Though 2013 has proven slightly less volatile for certain metals markets (base metals, for example), commodity volatility remains alive and well in the steel supply chain due to four factors, according to Accenture.
These factors have driven companies to a great debate: “…whether the industry should actively embrace futures markets and other hedging mechanisms or rather wait to see how they mature.”
This, in a time when managing commodity risk is more crucial than ever.
The volatility comes from four areas, according to the study – global macroeconomic and financial volatility, emerging markets’ macroeconomic policy flipping, the shift in raw material supply contracts (namely from an annual to a quarterly timeframe) and lastly, the stalling of M&A activity within the global steel industry.
And though the study really examines steel producers’ supply chains, any steel buying organization will stand to glean market intelligence by better understanding the upstream challenges and constraints.
Moreover, steel producers face margin erosion in the form of customer requests for longer quote validity and contract pricing, reduced forecasting capability and degree of fragmentation among the supplier community, creating an increased emphasis on price vs. other product attributes.
Advanced Commodity Risk Management Strategies
The report, not surprisingly, urges steelmakers to adopt a more advanced commodity risk management strategy sooner rather than later, and lays out a series of steps, starting with assessing a company’s appetite for risk.
In turn, steel buying organizations can benefit from some of these same comments in the report. From our own consulting experience, we can confirm companies tend to slide toward one end of the spectrum or another from trading/hedging to reduce margin risk or, to try to (in our words) “beat the market” by taking a position on a particular price movement in an attempt to increase margins.
What often goes unsaid, however, involves a simple fact that most buying organizations miss – buying on the spot market falls into the “speculation” camp anyway, though most businesses deploy this practice as their primary metal purchasing strategy.
Scan the Competitive Landscape
Accenture suggests companies not focus on the question of “how much should we speculate,” but rather determine their risk appetites based upon “an appraisal of the competitive landscape and the insights on how markets for raw materials and products are developing.” To support the strategy, the report suggests all companies develop internal controls and create a risk framework to allow the company to “measure and control risk,” as well as develop clearly defined “policies and directives that disseminate into measurements of risk…”
Next, with a strong foundation in place, firms can begin to form a trading function. Building a trading function allows companies to adeptly establish pricing mechanisms. The report suggests firms can many things, such as improve product pricing, dissect sales contracts (what we might call cost decomposition) and provide forecasting and planning, particularly around budgeting.
The report identifies a broad range of additional benefits to steel producers that adopt a comprehensive commodity risk management strategy, including first mover advantage and improved shareholder returns. The authors also suggest that commodity pricing and risk management strategies will become pervasive throughout the industry, despite the slower uptake in the use of steel hedging instruments on the part of metal buying organizations.
The last page of the report includes a full listing of exchanges and banks that provide hedging instruments to the steel industry.
Also: SAVE THE DATE! October 7-9, 2013