London Metal Exchange to Launch Steel Scrap and Rebar Contracts

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The LME has come a long way since the Jerusalem Coffee-house on Cornhill in the City of London 137 years ago.

Not geographically, it’s just a little further along the road now on Leadenhall Street, but certainly in becoming the global benchmark for base metal prices. Some 80% of base metals traded around the world have their prices set to LME benchmarks and a mere 11 ring-dealing members set prices in the open cry forum and LME Select electronic platform.

That was just shy of $15 trillion dollars and 4 billions tons of metal in 2013, in spite of competition from other metals bourses, not least of which is China’s growing Shanghai Futures Exchange SHFE. So it’s not as surprising as it may at first seem, that the LME is planning to offer hedging services in steel products, an area the SHFE has been active in for some years, as it seeks to maintain its prominence in metals markets.

Steel Products

According to Bloomberg the SHFE started steel rebar contracts in March 2009. That contract is now the most-traded metal by volume in China, with 293.7 million lots valued at 10.9 trillion yuan ($1.7tn) changing hands in 2013, according to SHFE data.

This week, the SHFE has added hot-rolled coil with nine monthly contracts from June to March 2015. Hot-rolled coil will join rebar and steel wire to provide a spread of steel semi-finished product price-hedging services principally for the Chinese domestic market, but increasingly of interest to international investors.

Not to be outdone, the LME announced this month they intend to introduce cash-settled (as opposed to the exchange’s more common physically delivered base metal) contracts for rebar and steel scrap. The LME has been operating an underwhelming and unsuccessful steel billet contract for a number of years which, in spite of recent changes to make it less global and more European, is STILL struggling to gain traction.

The First of Many?

If the new rebar and scrap contracts do better in the cash-settled form, the LME has said they may introduce iron ore, coking coal and even steel coil in a second phase. Even so, the rebar and scrap contracts won’t launch until next year, a Reuters article reports. They will probably come out shortly after the aluminum physical-delivery premium contracts, which will also be cash-settled and were announced earlier this year in response to the market’s criticism of the disconnect between the LME aluminum price and the actual price consumers now have to pay to secure physical delivery of the metal from mills and traders.

It will be interesting to see if the LME’s steel contracts gain sufficient interest to reach escape velocity. To do so, they will need to become sufficiently liquid to give reliable price realization and hedging opportunities for producers, consumers and traders. In reality, buyers are often the last to embrace new pricing opportunities, investors usually see it as a speculative opportunity and their participation is what creates the liquidity.

Speculators Are Key

Whether there will be a flood of investors keen to play the rebar and scrap markets remains to be seen. Construction is weak and the LME’s steel billet contract has not proven attractive to the steel billet/rebar community. Scrap may prove more attractive to the trade, by its very nature the industry requires time to accumulate parcels of inventory exposing traders to price fluctuations. Logic suggests a hedging tool may be of value in such circumstances. Modern scrap dealers are a sophisticated bunch and could readily accommodate hedging tools if they proved reliable and mitigated risk.

Full marks to the LME for trying to continually reinvent itself and stay relevant to a fast changing world, we will be keen to see how the new contracts attract interest when they finally come to market.

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