iron ore pricing: a review of methodology and the emergence of

© 2013 Platts, McGraw Hill Financial. All rights reserved.

Iron Ore Pricing: A Review of Methodology and the Emergence of Floating Price Activity

Keith Tan, Managing Editor, Steel Raw Materials

Singapore, May 31, 2013

Agenda

• Platts price discovery process

• Growth in transparency and trading platforms

• Floating price activity and its relation to quality

and timing

2

Platts a unit of McGraw Hill Financial (NYSE: MHFI)

3

Introducing Platts

• Founded in 1909, Platts is the world’s largest energy and metals information provider

• Every day, more than US$10 billion in trading activity and term contract sales are based on Platts benchmarks, in the oil, gas, petrochemical, metals and shipping markets

• Platts brings transparency to the markets through active spot price reporting, market commentaries and a published assessment methodology

4

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5

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6

Daily and Real-Time Publications for Iron Ore & Coking Coal & Steel & Freight

7

Platts Focus, Impact and Relevance

8

• Platts benchmarks are used to price term contracts

• Futures settlements are often tied to spot market Platts covers

• Derivatives “price out” against Platts spot price assessments or futures settlements

Futures

OTC

Derivatives

Term Contracts

Spot

Platts Focus: The Spot Market

• Spot prices are established at the margin

• Term contracts are priced on Platts assessments

• Paper swaps prices settle off spot prices

9

Platts

assessments

Large Spreads Between Term and Spot Trigger Pricing Shifts

45

65

85

105

125

145

165

185

04/01/07 10/01/07 04/01/08 10/01/08 04/01/09 10/01/09 04/01/10 10/01/10 04/01/11 10/01/11 04/01/12

$/mt Last 5 years of iron ore prices (62%-Fe basis)

5年以來鐵礦石現貨價格的走勢年以來鐵礦石現貨價格的走勢年以來鐵礦石現貨價格的走勢年以來鐵礦石現貨價格的走勢(62%品位為基準品位為基準品位為基準品位為基準)

Spot price IODEX (CFR CHINA)

Contract price (FOB AUS)

Quarterly Monthly/shorter termAnnual “benchmark” pricing

IODEX 62% CFR China is Now a Global Benchmark

11

12

Characteristics of a Good Benchmark

Adherence to international norms of trading

High degree of transparency

Benchmark assessment methodology is clearly defined

Benchmark assessments are open to industry scrutiny

Market acceptance

Chain formation – high degree of circulation

Leads to the development of a forward market

Agenda

• Platts price discovery process

• Growth in transparency and trading platforms

• Floating price activity and its relation to

quality and timing

13

Key Characteristics of Physical Commodity Markets

• Illiquid

– Large cargo size and differentiated quality specs prevent cargoes from changing hands multiple times

• Opaque

– Bilateral/OTC nature of negotiations means participants don’t know, at each point of time, what the best bids/offers in the market are

• Non-standardized

– Variations in quality, delivery timing, cargo size, payment terms need to be accounted for in the generation of an accurate spot price assessment

14

Spot iron ore transactions Platts observed

• In 2012, Platts observed 75.4 million mt (in 737 trades) worth of spot iron ore transactions

• This figure is about 10% of the total seaborne volume China imported that year

• Spot transaction volumes change according to various factors, one of the most important being the rate of uptake/performance of long-term contractual volumes

• Generally speaking, LTC uptake/performance is strong when there is little incentive for counterparties to obtain cargoes through the spot market as an alternative means (effected when the spread between spot and LTC prices is thin)

15

Key Characteristics of Physical Commodity Markets

• Now, compare this with SHFE rebar futures,

for example:

– Highly liquid: Millions of transactions a day

– Transparent: Electronic trading enables real-time visibility

of bid/offer spreads and transaction levels

– Standardized: Fixed contract specifications

16

Platts Assessment Reflects Marginal Price

17

Iron ore market Rebar futures market

150

149

150 150

149

148

145

146

143

142

141 141

140

139

140

138 138 138

139 139

Assessment of price at

margin constrained by

lowest offer, highest bidSellers and

buyers often

apart in

tradable price

ideas

xx

x

x

x

x

xx

xx

xxx

x

xx

xx

x

xx

xxx

x

x

x xxx

x

x

Weighted-averaging best suits

highly liquid markets

x

xx

Sellers and buyers

intersect multiple

times

Iron Ore Prices Increasingly Responsive to Related Markets

18

Platts

assessments

are time

sensitive and

clearly time-

stamped

How Data is Analyzed: Time Sensitive Data

19

Time stamps

allow for true

reflection of spreads

Value is a Function of Time

Price

Time11 am 3 pm 5:30 pm

Best offer: $140

Best bid: $135Deal done:

