Behind the Sudden Participation of the Top Three Mines in CBMX
Source: Innovative Finance Observation Date: April 2, 2012
At 8:00p.m. of March 29, China Beijing International Mining Exchange (hereinafter referred to as CBMX) signed a memorandum with Brazil-based CVRD in Singapore; less than 24 hours later, at 11:49a.m. of March 30, CBMX signed an agreement with Rio Tinto PLC (hereinafter referred to as Rio Tinto) in Singapore, meaning the latter to become a sponsor member of China Iron Ore Spot Trading Platform (the Platform).
In the ten days since March 20, three foreign mines joined or showed an interest in the Platform, from which many people have felt the strength of CBMX.
As a saying goes, there is no free lunch in the world. Foreign mines have their own intents when they join or show interest in the Platform. It makes less difference to foreign mines, which have got huge profits, to join the Platform or to join globalOre launched by BHP Billiton. Nonetheless, both platforms can help them realize the dream of promoting spot trade of iron ores and thus maximizing their profits. (By Liu Chang, a reporter with Innovative Finance Observation)
To CVRD, One Stone at Two Birds
Compared with FMG and Rio Tinto, which have become members of CBMX, CVRD only signed a memorandum of understanding with CBMX. According to relevant information, a memorandum of understanding, regarded as an agreement by some Chinese, refers to "a document recording the common understanding reached between two parties through discussions and negotiations." In a memorandum of understanding, except for clauses on confidentiality, termination, application of law, expense allocation, exclusive negotiations, dispute settlement, other clauses are not legally binding to both parties. Both parties of a memorandum of understanding are not legally obliged to such a memorandum until it is converted to an official treaty.
Liang Ruodong, vice president of CBMX told the reporter with Innovative Finance Observation, FMG signed an agreement directly to become a sponsor member of CMBX without a prior memorandum of understanding.
Thus, we can understand that CVRD keeps a way for its retreat as it just said, "Give support to China Iron Ore Spot Trading Platform and wishes the Platform could operate smoothly and healthily". However, it has not yet confirmed that it will join the Platform
Such a choice is not a surprise to Zhang Jiabin, a senior analyst at the Ore department of Umetal. He thinks that the major reason is that it has to negotiate with relevant Chinese authorities for the latter’s permission for its vessels as big as 400 thousand tonnages berthing at Chinese ports. At this critical moment, its participation in the platform of CMBX as the first one to do so among the top three mines has been aimed to provide important weight and prerequisite for the negotiation.
Previously, to ship more raw materials to meet the needs from the economic growth in China and reduce the costs of transoceanic shipment of iron ores so as to lower ocean freights and alleviate the volatility in the prices of iron ores, CVRD built a number of new, larger and more efficient vessels, only to find that they have been hampered by the new regulations promulgated by the Ministry of Transport of the PRC. When this large fleet can be allowed to berth at Chinese port is still unknown.
On this February 1, CVRD also posted a statement on its official site that the 400-thousand-tonnage iron ore carriers owned or rented by it will berth at Chinese terminals only when they completely meet the requirements of Chinese regulations.
Recently, it has been reported in the industry that the berthing of 400-thousand-tonnage ore carriers of CVRD will be settled in May. But, Jia Dashan, deputy director at China Waterborne Transport Research Institute of the Ministry of Transport publicly told the media that no any relevant information was heard, "the formulation of the safety design standard on vessels with a tonnage of more than 400 thousand tons are not started yet and as a result everything is unsure before the publication of this standard."
The conclusion of a memorandum of understanding is a sign of waiting and seeing to some extent. According to the analysis of Zhang Jiabin, the Chinese government has not yet agreed to the berthing of large vessels of CVRD at Chinese ports, or in other words, it has not taken some active steps, for example, to make compromise to permit a vessel carrying 300 thousand tons of cargos, albeit with an tonnage of 400 thousand tons, to berth at Chinese ports. In such a circumstance, CVRD supported the platform of CBMX in the first place among the top three mines, which implied that it has shown its goodwill to the Chinese government and next was the attitude of the latter on the berthing of its large vessels.
