Some of Australian miner Rio Tinto's iron ore lump term buyers are seeing greater exposure to price risk from the floor premiums set in their contracts, amid the sharp fall in spot lump premiums this year.
According to several contract buyers of Rio Tinto's flagship 62%-Fe Pilbara Blend lump, the contract premium of PB lump is settled against the monthly average of weekly Platts spot lump assessments and adding a value premium of $0.005/dry metric ton unit.
But in the event the monthly average Platts lump premium assessment is lower than the floor premium set by Rio Tinto -- which ranges from $0.01/dmtu to $0.06/dmtu among different buyers -- in the term contract, the floor premium is used as the settlement premium instead.
An official from Rio Tinto's Singapore office said he could not comment on term contract issues when contacted by Platts.
Platts last assessed the weekly 62.5%-Fe spot lump premium at $0.0625/dmtu on October 28, down sharply from $0.31/dmtu on January 7.
A source from a major steel mill, whose floor premium is set at $0.01/dmtu, said: "It is unlikely for market to fall to below $0.01/dmtu level. It has little impact on us so far and I am not too worried actually."
But for buyers whose floor premiums are set at $0.05/dmtu or $0.06/dmtu, the downtrend in lump premiums means they will have to pay higher prices compared with spot buyers.
A Beijing-based trader, whose floor premium is set at $0.05/dmtu, said that "when we signed the contract, [the] spot lump premium is much higher than [the] floor price. No one expected that market will come down so soon."
But most buyers are unlikely to drop their term contracts in favor of the spot market, as their lump term purchases are bundled together with PB fines.
"If you want to take fines from the miner, we need to buy lump at the same time. It is part of [the] term contract and almost non-negotiable for contractual customers," one of the term buyers said.
He added that every co-loaded cargo normally comprises 100,00 mt fines and 70,000 mt lump.
Looking ahead, lump premiums are unlikely to stage a seasonal recovery at the end of the year -- as it did last year -- because of losses incurred by steelmakers and an oversupply of lump cargoes, according to market sources.
Lump premium had fallen to an all-time low of $0.035/dmtu on June 18, 2014, before rebounding gradually to above the $0.30/dmtu level at the end of last year, Platts data showed. "Lump supply keeps going up in Q3 and [the] market is flooded with lump cargoes. I think it is very easy [for the lump premium] to fall [to] below $0.05/dmtu level, but we still need to pay [the] floor price to meet term commitments." said a source from a central China steelmaker which has renewed its term contract at a floor premium of $0.05/dmtu.
"It will definitely bring more financial pressure to steel mills, not to mention all steelmakers are losing money and every penny is very important now," he added.
The Beijing-based trader noted that PB lump is trading at a premium of $0.03/dmtu at the Chinese ports.
"[It is] still difficult to offload cargoes [at that level]. I would not be surprise to see [seaborne] spot premiums fall to $0.05/dmtu mark," he said.
Rio Tinto produced 34.67 million mt of PB fines and 24.31 million mt of PB lump in the third quarter of 2015, up 13% and 25% respectively from Q3 2014, according to the company's production report released in October.
