LME Hedging Tools Steel Takes One Step Forward, Plastics Takes Two Steps Back

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For much of this year, MetalMiner has written extensively on ETFs (Exchange Traded Funds) as they relate to PGM (precious metals), REE (rare earth elements) and now base metal ETFs. But before ETFs, came futures markets that for many metal-buying organizations remain very much a black box risk management tool. Though many metal buying organizations don’t or can’t take advantage of formal hedging contracts, what has become clear is that these organizations have asked suppliers to lengthen contracts and hold firm (and fixed) pricing for the duration of the period. And on the flip side, the supply side, commodity volatility has resulted in shortened contract terms. In other words, buyers want more certainty (to mitigate risk) whereas mills and suppliers face more commodity volatility than ever before (think about the trend of the iron ore contracts moving from annual to quarterly to now spot prices). All of this has resulted in an increased need for risk mitigation tools such as futures contracts. And yet making a new market remains challenging. In fact, the LME announced this week it would end its six-year plastics futures contract due to poor volume (e.g. liquidity) and lack of open interest.

Yet on the steel side of things, we see growing interest here in the US. In fact, Sterling Steel Co. LLC, a unit of Leggett & Platt applied recently to the LME to have its company (and billets) registered for delivery under the LME steel contract according to this article. We consider this development interesting for a couple of reasons. First, the US market in general, tends to lag other markets (from a metals futures trading perspective). Most of the futures contracts and metal ETFs originated overseas. Second, producer participation in futures markets appeared less than fully enthusiastic about the use of these exchanges.  But with the addition of Chicago and Detroit as authorized points of delivery for the steel billet contract and more buying organizations seeking to manage price stability, we should not find ourselves surprised that finally a US steel billet producer has decided to participate. We expect more to follow suit.

As we have said many times before on these virtual pages, commodity volatility has become a permanent fixture of the metal sourcing landscape. A key core competency, quite new to metal buying organizations, involves a deep understanding of hedging techniques and mechanisms. At a minimum, companies will need to understand some of the basic language and trends e.g. forward price curves, contango, backwardation and how their purchases correlate (statistically) with various futures contracts. By no means “are we there yet in fact for many steel products the correlation remains less than robust. But eventually, more products will become available and more industry participants will take active roles to mitigate risk.   As a buying organization, if you are asking your suppliers/mills to hold contracts fixed for longer periods of time (and your suppliers agree to do so, a big if in today’s markets) just know that you are paying a risk premium to those suppliers/mills.  Instead, buying organizations will want to come up the learning curve on these hedging techniques to better manage their own risk (and costs).

–Lisa Reisman

Comment (1)

  1. Anonymous says:

    Lisa, you note that “for many steel products the correlation remains less than robust”, being more specific here would be very useful. Are you talking about a lack of correlation of US long products to the LME billet contract or something else?

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