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The London Metal Exchange (LME) launched three new contracts this week — LME Aluminium Premiums, LME Steel Rebar and LME Steel Scrap, the first new contracts to be offered by the Exchange in more than five years.
The two steel contracts are cash-settled against physical Turkish scrap and rebar price indexes as opposed to the current steel billet contracts that are settled by physical delivery and have largely proved to be a failure since launch.
Why, we might ask, would these new contracts prove anymore successful? Well acknowledging the failure with billet, the LME has worked assiduously to garner industry support both in the shaping and specification of the new contracts. Goldman Sachs, for example, is on the LME’s steel committee and major trading firms like Stemcor have publicly stated they intend to be actively involved from day one, although they still add the caveat “subject to market conditions and liquidity.”
Liquidity was always a major issue for the billet contract. It never secured anywhere near enough interest from the trade to generate sufficient volume and, hence, a fair market price.
Rebar and Scrap
The steel scrap and rebar contracts will be traded on LME Select in small lots of just 10 metric tons making them more accessible for smaller market players, while, at the same time, the LME is offering discounts for volume trades to encourage liquidity.
It is clear the LME is cognizant of the risks associated with lack of uptake and has put considerable effort into getting the trade on board from the outset, according to Reuters. One has to assume that, as a result, there has been significant buy in from key market players and that uptake will be quicker and more comprehensive than for the old billet contract.
The success of cash-settled contracts in the iron ore market suggests there is an appetite out there for hedging in the steel supply chain and the attraction of hedging for firms engaged in the gradual inventory build of volatile-priced products like steel scrap seems, on the face of it, to be obvious. Both the trade and speculators will be watching with interest.
Of more interest to the users of the LME’s largest contract, aluminum, is the simultaneous launch of the long-awaited physical delivery premiums contract. In fact, so long-awaited that many were of the opinion the LME had missed the boat.
The industry was crying out for such a contract at the height of the premiums scandal. This time last year premiums were heading for nearly $500 per ton but during 2015 they have collapsed reverting to near historic levels of around $100 per mt. In recent weeks, though, as if on cue, they have begun to rise again, currently to around $160-170 per ton with every prospect of a tighter domestic US market (as the likes of Alcoa and Century close smelters) resulting in higher premiums next year, maybe the LME’s timing will prove to be good after all.
Some would argue the CME Group has beaten the LME to it, their US contract was brought out in 2012 and, this September, they added a European version with plans for a Japanese contract next month. To date, though, volumes have been disappointing and, although they are increasing, still lack the liquidity that only comes from volume. The LME contract by comparison has four regional variations, the US, Europe, East Asia and South East Asia, and will be physically as opposed to the CME’s contracts, which are cash settled. How popular they will be remains to be seen, whilst there was clamour for such a product a year ago uptake may be slow. The original Aluminium contract took a long time to gain traction being shunned by the industry in its early days before growing now to the largest contract on the LME.