ArcelorMittal, Short Term Contracts and the Price of Steel

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ArcelorMittal, the world’s largest steelmaker posted a large loss yesterday of $2.6b for the fourth quarter. Though the loss comes as no surprise, the explanation behind the poor performance suggests two very divergent strategies on the part of producers which have lessons for the customer buying side as well. Unlike it’s competitor Thyssen Krupp who relies on long term contracts, ArcelorMittal relies on spot purchases according to this Forbes article. And though the markets may be discouraged by this news both for Arcelor and for the economy in general, there are some interesting points worth noting.

Though this strategy of taking on a greater mix of spot buys vs. contract buys may appear to be backfiring right now, let’s not forget that ArcelorMittal posted record profits during most of 2008 and outperformed its peers by being able to pass along price increases quickly. ArcelorMittal relies on contracts for only about 20% of its order book, the rest come from spot purchases. Thyssen Krupp, on the other hand, relies on long term contracts for 60% of its business. Long term contracts may not allow a producer to take advantage of the highest prices in the market, however, they do provide earnings protection on the down side. In other words, contracts can help mitigate earnings risk.

From a customer perspective, long term contracts make a lot of sense in rising markets, particularly if the buying organization can “lock-in” lower pricing through a hedge or other forward instrument. But in falling markets, nobody wants to get stuck holding the bag, so to speak. Short term buys allow a firm to capture price declines to average against high prices paid earlier.

The real question to ask however – how many additional production cuts will get implemented in 2009 to shore up the price of steel seems to be answered at least for the short term. According to Steel Business Briefing, Arcelor announced an additional 12m ton cut for Q1 ’09. This is 1m tons more than Q4 ’09. Furthermore, production capacity will range from 55-60% through March, until “de-stocking is completed,” according to SBB.

De-stocking of course relates to overall demand. We’ve heard wild variances among manufacturers in terms of volume for 2009 vs. 2008. What do your volumes look like? Take our quiz below. We’ll publish the results on Friday.

–Lisa Reisman

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