$136 Best offer: $134

Market on Close

Best bid: $132

How the Assessments Appear in the Newsletters

21

Specifications: Exactly What is Being Assessed

22

Platts IODEX Specifications

62%-Fe Iron Ore Fines

Assessment window: Based on information collected up to market close as of 5.30 pm in Singapore/Beijing/HK (3 pm in New Delhi, 10.30 am in London)

Timing: Delivery 2-8 weeks forward from publication date

Basis: CFR North China, normalized to Qingdao

Cargo size: Minimum of 35,000 mt

Credit terms: Letter of credit at sight

Quality Specifications: Sizing up to 10 mm for up to 90% of cargo,

Iron 62%, Aluminum dioxide 2%, Silicon dioxide 4.5%, Phosphorus 0.075%, Sulfur 0.02%

23

Platts Position in Iron Ore and Coking Coal Pricing

• Platts is the first to publish daily spot price assessments Iron ore: since June 2, 2008Coking coal: since March 15, 2010

• Platts IODEX is the most widely used, with more than 90% of seaborne, physical iron ore priced against it

• Coking coal contract prices are mostly negotiated quarterly, but index-linkage is increasingly prevalent with suppliers in Colombia, Indonesia and Australia

• As we speak, the Q2 2013 coking coal benchmark is breaking down as a result of spot transactions being done much lower than that

24

Platts Iron Ore Quality Normalization

Normalization

• Quality is but just one aspect of normalization

carried out on information obtained

• Other parameters normalized include volume,

timing, location, and payment terms, for example

26

X X

62%Fe

CFR Qingdao

� Timing/Delivery dates

� Quality

� Quantity

� Location

� Terms of trade

Normalization Makes Sense of Variations in Trading Dimensions

27

Iron Ore Quality Normalization

28

- Quality differentials established through a survey with medium-to-large Chinese steelmakers

- Enables comparison of iron ore qualities based on technical merit - Cross-checked with spot transactional data obtained, and adjusted to

reflect changes in market conditions

Fe Alumina Silica Phosphorus Sulfur 62% 2-4% 4.5-5.5% >0.075% >0.07%

positive negative negative negative negative per dmtu -$0.75 -$1.50 reject reject

Note:Phosphorus and sulfur: Most buyers tend to reject cargoes exceeding these thresholds, and those that are accepted are usually with a sharp discount requested. The discount may or may not be linked to the cost of dephosphorization/desulfurization, as there tend to be other market-related contributing factors that may be the result of bilateral negotiation.

Representativeness

• Every steel mill evaluates iron ore qualities differently depending on its facilities, and availability of domestic ore

• As Platts iron ore assessments are on a CFR China basis, the quality differentials are reflective of the medium-to-large Chinese mills surveyed

• Regional differences shown by mills in other parts of NE Asia and Europe are more opaque owing to their lower reliance on spot material, but this is changing as they realize how it is also possible to obtain premium material from the spot market

29

Agenda

• Platts price discovery process

• Growth in transparency and trading platforms

• Floating price activity and its relation to

quality and timing

30

What Transparency Brings About

• Increases confidence in price benchmarks

• Encourages responsible behavior

• Simplifies participation in the price discovery process

• Establishes high quality information for

decision making

Increase in Informational Transparency

• Platts real-time deal, bid and offer information

disseminated widely in marketplace

• Named counterparties in daily reports has become

the norm

• Market’s demand for transparency increases

32

Increase in Informational Transparency

• Tender and deal information now promptly available,

with Platts editors at nexus of the market

33

Iron ore, 57.6%-Fe Australian Yandi fines -- BHP Billiton sold at

$104.68/dmt CFR Qingdao , 170,000 mt, loading Sep 25-Oct 4

Iron ore, 65.27%-Fe Brazilian Iron Ore Carajas Fines (IOCJ) -- Vale sold at

$121.76/dmt CFR China, 240,071 mt, passing Singapore Oct 18, Al 1.13%, Si

2.58%, P 0.041%, Mn 0.49%, LOI 1.79%, moisture 8.4%, traders who received

the tender said Iron ore, 64%-Fe Brazilian Lump Ore Blast Furnace Tubarao (LOBT) -- Vale

sold at $117/dmt CFR China, 80,000 mt , passing Singapore Oct 23, Al 1.4%,

Si 4%, P 0.065%, Mn 0.15%, LOI 2.7%, according to traders who received the

tender

Increase in Informational Transparency

More than 50 named counterparties published in Steel Markets Daily since October 2011

