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Thursday, February 10, 2011

The Story of how FMC allowed Iron Ore futures

I read in Mint(article here) about the Indian commodities futures regulator FMC Chairman permitting commodity exchanges to offer iron ore contracts. But it was only during his talk(described in my other post) that the details of this decision was explained. Mineral ores are bulky, difficult to transport(poor transport from mines) and hard to deliver on the exchange platform(can you have warehouses for 1000's of tonnes of ore). Still, as iron ore exporting states had either banned(Karnataka) or sought bans(Orissa) on export of iron ore, the FMC thought of introducing a contract to help hedge against the resultant price fluctuations.

When the FMC had received a proposal 4-5 months ago about introducing these futures, it took them time to decide on a 'reference price'. After all, ore quality varies as per the mine, and the price is excluding transportation costs which can vary as per distance, mode(truck/train) etc. Also, the spot market is fragmented and small due to long term purchase commitments. But when they resolved the issue of 'reference price', they had to forgo the 'physical settlement option' prevalent in other commodities.

The absence of physical settlement may induce price manipulation but as mentioned by Mr BC Khatua, the basic metal ores(iron, copper) being widely tracked and monitored, the manipulation risk is low at the domestic level(of course, in my view, you cannot account for global mining cartels). It is too early to evaluate whether this futures contract will help steel producers but it should be interesting.

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