As the Big 3 iron ore producers have altered the way they manage contracts with key steel customers (going from annual to quarterly back to spot, most likely), steel producers have faced a challenge in aligning sales contracts with purchase contracts. According to a recent article, about 60% of ThyssenKrupp’s customers have long term or annual contracts. It appears as though Thyssen would like to move to annual contracts with formulas, adjusting on a quarterly basis to avoid a time-consuming negotiation process. Instead, Thyssen will rely upon raw material indexes and pre-agreed upon formulas with clients to set the annual contracts that will automatically adjust on a quarterly basis. Apparently, this represents the first time Thyssen has openly discussed its contracting process.
Of course, using price indexes as a means of contract negotiation is nothing new. In fact, many metal buying organizations regularly deploy index-based formulas as a means of not so much saving money but reducing risk. MetalMiner has written extensively about the use of price indexes as a basis for contract discussions we have re-linked to two posts which go one step further in laying out the contracting options for rising, falling and flat markets:
In the case of steel coming from integrated producers iron ore and coking coal represent the two largest cost factors in producing one ton of steel. Iron ore spot prices continue to rise, see chart below:
Source: Iron Ore and Steel Derivatives Association
In addition, our own models show a 39% increase in iron ore from the April July time frame. For coking coal, the numbers increased by 4% over the same time period (we used $167 as our iron ore input cost per ton and $117 per ton for coking coal those numbers based on IMF data and EIA data).
For steel coming from EAF producers, the major cost variable involves scrap. Although steel scrap prices have drifted down in recent months, they remain higher than 2009 price levels and in recent days have seen upward movement for both No. 1 HMS scrap and shredded scrap. We will post an article tomorrow covering metal scrap markets.
In the meantime, the tracking of key raw material cost inputs remains a primary function for most metal category sourcing managers. Combined with a strategic sourcing initiative to lower the value-add costs (the non-metal related cost elements), the use of price indexes can help mitigate price risk.
As many of you know, MetalMiner operates a global metals price index, MetalMiner IndX(SM) for a range of steel products and non-ferrous metals covering several Asian markets. The service is free. You may register for the service here.