WALL STREET AND MINERS TO GAIN AS BENCHMARK SYSTEM IS LEFT BEHIND

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For more than 40 years, iron ore prices have been settled in secretive – and often acrimonious – negotiations between global steelmakers and miners. The tradition fell apart yesterday as BHP Billiton said the iron ore price for a third of its customers would be determined by prices on the spot market.

The move – a victory for BHP's chief executive Marius Kloppers – has an unexpected winner: Wall Street's banks. Analysts and bankers say it will be a critical boost to the nascent derivatives swap market, where investors can bet on the direction of iron ore prices.

“While the futures market for iron ore is still small, we expect it to become increasingly important as the nature of iron ore contract sales changes,” says Christopher LaFemina, mining analyst at Barclays Capital in London.

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The swaps iron ore market was launched by Deutsche Bank and Credit Suisse last year and between May and December of 2008 traded a volume equal to about 7m tonnes of ore, a fraction of the 180m tonnes transacted last year in the physical spot market.

Recently, banks such as Morgan Stanley and Barclays Capital have joined, and volumes have increased to about 12.5m tonnes so far this year, brokers say. The Singapore Exchange and LCH.Clearnet, Europe's leading clearing houses, have also joined, offering clearing for the private, bilateral, over-the-counter contracts.

Traders and brokers say Asian steelmakers are getting ready to participate in the market – joining some shipping companies, iron ore miners and hedge funds – but acknowledge that the development of the derivatives will be painfully slow. Another barrier is Beijing's reluctance to the use of derivatives by steelmakers.

If the experience of trading aluminium or coal is any guide – where a derivatives market emerged in the 1980s and 2000s, respectively, as the industry changed the way it priced the commodities – it could take up to a decade for the iron ore swaps market to develop fully.

Steelmakers could use the swap market to hedge the cost of iron ore, in a similar way to oil companies hedging the cost of crude for their refineries. Miners can also raise finance easily by locking up an iron ore price years in advance, bankers say.