By sea, the distance between Brazil and China is 2-3 times as much as that between Australia and China. As a result, high sea freights have been always a disadvantage of CVRD in its competition with Rio Tinto and BHP Billiton. Thus, it is nothing but a consideration of CVRD for its own interest to pay attention to the attitude of China on the berthing of it large vessels.
"Now, CVRD has shown its goodwill to China. But if it chose to be a member of CBMX, once the Chinese side does not allow the berthing of its large vessels, it would have no weight to bargain with the Chinese government. In view of this, what it chose was to sign a memorandum of understanding."Zhang Jiabin told the reporter with Innovative Finance Observation.
On the other side, the timing that it chose to show its goodwill following FMG’s participation in the Platform indicated that it took account of the interest of the top three mines as a whole.
Zhang Jiabin thinks, although they are competing with each other, they as a whole also coordinate with each other, thus, "The top three mines have well understanding of their collective interests."
When the platform of CBMX was just formed, what it considered most was the likely lack of support from overseas mines. The top three mines were indifferent to the platform at first, maybe because none of them wanted to be a precedent among foreign mimes. At this moment, FMG, an emerging mine also from Australia, became the first overseas member in the Platform. Zhang Jiabin thinks the action of FMG broke the ice.
He points out, due to the coordination with Rio Tinto and BHP Billiton, CVRD had not been willing to break the ice, while the participation of FMG gave it an excuse and implied to Rio Tinto and BHP Billiton that the balance was in favor of CBMX. Therefore, both of them would be more easily to accept the goodwill showed by CVRD to the platform and furthermore, what it signed was just a memorandum of understanding.
In such a way, CVRD has suggested to the Chinese government that it be the first one of the top three mines to support the platform so that it has won some weight in the negotiation on the berthing of its large vessels on one hand; on the other hand, it also took account of the sentiments of Rio Tinto and BHP Billiton. Therefore, it is a wise action.
BHP Billiton will overturn Platts Index?
Until the time when the reporter delivered the news, of the top three mines, only BHP Billiton has not yet taken any substantial step toward joining the platform of CBMX. But it is widely believed in the industry that its participation is around the corner. If it does so in future, its relations with the platform and globalOre will become much subtle.
Some people in the industry has long regarded the relationship between globalOre and the platform of CBMX as being competitive because "the ultimate goal of both platforms is to launch their own price indices separately." The globalOre platform was initiated by BHP Billiton, but most iron ore trade is priced on the basis of Platts Index. This means that whether BHP Billiton will join either of these platforms, Platters Index will inevitably get a hit. In particular, as a shareholder of globalOre, BHP Billiton is likely to damp its own interest, if it joins the platform of CBMX.
In this respect, Zhang Jiabin prefers to believe that the participation of BHP Billiton in either platform is not to overturn Platts Index altogether but rather to upgrade it, "this is likely to be a strategy of BHP Billiton".
An important reason why Platts Index can stand out from a lot of indices to become the pricing benchmark has been the support of the top three mines. But as it is calculated on the basis of price inquiries, it is less transparent to some extent. "In recent years, many companies, especially buyers have shown dissatisfaction over Platts Index." said Zhang Jiabin.
In his view, BHP Billiton has well understood the dissatisfaction of most Chinese traders and steel companies and it is due to such dissatisfaction that CISA and many websites in China have launched a range of price indices to counter against Platts Index.
"As a result, Platts Index cannot be used in the long run, but BHP Billiton is locating a new price index, which is acceptable to the Chinese side, to continue its control over the entire market." He pointed out that Platts Index must be impacted, whether BHP Billiton is to use the index of globalOre or that of CBMX in its trade. But the spread between these two price indices must be small. "Just like other indices on the international market that have a spread of 1-2 dollars only with Platts Index, which has little impact on mines which have huge profits.
