Japan’s first iron ore swap agreed

Mitsui, the Tokyo-based trading house, announced it has signed the country’s first ore swap, with Credit Suisse.

The swap allows Mitsui, which acts as a middleman between iron ore miners such as Vale of Brazil, Rio Tinto and BHP Billiton and the Japanese steelmakers, “to hedge the price of the commodity, avoiding the volatility of quarterly contracts.”

But that volatility only came about because miners and steelmakers abandoned their 40-year system of steady price-agreements.

Steelmakers facing the short term price crunch and financial crisis of 2008 abandoned the deals struck with miners and bought ore using spot deals. Miners moved from annual to quarterly deals. Prices fluctuate because of short term imbalances between supply and demand. Steelmakers have to pay a premium to financial intermediaries to remove their risk.

In ten years time the size of the virtual iron ore market is expected to exceed the size of the real iron-ore market. Additional volatility will be introduced since the price of ore is now driven by what investors can earn in other financial markets.

Steelmakers exchange short term pain in 2008 for long term pain and price instability, and the prospect that real projects (bridges, skyscrapers, railways, power plants) using steel will collapse/be delayed/go over budget because financial investors decide to corner the market in steel, or leave steel to invest in (say) coffee beans.

Having the financial casino take bets on the outcome of real world events is one thing. Having real world events driven by bets being taken in the financial casino is quite another. The tail is wagging the dog.

http://www.ft.com/cms/s/0/04be1fd8-82c3-11df-85ba-00144feabdc0.html

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