Scrap Futures – Coming to a Market Near You

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This week I am attending the ISRI conference here in Chicago. For those of you not familiar with ISRI (Institute of Scrap Recycling Industries), they put on quite a comprehensive commodities round table event covering a full range of scrap markets. We’ll try to cover key metals-related scrap markets over the coming three days. Monday kicked off with ferrous metals and in particular, a lengthy discussion about the development of scrap futures markets here in the US. Before your eyes glaze over, consider some of the key pieces of background information shared by panel speakers Pat McCormick of World Steel Exchange and Paul Shellman of the CME (whom MetalMiner has spoken to previously on the subject of futures markets). Both speakers confirmed two trends related to steel scrap prices. The first trend involves steel price volatility specifically that volatility will not go away (no surprise there). The second trend involves the long-term cyclical growth of global steel production (and hence the rising demand for scrap). Paul also pointed to several other trends of interest, in particular, “spot pricing in steel making raw materials will become the new paradigm. And though the iron ore producers moved to quarterly price contracts, spot pricing reigns supreme.

Because spot pricing creates greater volatility, “the industry will have to deal with persistent price volatility, according to Shellman, “futures will help manage price exposures. Shellman continued by saying that vertical integration simply doesn’t work. It hasn’t worked in other markets and won’t work for steel. And though many metals markets have balked at futures contracts, many of the “newer futures tools have actually done remarkably well, notably the molybdenum and cobalt contracts.

In many respects, the Chinese are much further ahead of the US when it comes to steel futures contracts. Pat mentioned that the Shanghai rebar contract has already traded more than 200m tons of steel. One conference attendee posed the following question, “we’ve survived a long time without these tools. Why are these tools necessary now and what is the downside? How can these ultimately be instituted by people and companies? Pat from World Steel Exchange answered by saying, “The price movement for scrap was pretty much a flat line. The volatility and inventory risk in dollars and cents has become more significant. Now we have a slow-growth advanced country economic outlook. It’s hard to transfer the price changes (editor’s note: price fluctuations) down the supply chain. Someone has to manage the risk. The number one question people should be asking is, “how do I manage my exposure to scrap? Obviously the panelists believe steel scrap futures contracts can serve as a big part of the answer.

Another audience member asked whether or not the “speculators have caused the increase in prices for other markets (much attention gets paid to oil speculators at the top of the market in 2008). Paul Shellman answered that question, “futures markets change the contango/backwardation of the forward price but they don’t change the underlying supply/demand equation in the physicals markets. Futures markets have highly restrictive participation as to who gets to take possession of say crude oil and in this case steel scrap. In a regulated market, it is controlled.”

As to the steel scrap contract specifications, Pat suggested his firm had developed three contracts – each for 20 gross tons. For prime scrap he suggested No. 1 busheling .999 even though the index is a composite index meaning it covers multiple geographies. Participants can hedge exposure to price change. For obsolete there will be a shredded contract, now favored from a handling standpoint. On the international market Pat said there would be a No. 1 HMS contract because it is still a very popular export grade.

Scrap buyers and sellers will want to pay close attention when these futures contracts are launched.

–Lisa Reisman

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