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Recently, Vale of Brazil Metals (Shanghai) Co., Ltd. (Vale) and Shandong Laigang Yongfeng Trade Co., Ltd. (“Laigang Yongfeng”) sign the basis trading contract with the iron ore futures price of Dalian Commodity Exchange (DCE) as the benchmark. Vale is the first overseas miner carrying out basis trading based on the futures price. Market participants believe that it marks the largest iron ore producer in the world has begun to price by referring to the Chinese iron ore futures price, which has significant implications for the global iron ore market in terms of promoting basis trading, optimizing pricing model and enhance the influence of China prices.
The basis trading contract between Vale and Laigang Yongfeng adopts “futures price + basis” as the settlement price, with Brazilian Blend Fines (BRBF) as the chosen mine and Qingdao Qianwan Port as the delivery site. The two sides use DCE iron ore 2005 Contract as the price benchmark and set the basis against such factors as the spread between domestic futures and spot prices. The typical seller offer mode is adopted in this deal, in which Vale exercises the pricing right as the seller, and Laigang Yongfeng locks up the purchase cost by hedging in the DCE market as the buyer.
By engaging in basis trading, overseas miners can sell spot goods denominated in RMB and priced against futures price while not directly involving in the futures market, which will help hedge against price fluctuation risks and consolidate the relationship with downstream Chinese clients. “Basis trading is very flexible, and it offers an effective instrument for price risk management and RMB pricing. As port trade and RMB pricing are getting increasingly popular, basis trading can enrich the pricing patterns for spot trades.” says a Vale official.
Vale has attempted to produce mixed ores and conduct RMB spot goods selling at ports in China since 2015, with an aim of getting closer to the Chinese market and satisfying the demand of end users. In 2018, the iron ore sales volume of Vale settled by RMB was 18 million tonnes. This deal is the first time that the world largest iron ore producer sells referring to the Chinese iron ore futures price, representing a new exploration in derivatives pricing model in addition to the long-term agreement pricing and index pricing.
For domestic steel mills, basis trading can help them to get goods in advance and price flexibly in order to lock up cost and profits. Compared with the fluctuations of absolute price, the basis is less volatile so basis trading can help them to reduce the trading risks. “Compared with the traditional long-term agreement pricing and Platts index pricing, the pricing cycle of basis trading is more flexible, and enterprises can choose a more suitable one instead of restricting the trade cycle to a certain period of time as required in the traditional long-term agreement and index pricing models. Meanwhile, the futures market offers fair and transparent real-time price signals, allowing enterprises to dynamically manage trading and inventory according to market realities and greatly reducing their default risks.” says Li Chao, General Manager of Laigang Yongfeng.
A market participant introduces that compared with the spot price index, the iron ore futures price is formed through the trading of large numbers of industrial enterprises and investors. In this way, the price generation is fairer and more transparent, and it reflects the iron ore supply-demand pattern. In particular, the iron ore futures has received great attention from overseas markets since its internationalization last year and it has attracted foreign clients from 15 countries and regions such as Australia and Japan. The iron ore futures internationalization will help build the iron ore RMB pricing benchmark with global representativeness in China, allow Chinese buyers to voice out in the international market, enhance the international influence of China’s prices, and promote the transformation of the Chinese iron and steel industry from a passive price receiver to a price-setting participant. In addition, as more and more domestic and overseas enterprises engage in basis trading using Chinese futures price as the benchmark, the proportions of international trades denominated and settled in RMB are expected to increase, thus promoting the futures market to better serve the RMB internationalization strategy.