However, a new index as such is likely to be accepted by Chinese steel companies and traders. "At the beginning, China did not accept index-based prices, but later they accepted. Then they accepted prices determined case by case rather than Platts Index. If now a new index different from Platts Index is launched, they may think it is fair and are willing to do trade on the basis of it." Zhang Jiabin thinks, "Apparently, to launch another index is irrational while there is already one in place, but in fact what BHP Billiton is going to do is just to launch an upgraded one to relieve the dissatisfaction of Chinese companies over Platts Index for now and the new one is nothing but a mask."
Even though both price indices were published, which to be used would be still dependent on buyers and sellers. As just a service agency, what CBMX can do is to calculate an index on the basis of the data of day-to-day trade, but it is just an option available to mines, steel companies and traders.
Another analyst who did not want to disclose her name gave an example: "If a mine proposes to settle the trade with Platts Index, but the steel plant thinks the price will be lower if the index of CBMX is used. Then, the both parties must negotiate about it in the end and they may reach a compromise to use the weighted average of these two indices. It is a possibility." She thought, "If the index of CBMX is relatively lower and all trade is done on the basis of this index, mines will not lose a lot. However, in the long run, the Chinese side will not necessarily benefit much from it." Spot trade is the real intent of mines On March 20, FMG became the first overseas mine to become a member of the platform of CBMX. This emerging mine, planning to expand its output to 155 million tons in 2013, is eager to develop a large number of additional Chinese clients and it is not of the same magnitude as the top three mines. As a result its participation was just from its own consideration irrespective the feelings of the top three mines Subsequently, goodwill of CVRD and the membership of Rio Tinto have delighted the industry. In respect of such a result, the above-mentioned anonymous analyst thought, "The top three mines must have had their own expectation. After all, compared with the participation of hundreds of Chinese steel companies and traders in overseas platform, what the platform of CBMX needs is to engage overseas mines in a relatively small number. At this point, CBMX is in a favorable position." The industry speaks highly of the great achievement of CBMX, believing it will enable China to have more say in the international iron ore trade. Notwithstanding, except the delight, we also have to note that both platforms, more influence may either of them have, will help overseas mines, in particular the top three mines, realize the goal of spot trade in their iron ore trade. Zhang Jiabin thinks the reason for the Chinese side to strive to promote the establishment of the iron ore spot trading platform has been to save face. Previously, China was always in a passive position in iron ore negotiations and the establishment of such a platform was proposed by globalOre in the first place and followed suit by CBMX. "The Chinese side might think that the trade volume of iron ores is so large that China ought to have a platform; and another attraction is incomes such as handling charges generated from trade on this platform." Overseas mines’ wiliness to join the platform of CBMX and even to do trade on the basis of the price index of CBMX has been more than a sign of their indifference to the platform and the price index. "To execute contracts in line with which index is indeed not important to mines with lavish profits in view of little difference between the averages of indices in a year." He added, like other commodities, to traders, their profits are almost the same whether they do trade on Dalian Commodity Exchange or other exchanges. "However, whatever platform the trade is done on, the spot trading platforms will promote the dominance of spot trade, which is likely the result that overseas mines desire most", He said, "because in the longer run, spot trade is the guarantee for the maximization of the profits of mines. And once this end is realized, steel plants in China will be reduced to nothing but processing plants." According to his analysis, spot trade means that the settled prices of iron ores can be adjusted at any time in line with changes to market supply and demand. In other words, while steel plants raise prices, so do iron ores. "As a result, steel plants can never get excess profits but instead what they will earn is just processing charges. If certain steel plants have higher costs and their products are less competitive, they may stand on the age of losses. Consequently, only those advanced private enterprises or low-cost SOEs can make profits." In his view, the profits in the process of iron ores being converted into steel products are divided mostly between mines and steel plants, meaning the profits of mines must be maximized if those of steel plants are much meager. "Whether the market is sluggish or not, if steel plants cannot make profits, the remained profits are attributed to mines."
Ever since last autumn, some medium and large steel plants have seen their margins less than 3%. "In such a circumstance, all profits have been captured by mines," Zhang Jiabin thought, "mines cannot control the future market demand, but what they can do is to maximize their profits by undercutting those attributable to steel plants, which is the ideal result of the dominance of spot trade."
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