Two days ago I attended a webinar hosted by the OESA (Original Equipment Supplier’s Association), for the automotive industry. The presentation covered the new HR coil steel contract that will be available via Nymex beginning October 20. And though the presentation covered many of the technical aspects of the contract and the high level benefits, I felt it didn’t address some of the very fundamental questions that many sourcing professionals, who may have limited experience in hedging and derivatives may want to see addressed. This post attempts to address some of these questions:
1. Who exactly (and be specific please) can take advantage of this HR Coil contract?
Anyone in the supply chain can take advantage of this contract including an OEM, component supplier, service center, or distributor if they face price exposure to hot rolled coil. In other words, it is not necessary that a company be purchasing plain hot rolled coil. They could be buying a product that contains hot rolled coil. If a company has in place a negotiated contract for a component, assembly, product etc in which the contract is tied to movements in hot rolled coil pricing, the Nymex Midwest Hot Rolled Coil contract could apply. If a company is purchasing a product that is made from other semi-finished steel products like pipes, bars etc then this contract would not apply.
2. Would the contract apply to CR coil since CR coil depends upon HR coil?
In theory, cold rolled coil should move in conjunction with the price of hot rolled coil but in actuality, other factors can influence the price of cold rolled coil that don’t affect the hot rolled price. The Nymex contract would not be applicable to CR coil.
3. Why would I want to hedge my HR coil purchases if the market appears to be heading down anyway?
Let’s examine that one in a little detail. First, I would highly advise every reader contemplating this new steel coil contract to consider how Southwest Airlines has protected it’s profits going back to 1998. This USA Today article from the summer explains some of the benefits Southwest achieved using a risk management strategy around jet fuel hedging. In short, for companies that have margin exposure to hot rolled coil prices (in other words, for companies that can’t pass on price increases), taking advantage of a hedging mechanism in a downward market can help a company ‘lock-in’ its price position for a longer period of time then simply relying on the spot market, which is subject to price increases. If you look at what Southwest did in comparison to the other major airlines, the strategy paid off. American Airlines paid $3.17/gallon earlier this year while Delta paid $3.13. And Southwest? They paid $2.17. Of course this example demonstrates a success in a rising market. And Southwest has not placed a significant contract in over 15 months, according to the article. Does that mean that the strategy is no longer workable? No, but market conditions are still unsettled, though crude futures are way off their high and back down to $93.95/barrel. But you can bet one thing – Southwest is monitoring prices like a hawk. They may very well lock in some contracts as the market moves down, to maintain that lower price (hence margin) stability.
If you are seeking to learn more about the new US Midwest Hot Rolled Coil contract, check out the following links:
We will continue reporting on this contract and its impact on manufacturing companies. In the meantime, if you have a question, drop us a line at lreisman [at] aptiumglobal [dot] com. If we don’t know the answer, we’re happy to research it!