We recently printed the details of an interview with Brad Clark of leading scrap swaps brokers Freight Investor Services, about the opportunity the OTC scrap swaps market could provide for those companies involved in the EAF steel market to hedge their price risk.
As Brad said at the time, a large part of their work is in education, making the market of the opportunities scrap hedging can provide and explaining how it works. The release by Freight Investor Services (with support from The Steel Index) of a detailed 17-page report moves that process purposely forward by providing market participants with a detailed and concise explanation of the background, structure and workings of the steel scrap swaps market for the first time.
To better understand what the report contains, we caught up with Sam Mehew, derivatives broker at FIS, Tim Hard, director of steel & scrap at the Steel Index (TSI), and Jarek Mlodziejewski, an analyst at TSI in London, to better understand what the report contains and the value for anyone interested in managing their steel price risk.
According to Mehew, the motivation for producing the report sprung from the same challenge Brad was facing in the North American market — namely, education. In fact in Europe, scrap processors and scrap consumers are (if anything) even further behind the curve than in the US, where the presence of a progressively more liquid HR coil contract for the last few years has meant players are more aware of the benefits of swaps for price hedging. Also, a direct correlation for those in long products can be drawn from experience in the flats market that have been using the HRC contract.
Hard advised that the swaps market faces “early adopter syndrome,” wherein 90 percent of the industry is unfamiliar with scrap swaps and yet participants readily admit they operate in a volatile market with considerable medium-to-long-term price uncertainty. Most individuals in the steel industry, whether producer or consumer, are aware (via the press) of the success of the iron ore swaps market in providing price hedging for those involved in the BOF production route.
But iron ore swaps provide little or no opportunity to hedge for those linked to the EAF or Electric Arc steelmaking side of the industry, in spite of nearly a third of the world’s 1.4 billion tons of steel being produced via this route in 2010. Tim pointed out that while iron ore, even in the very latest price model formulated by TSI, makes up only some 48 percent of the cost of one ton of steel produced via the BOF route, scrap makes up for 80 percent in EAF steel, a far higher proportion of costs.
So if a scrap-based index offers far greater visibility into the EAF market and price dynamics, I asked, are there material differences between TSI’s scrap index and other providers?
Check back in for Part Two.