December 2021

Argus White Paper:Portside iron ore:
The future(s) kingAs risk in iron ore trade surges, forward markets are catching up. International exchanges have long lacked
a product to manage operating and basis risk involved in trading ore at the docks of the world’s largest
buyer — China. But next month, CME Group will launch two new cleared contracts for portside iron ore at
Qingdao port, which will settle against the Argus PCX 62% Fe index. The contracts will offer brand new, andincreasingly essential, hedging and trading opportunities to the market’s widest set of participants.
The financial market around seaborne iron ore evolved rapidly,
and needed to. Anyone spying the first rogue greys aroundtheir temple will remember the risky operating environmentof iron ore trading around 2007-10, when fortunes were madeand lost and a decades-old pricing system met its end.
Things are calmer now — price risk has been largely tamed,with hedging of cross-border iron ore using 62% Fe futurescommonplace. But so much of the past decade was spent withmultiple exchanges competing for the 62% Fe crown that innovation in the seaborne space took a back seat.
Fear of diluting liquidity in the main market slowed the roll-out ofnew products. New ore contracts emerged, but often too late. A
much-anticipated 58% Fe “low-grade” iron ore futures contract
was launched after the physical market had hitched all lower-Fesales to the 62% benchmark. High-grade ore futures arrived
later, after two blowouts in quality spreads had been and gone.

Seaborne (ICX) and portside (PCX) iron ore
250200$/t10

Seaborne-Portside spread (RHS)ICX 62% Fe Seaborne Iron Ore

8PCX 62% Fe Portside Ore (seaborne equivalent)

64150

20

100-2-450-6-80

Jan 20

Apr 20Jul 20

Oct 20Jan 21

Apr 21

Jul 21-10

Moving on(shore)

As the seaborne pricing system ossified, in the backgrounda parallel and potentially rival physical trading system wasgrowing, with small parcels of prompt secondary ore changing hands at China’s ports — the so-called “onshore” market.
That has grown alongside a highly liquid, physically settled
financial contract launched in China and priced in yuan.

Participation in the traded seaborne market in iron ore hasthinned out. Several years ago, international trading houses
joined Chinese counterparts in buying cargoes on the sea in
US dollars, then landing them and selling in Chinese yuan oncecleared through customs. This less capital-intensive market
has become more dynamic than the seaborne space, which
has seen disintermediation leach vibrancy from the secondarymarket. In a parallel trend, international mining firms looking
to get closer to customers have established onshore entities tosell directly to Chinese customers at port in their own currency.

This has been supplemented by a range of formal, and informal innovation, creating a market ecosystem similar, but
fundamentally different, to the seaborne market. International
futures markets have not kept pace. They need to, not least as
portside pricing is looking to emerge beyond China’s borders
as a force in pricing.

Growing portside dynamism has coincided with a concerted
push from China to give greater credence to — more abundant —portside transactions in the seaborne price discovery mechanism. The sophistication and maturity of the onshore “retail”
market is on the rise, shown by an increase in onscreen platform
trades, index referencing and “basis-trading” linked to futures.

Metalsilluminating the markets

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Argus White Paper: Portside iron ore: The future(s) kingStuck onshore

Companies with onshore and offshore price exposure currently
have options for managing price risk, albeit imperfectly. A quirkof Chinese commodity futures markets means liquidity in theiron ore contract is typically pooled in a single month, corresponding to agricultural seasons. So anyone hedging landed
iron ore in China December 2021 would most likely have to use
a May 2022 contract. There is plenty of liquidity, but such onlyoffers a directional hedge, not one linked to the arrival date, or
the pricing of the seaborne purchase. Cue basis risk.
A further complication lies in the physical settlement mechanism. Grade tolerances for delivery mean prices follow thetrend of the lowest-common denominator product that meetsthe required specification, typically an Australian low-gradeore. This does not always track the price trend of mainstream
medium-grade fines. Thresholds have been revised in thepast, impacting the value of open positions significantly.
Finally, currency and operational risk are fundamentally different to international offshore markets. Onshore iron ore futures
sit in China, where the government has oscillated between
supporting home-grown financial markets and trying to tamethem during periods of extreme volatility.

Enter PCX portside iron ore futures

This is stoking demand for a more conventional futurescontract, akin to those available for the seaborne market,
which allows hedging of a mainstream ore across a range oftimings. While over-the-counter (OTC) forwards, swaps andoptions do exist, trading could be cheaper and counterparty
risk reduced through a standardised internationally-accessible exchange-cleared contract.
Enter the new CME contracts. They offer a direct proxy for theonshore iron ore market, but cash-settled against the Argus
PCX — an index with a mainstream grade specification. It willreflect onshore price trends, but match the Singapore publication schedule of existing seaborne iron ore contracts, avoiding
weekend index prints. The underlying index specification will
also closely match that of offshore futures, making it easier totrade a spread between the two.
Offshore clearing makes the contract accessible tointernational investors in either US dollars or Chinese yuan.
The index will be published from Singapore, a neutral trading
hub with a concentration of buyers and sellers operating
within a strong regulatory framework.
The two contracts will offer the market slightly differentiatedvehicles for hedging and managing risk linked to portside prices:• T he Iron Ore China Portside Fines CNH fot Qingdao futures(CME product code PAC) will be quoted in Chinese Renminbi(CNH) per wet metric tonne, and settle to the Argus PCX
Index. This index represents the true portside priceassessed daily at Qingdao port.
• T he Iron Ore China Portside Fines USD Seaborne Equivalent
futures (CME product code PAU) will be quoted in USD per
dry metric tonne, and settled to the Argus PCX Seaborne
Equivalent Index. This index represents the portside price at
Qingdao, adjusted for moisture content, VAT and port fees,
and converted into USD – a more like-for-like comparison
with existing seaborne iron ore derivatives.

Use cases for the new contract

CME PCX futures could be used in a number of ways. Trading
firms purchasing in US dollars and selling at a landed price at
Chinese ports could lock in their sales price, as well as theirpurchase price, in advance. Companies both buying and selling at port could use the contract to hedge trade time spreads.
Further, it offers an additional means for non-China based
entities to manage risk and take a view on price direction.
Volatility between seaborne and portside prices has been particularly acute, with the spread between the two blowing out
to the equivalent of up to $10/t on some days, with monthly
spreads varying from -$7.50/dmt to +$8.80/dmt. Now, this canbe traded.

The index: Argus PCX 62% Fe
Argus has been assessing the price of iron ore at Chinese
ports for nearly eight years. PCX is the portside counterpart
to the flagship seaborne ICX index, used in a wide range oflong-term supply contracts by the world’s largest mining
companies and steelmakers. The specification of PCX isidentical to that of ICX, which closely approximates themost liquid Australian medium-grade fines product. The
price point also matches ICX, reflecting the landed price ofiron ore at Qingdao port.
The price is calculated as a volume-weighted averageof transactions for relevant grades at both Qingdao andnearby Rizhao port, supplemented with a market surveyof bids, offers and tradeable values. Alongside PCX, Argus
publishes prices for a range of common grades, including
Newman Fines, PB Fines, Super Special Fines (SSF) andBrazilian Blend Fines (BRBF).

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