Iron Ore Pricing
STATEMENT ON MONETARY POLICY | august 2012
15
Box B
Iron Ore Pricing
Graph B1
In recent years, the prices received by Australian
iron ore producers have become more responsive
to shorter-term developments affecting supply
and demand. This reflects a move to shorter-term
contracts and a larger share of iron ore being traded
at spot prices. It has resulted in an increase in the
variability of iron ore export prices, which feed into
Australia’s terms of trade.
Until the mid 2000s, most trade in iron ore was based
on longer-term contract prices. Hence, the average
export price of Australian iron ore closely followed
the annual fixed-term contract price (Graph B1). In
2007, an especially large gap opened up between the
spot price and benchmark contract price as demand
growth outstripped that of supply. This created an
incentive for iron ore producers to sell additional
supply into the spot market. Conversely, when the
spot price fell below the contract price in mid 2008,
there was an incentive for those buying iron ore to
minimise their purchases of iron ore under contract
and purchase instead on the spot market. The large
gaps between spot and contract prices also induced
buyers and sellers to renegotiate existing contracts.
Consequently, around this time an increasing share
of iron ore began to be traded either on the basis
of shorter-term contracts or in the spot market. The
initial move was from annual to quarterly contracts,
and over time to monthly contracts.
The gradual move from quarterly contracts towards
monthly contracts, and from contracts to spot sales,
has occurred for iron ore exports from Australia and
other large producers such as Brazil. The move to
spot sales appears to have accelerated since the end
of 2011 as the sharp fall in the spot price for iron ore
at that time encouraged buyers to push for contracts
to be renegotiated to shorter terms.
Market reports suggest that, in aggregate, monthly
contracts and spot sales now account for more
than half of all Australian iron ore exports, although
this share varies somewhat across producers. The
remainder of Australian iron ore exports are based on
longer-term contracts, many of which are quarterly,
with some large Japanese steel mills reportedly
preferring this pricing arrangement.
All of these changes in pricing arrangements mean
that the average Australian export price of iron ore
moves more closely with prices in the iron ore spot
market than in the past.
The increasing use of shorter-term price contracts
has also encouraged more activity and liquidity in
iron ore derivative markets as firms increase their use
of hedging instruments. One example is over-the-
counter iron ore swap contracts, which are derivative
contracts in which one party agrees to pay the other
party a fixed price in return for receiving the average
iron ore spot price over the term of the swap.
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40
80
120
160
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40
80
120
160
Iron Ore Prices
*Month average; iron ore fines; free on board basis
** RBA estimate of quarterly contract from 2010 onward
Sources: ABARES; ABS; Bloomberg; RBA
2012
Spot*
US$/t
201020082006
Contract**
Average
Australian export
price
US$/t
20042002
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