mentioned risks to meeting production guidance associated with approximately 90 million mt of replacement mine capacity at existing hubs and the start-up Gudai-Darri.

Given the tight supply, spot premiums for Rio Tinto's Pilbarra Blend Fines over IODEX have traced a bullish trend this year, exceeding $10/dmt and staying above that for a substantial period.

According to market sources, several traders had short sold PBF cargoes, expecting weakening steel margins to dampen premiums. However, when it was time to ship the cargo, PBF supply was persistently tight, forcing these traders to buy spot PBF cargoes at high premiums. Although Rio Tinto had lowered PBF shipment volumes in Q2, it did not reduce the brand's spot availability.

Environment protection measures to benefit high grade ores

China's stringent emission controls throughout Q2 buoyed the prices of premium ores, including both lump and high-grade fines.

The seaborne lump premium defied seasonality pressures to hit an all-time high of 76.75 cents/dmtu on June 18 as Chinese steel mills maintained stable lump usage rates on expectations that sintering restrictions, which had started from China's Tangshan city, become more stringent and widespread.

Meanwhile, steel mills in Shandong province and those alongside the Yangtze River had committed to purchasing lump cargoes as their margins were largely healthy. Several cargoes were resold and diverted to Japan from China to meet improving local demand, which further tightened China's lump market.

Overall lump tightness was reflected in the limited liquidity in the spot market. Rio Tinto sold only one shipment of Pilbara Blend lump in Q2, and a total of three in H1. BHP sold six shipments of Newman Blend lump in Q2, and seven in total in H1. This compares with 31 lump cargoes sold collectively by these miners in H2 2020.

In Q3, market participants expect a recovery in BHP's lump supply as South Flank mine will increase the proportion of lump it produces to 30%-33%, from 25%. Simultaneously, high lump prices are expected to encourage end-users to switch to lower grade lumps, potentially exerting some downward pressure on prices.

A similar trend was observed for high grade sintering fines in Q2. A focus on high pig iron productivity, in the context of healthy margins, and on emission reductions have led to a record wide spread between 65% Fe index and 62% IODEX. This spread reached as high as $35.30/dmt in May, before dropping to $31.25/dmt end-June.

Hand-to-mouth buying drives port premiums higher

High market volatility and a resulting preference for portside procurement helped to increase the premium paid for iron ore at Chinese ports over seaborne material for most of Q2. At its widest, this 'port premium', or 'import margin', reached $21/dmt on May 11, in contrast with the Q1 import margin, which ranged between minus $4/dmt and plus $10/dmt.

The rising Q2 market had pushed Chinese steel mills to procure hand-to-mouth, as they sought to reduce physical stocks and exposure to price volatility. When more material was needed, the steel mills preferred to purchase quayside instead of seaborne cargoes.

Portside transactions allowed mills to purchase smaller iron ore parcels compared with the larger standard seaborne cargoes, enabling them to adjust their purchasing strategies more nimbly. Furthermore, given the market uncertainty, the ability to receive portside material promptly held greater appeal. It took weeks before seaborne cargoes were delivered.

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"In a high cost environment like the present, steel mills will make the most of the cargoes delivered under term contracts, reduce spot seaborne purchase and complement with port cargoes. It helps them manage risk and cashflow, although the port cargoes could be more expensive," a Chinese steel mill source said.

However, traders do not expect the wide price difference between port stock and seaborne cargoes, consistently seen in Q2, to continue into Q3. Nevertheless, traders expect this positive import margin to persist should volatility remain.