Reuters reported that Brazil's Vale SA expects a huge derivatives market in iron ore to eventually take shape as players seek hedging instruments to minimize risk from increasingly volatile prices.
Mr Jose Carlos Martins who runs the iron ore business for Vale the world's single largest producer of the commodity at a news conference in New York said that "I believe a big financialization of the iron ore market will be inevitable."
The price of iron ore, a key ingredient for steel, fell by a third in China's spot market in August before recouping all of its losses over three months.
The stormy price action was a result of a supply deluge, followed by a surge in demand in China, the world's largest market for iron ore.
Mr Martins said that "The Chinese have a very big risk appetite towards iron ore because they consume 65% of production. Other clients of iron ore who cannot work with this volatility will have to resort to financial instruments to guarantee market stability."
He said that "So, we see an increasing trend in the market to use more financial instruments or derivatives to try and hedge away risk. This will be much bigger in the European and Japanese markets."
The spot price of iron ore now hovering around USD 115 a tonne is still below levels that some producers find profitable. In August, the price fell under USD 89, below the production cost for at least 30% of the world's producers. Vale forecast a price range of USD 110 to USD 140 in 2013.
He added that for decades, iron ore sales were decided by an annual benchmark price system negotiated between producers and consumers, with contracts for as many as 10 to 15 years common in a market with predictable price growth.
The advent of huge supply demand from China's booming economy brought unprecedented volatility to the commodity, generating a spot market for iron ore that put pressure on producer consumer negotiated contracts.
China's top economic planner in October said that the country should move ahead with plans to launch futures contracts to help firms buying the steelmaking raw material manage price risks. 3 exchanges two in India and one in Singapore are currently trading iron ore futures although liquidity has been thin since trading kicked off last year.
He added that Vale has tried to preserve the negotiated contracts system with its customers by making price adjustments every quarter, but even that seemed inadequate at times in a gyrating spot market.
He said that "We believe the future of iron ore will be on deals based more than ever on the spot market, with contract terms of one to 3 years. Clients will not want long-term contracts.
Mr Murrilo Ferreira CEO of Vale SA said that while Vale was closely monitoring the market's move towards greater securitization, it was not playing any leading role in bringing about a change.
Mr Ferreira said that "There is no study or plans at Vale to be an active player in the iron ore derivatives market. The pricing system or levels with which clients became comfortable to hedge is not a process that happens overnight. I saw it in copper, I saw it in aluminium. It's really a long term process."
