By Maytaal Angel
LONDON (Reuters) - Top steelmakers ArcelorMittal and Tata Steel are dipping their toes into iron ore derivatives, marking a crucial milestone in developing trade for the world's second-largest commodity after oil.
Although the steelmakers continue to say publicly they do not use such products, sources said ArcelorMittal hedged a block of iron ore trades in September while Tata recently decided to use derivatives on a small scale next year.
"Arcelor are definitely trading iron ore swaps, they were active in September. But it's not being pushed top-down - they're trying to figure out how to organise themselves," a source with knowledge of the matter said.
A separate source said the decision to hedge at Tata had been taken at board level.
Both steelmakers declined to comment. Market sources say the two companies had opposed iron ore and steel derivatives on the grounds that such instruments could give speculators undue price influence.
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Iron ore derivative volumes are set to reach some 550 million tonnes this year, having roughly doubled every year since their launch by the Singapore Exchange in 2009.
Steelmakers and merchants in China - by far the world's biggest iron ore consumer - embraced the products.
Now, with the cautious entry of ArcelorMittal and Tata, a trend could be set in motion whereby smaller rivals follow suit, speculators jump in and volumes soar even further.
"The entry of the mills could bring the derivatives market to a tipping point fairly soon," said Steve Randall, managing director of price-setting agency The Steel Index.
"I expect next year we'll see over 1 billion tonnes of iron ore derivatives traded. That's getting close to the 1.3 billion tonnes of physical seaborne iron ore traded each year," he added.
The popularity of iron ore derivatives coincided with an explosion in spot market volumes around five years ago, when the market moved from annual benchmark pricing to shorter-term contracts based on daily indices. That raised price volatility and the need by industry participants to better manage risk.
Prices of iron ore - a key steelmaking input - have been volatile this year, falling 48 percent. While this should increase hedging needs, some experts say weak prices might temper enthusiasm among smaller steelmakers for hedging.
"High-cost iron ore producers have been priced out of the market, so price volatility could ebb next year. Smaller steelmakers could then say iron ore is not that volatile so why hedge," an industry source said.
However, most agree the script for iron ore has been set. They note that steelmakers are already under pressure from their clients to use derivatives in order to offer supply contracts that have prices fixed for several years.
"We're approaching investors who we want to sell windmills to and if we have a big risk on the steel element it makes us less attractive. One-year contracts are good but we'd like two-to three-year contracts," said Nikolag Ager Hamann, from the procurement department at wind-farm developer Dong Energy.
(Additional reporting by Silvia Antonioli in London; Editing by Veronica Brown and Dale Hudson)