34

Bagadiya Brothers Fuyi Wuzi Noble Resources Stemcor

Baosteel Resources General Nice Palabora Mining Co. Sundial Minerals

BHP Billiton Glencore Poly Resources Swiss Singapore

BM Holding Hebei Jingye Prosperity Steel United Synergy Resources

BST (HK) Hebei Shenglun PT Resources Tangshan Ganglu Steel

Cargill Hebei Steel Radiant World Tianjin Tiantie Metallurgical Group

China Railway Materials Henan Chaoyang Rio Tinto Toptip Holding

Citic Pacific Special Steel Hunan Valin Steel Rizhao Zhongrui Trafigura

CNBM Iron Ore Company of Canada Rungta Mines V.M. Salgaocar

Concord Fortune Jindal Steel & Power Ltd Sesa Goa Vale

Continental Resources KIOCL Shandong Chuanyang Steel Xiamen C&D

Essel Mining KMG Shandong Huaxin Xin Wu An Iron & Steel

Fengli Group Masteel International Shandong Wanbao Xinsha International

Focus Trading Metinvest Sinochem International Yanshan Steel

Fomento Resources Minmetals SinoGiant Zhejiang Materials International

Frost International MMTC Transnational Sinosteel Trading Zheshang Holdings

Physical Iron Ore Trading Platforms

• China Beijing International Mining Exchange (CBMX)

was launched May 8, and GlobalORE, May 30, 2012

• Counterparties are anonymous, and the available

details of each cargo’s specifications vary

• Transactions on the platforms and their eventual

performance cannot be verified by Platts without

counterparty information

35

Physical Iron Ore Trading Platforms

• Already prior to the launch of the platforms, the

market has become used to having details of trades

being furnished in reports like Steel Markets Daily

• Buyers and sellers need to know the full details of a

cargo, including specific brand/quality that they will

take delivery of/deliver, at the point of transaction

• Where there is uncertainty over the full details of a

trade, whether on or off a platform, Platts may

choose not to use it for assessment purposes

36

Quality of Information Varies

• The quality of the information we acquire varies

widely, and Platts has an interest to use only good

quality data for assessment purposes

• Quality information has the following characteristics:

– Transparent

– Verifiable

– Firm

– Eventually performed on (in the case of transactions)

37

Next Step in Transparency: eWindow

• Platts launched March 22 the eWindow for iron ore，

an online platform that is used as a communications

tool in Platts price discovery process

• Platts Editorial Window, allows market participants to

communicate bid, offer and transaction data to Platts

electronically with that information published in real-

time and visible to all subscribers.

38

Next Step in Transparency: eWindow

• Platts first introduced eWindow for petroleum

markets in Asia back in 2007. It was rolled out

gradually to other markets and is currently used as

part of the price assessment process in more than a

dozen petroleum markets.

• The technology behind eWindow was customized for

the Platts price assessment process under a license

agreement with ICE.

39

Agenda

• Platts price discovery process

• Growth in transparency and trading platforms

• Floating price activity and its relation to

quality and timing

40

Current State of Term Contract Pricing

41

Region Frequency of steel

pricing

Long-term contracts Spot purchases

China Monthly, every 10

days, or spot

Mostly priced on

monthly averages of

published indexes,

with some quarterly

averages

A large number of

contracts are also

based on 5-10 day

index averages

around Bill of Lading

or Notice of

Readiness

Proportion ranges

widely, from almost

none for large, state-

owned mills, to 100%

for small and

medium-sized private

mills

Japan, Korea, Taiwan,

Europe

Half-yearly or

quarterly, or on

contract basis

Mostly priced on

quarterly averages

Rarely, but some are

considering

increasing spot

proportions

• Spot deals on index-linked basis have increased in

prevalence as market seeks to mitigate price volatility

• Differentials to key indexes (62%-Fe IODEX, 58%-Fe)

used as expressions of differences in quality/value-in-

use and timing

• Trend mirrors developmental path in mature markets

like oil, in which majority of spot transactions are

index-linked for certain markets

• Market participants buy or sell physical on a floating

basis, and hedge their exposure by selling or buying

paper on a fixed-price basis

42

Emergence of Floating Price Activity in Spot Market

Floating Price Activity in Spot Trading – Examples

43

Differential

expression

Actual examples

Product Pricing basis Quotation period

Flat price 61%-Fe Pilbara Blend Fines 62%-Fe IODEX +$1/dmt Month of BL

63%-Fe Standard Sinter Feed

Guaiba (SSFG)

