Iron ores are rocks and minerals from which metallic iron can be economically extracted. The ores are usually rich in iron oxides and vary in color from dark grey, bright yellow, or deep purple to rusty red. The iron is usually found in the form of magnetite (Fe3O4, 72.4%Fe), hematite (Fe2O3, 69.9% Fe), goethite (FeO(OH), 62.9% Fe), limonite (FeO(OH)·n(H2O), 55% Fe) or siderite (FeCO3, 48.2% Fe).
Ores containing very high quantities of hematite or magnetite (greater than about 60% iron) are known as “natural ore” or “direct shipping ore”, meaning they can be fed directly into iron-making blast furnaces. Iron ore is the raw material used to make pig iron, which is one of the main raw materials to make steel—98% of the mined iron ore is used to make steel. In 2011 the Financial Times quoted Christopher LaFemina, mining analyst at Barclays Capital, saying that iron ore is “more integral to the global economy than any other commodity, except perhaps oil”.
Over the last 40 years, iron ore prices have been decided in closed-door negotiations between the small handful of miners and steelmakers which dominate both spot and contract markets. Traditionally, the first deal reached between these two groups sets a benchmark to be followed by the rest of the industry.
In recent years, however, this benchmark system has begun to break down, with participants along both demand and supply chains calling for a shift to short term pricing. Given that most other commodities already have a mature market-based pricing system, it is natural for iron ore to follow suit. To answer increasing market demands for more transparent pricing, a number of financial exchanges and/or clearing houses around the world have offered iron ore swaps clearing. The CME group, SGX (Singapore Exchange), London Clearing House (LCH.Clearnet), NOS Group and ICEX (Indian Commodities Exchange) all offer cleared swaps based on The Steel Index’s (TSI) iron ore transaction data. The CME also offers a Platts-based swap, in addition to their TSI swap clearing. The ICE (Intercontinental Exchange) offers a Platts-based swap clearing service also. The swaps market has grown quickly, with liquidity clustering around TSI’s pricing. By April 2011, over US$5.5 billion worth of iron ore swaps have been cleared basis TSI prices. By August 2012, in excess of one million tonnes of swaps trading per day was taking place regularly, basis TSI.
A relatively new development has also been the introduction of iron ore options, in addition to swaps. The CME group has been the venue most utilised for clearing of options written against TSI, with open interest at over 12,000 lots in August 2012.