Steel Hedging – Let the Games Begin!

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The LME’s first steel contract made its “soft launch” this past Monday ahead of full service being introduced in April of this year. The contract allows for steel billets in 65 ton lots to be traded 6 months forward for delivery to either the Marmara region in Turkey or Dubai, UAE for the Mediterranean contract or to Johor Malaysia or Inchon South Korea for the Asian contract.

As expected, volumes were low and probably orchestrated by some of the larger players to start the trading. The LME, however, was satisfied with the first day’s $1m turnover. It is hoped the contracts will pick up quicker than a plastics contract launched three years ago which failed to attract much interest, or for the Dubai Gold & Commodities Exchange (DGCX) steel contract launched late last year and now averaging 75 contracts or 750 tons a day. The DGCX contract is for reinforcing bar (rebar) used in the construction industry; consequently it is very applicable to the local Dubai market which is booming. The LME contract on the other hand is for steel billets, one step back up the food chain from rebar (billets are considered the starter material for making not just rebar but wire rod and merchant bars too). Consequently, the LME is hoping that consumers of a wide range of steel long products will take up the contract to hedge their forward supply risks.

Certainly there is much to aim for; a total 636 million tons of billet were produced in 2006, more than 10 times the total 61.3 million tons of non-ferrous metals such as gold and aluminum in the same year. The steel billet market was valued at $310 billion in 2006, about 35% more than the $230 billion value for all of the LME’s non-ferrous metals products. How much and how quickly the LME’s contract is taken up remains to be seen. There has been considerable skepticism from the larger producers. They see a futures contract as increasing the probability of volatility and running counter to their own efforts to bring stability to the market by consolidation and production management. The main interest in the contract has come from the banks and from small to medium size suppliers and manufacturers. The banks see it as a potential route to hedge risk on loans to the industry and (here comes the major producers concern) as a vehicle to tap into another lucrative volatile commodity market. Interestingly none of the western steel producers have applied for their billets to be approved as a deliverable brand. All the accepted brands are East European (principally Russian and Ukrainian), Turkish, or Greek with one Asian exception from Malaysia.

Of greater interest to US manufacturers is the eventual launch later this year of the much delayed Hot Rolled Steel Coil market by New York’s NYMEX exchange. This contract will allow consumers of steel sheet and plate to finally access a forward market. It will also allow buyers to arrange their physical purchase contracts accordingly, essentially locking in current pricing over a much longer term than producers are currently willing to offer. This is an issue for the steel goods market that we have seen time and again – the inability to create a national benchmark for steel pricing and to hedge the risk on the underlying metal component of semi finished and finished goods.

So it may have been a soft start but it’s likely to ring in some fundamental changes to the way steel is priced in the years ahead. We welcome the new contract and feel this will bring significant benefits especially if the LME’s lead encourages NYMEX to get their act together on the HR coil contract over the coming months.

–Stuart Burns

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