(Bid by Shandong Wanbao)

Platts IODEX + 1%-Fe differential

+$0/dmt

5 days before and after NOR

(discharge port), excl. NOR

date

61.8%-Fe Brazilian fines with

7.4% SiO2

(Mineracao Usiminas)

IODEX +flat-price discount per 1%

silica exceeding 4.5% (bidder

seeking smallest discount

quantum wins cargo)

10 days before and after BL

63%-Fe Newman Lump IODEX +$0.16/dmtu Month of delivery

58%-Fe Indian fines

(Fomento Resources)

Platts 58%-Fe +$0/dmt minus

Freight

5 days on and after offer date

Percentage 57%-Fe Super Special Fines Dmtu value of 62%-Fe IODEX -3% 5 days on and before NOR

(discharge port)

61%-Fe fines (illustration for

product that’s new to the

market)

[(61/62%-Fe IODEX) * 103% -

$7/dmt]

(103% expresses VIU; $7 as silica

discount)

Month of BL

What do Price Differentials Express?

• Why does the market apply premiums or discounts

to published benchmark prices?

– Quality differences (Chemical, Physical, Metallurgical)

– Locational differences

– Terms and conditions differences

– Most importantly: timing differences

44

Recall Platts Specification for Timing

45

62%-Fe Iron Ore Fines

Assessment window: Based on information collected up to market close as of 5.30 pm in Singapore/Beijing/HK (3 pm in New Delhi, 10.30 am in London)

Timing: Delivery 2-8 weeks forward from publication date

Basis: CFR North China, normalized to Qingdao

Cargo size: Minimum of 35,000 mt

Credit terms: Letter of credit at sight

Quality Specifications: Sizing up to 10 mm for up to 90% of cargo, Iron 62%,

Aluminum dioxide: 2%, Silicon dioxide 4.5%, Phosphorus 0.075%, Sulfur 0.02%

Spot Activity Concentrated Around 4th-5th Week Forward

(Middle of 2-8 week forward assessment window)

0

5

10

15

20

25

30

35

40

45

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74

Nu

mb

er

of

carg

oe

s

Days forward from transaction date

Cargo delivery timings by origin

Australia

Brazil

India

South Africa

(Spot transactions observed Jan-Dec 2012)

Source: Platts

Concentration of spot activity

determines the “mid window” that is

the target of Platts normalization for

timing

Market-on-Close: Guiding Concepts

• Physical prices take precedence over swaps prices

• Outright prices take precedence over floating prices

• Platts assessment process takes into account the

value of the daily backwardation or contango

• Gradient of backwardation/contango can be derived

from swaps forward curve

47

Prompt Deal Carries Time Premium in a Backwardation

48

135

137

139

141

143

145

147

149

Weeks

Premium

0

Mid window 820

Deal at $145 for cargo arriving 3rd week forward

Mid window: Target point of normalization

Prompt Deal Carries Time Premium in a Backwardation

49

135

137

139

141

143

145

147

149

Weeks

Discount

0

Mid window 820

Deal at $140 for cargo arriving 7rd week forward

Mid window: Target point of normalization

Valuing Daily Backwardation Using Swaps: A Simplified Illustration

50

135

137

139

141

143

145

147

149

0

May

May swap: $145

Jun swap: $143

Daily backwardation = (145-143) / 30 days

= $0.067

Jun Jul

X

X

Calculating Value of Backwardation

51

135

137

139

141

143

145

147

149

Weeks

Premium

0

Mid window 820

IF

Time difference between deal and mid window = 18 days

AND

Daily backwardation = $0.067

Backwardation over 18 days = 18 * 0.067

= $1.21

Calculating Value of Backwardation

52

135

137

139

141

143

145

147

149

Weeks

Premium = $1.21

0

Mid window 820

Therefore, to normalize transaction for timing:

Transaction price - backwardation

= 145 - 1.21

= $143.79

Transaction = $145

Normalized = $143.79

Platts IODEX Swap Futures Forward Curve

53

Core Formula Underpinning Market Values

54

When Platts assesses a physical market, there can be only one value for a cargo of iron ore. That value can be expressed as an outright price, and a floating price.

The market reconciles value using the following simple formula:

Outright Price = Settlement basis plus differential

Core Formula Underpinning PlattsAssessment Process

55

The market reconciles value in real time using

the following simple formula:

Price = Swap plus differential

Px = Sw + Diff

Thank you!

Further questions, comments?

Please contact:

+ 65-6530-6557

keith.tan@platts.com

iodex@platts.com