Articles on: Metal Prices

Lately, our most popular inbound phone call involves our soon-to-be-released GOES Index followed by the rant/request for our thoughts on the latest steel mill price increases. That call basically goes like this: “Lisa, the mills have raised prices again, but I don’t see how the raw material prices support the increase. What do you think?

By habit I tend to say, “let me take a look and I’ll write a post on it.” So, we will now attempt to answer the question does the underlying raw material data support the recently announced mill price hikes? We could argue both yes and no.

The Case for Yes (Price Increases Are Justified)

As a fan of history, one need only look back over the past three years to see that scrap prices (though we’ll only show HMS #1 as an example) remain stubbornly high. Now granted, we haven’t seen any great price movement in August. In fact, according to The Steel Index, domestic shredded scrap prices have traded within a relatively tight spread — a low of $440/long ton in May to a high of $463/long ton in July, only to settle somewhere in the low $450’s/long ton now.

Sources: Steelbenchmarker.com and MetalMiner

The Case for No (Price Increases Not Justified)

Obviously, with no obvious upward sloping line, buying organizations may quickly come to the conclusion that a price increase seems out of line. However, when one considers seasonality and the timing as to when steel prices peak and trough within a calendar year, a different story starts to emerge. First the factoids:

  1. Steel prices bottomed in mid-August
  2. Turkey has recently experienced strong domestic demand for rebar, according to The Steel Index, and Turkish demand serves as a great proxy for steel scrap price direction
  3. Demand often picks up after Labor Day

As another example, take a look at this nearly two-and-a-half-year price chart of hot rolled coil prices:

Sources: Steelbenchmarker.com and MetalMiner

Price troughs have occurred in the summer months (July/August) as well as in the month of December (or November). What follows looks like an upward price ascent immediately following each trough. Although scrap prices have held steady (remember, they remain historically high) and we haven’t even commented on either coking coal or iron ore (other key raw materials), steel prices have already bottomed. And if history tells us anything, mills may have taken their pricing queues from that. When we hear mills talk about “market conditions,” we can infer they have analyzed similar trends; at least we can say that with some reasonableness based on the past couple of years.

Steel producers believe “market conditions may appear ripe for a price increase. Of course that only holds true if demand holds true. So you tell us how does demand look?

–Lisa Reisman

Global aluminum output has been steadily rising since the start of the year, supported mainly by Chinese and Middle East/Gulf growth with the market in a net surplus of 221,300 metric tons, according to the World Bureau of Metal Statistics.

Long-awaited production cutbacks in China failed to materialize in the early summer and if anything, growth continued with China producing some 41 percent of global production by the middle of this year. However, a Reuters article reports aluminum producers in China’s Guangxi province will start cutting production in September due to power shortages there, a move that is expected to support prices in the fourth quarter, the news service says.

Around 15 percent, or over 120,000 tons per year, of Guangxi’s 810,000-ton annual production capacity of aluminum may be affected by the power shortages, and although only equivalent to only 4 percent of China’s total production capacity, the cuts would be enough to push the country’s demand and supply from a slight surplus to equilibrium, a local analyst is quoted as saying.

Apparently the southern area grid is facing a deficit of 10 percent in power demand, due in part to a drop in hydro power production. The grid also supplies Guizhou and Yunnan provinces, both of which produce about 1 million tons per year each. We have been advised by some China specialists that smelters generally have captive power agreements or facilities which make them unlikely to be impacted by wider grid shortages, but the drop in production last month suggests the smelters are more vulnerable than reported.

The WBMS estimated China was a net exporter of 185,000 tons in the first half of this year. That figure could easily be reversed with current closures and it’s entirely possible we will see the country swing into net imports, particularly at current market prices which are not favorable for the highest quartile of Chinese aluminum producers. Rusal has just posted a much lower set of numbers for the second quarter, blaming raw materials, power and labor — all contributing to a 70 percent collapse in profits. Prices were high in the second quarter, which suggests power costs are even beginning to seriously impact one of the historically lowest cost producers outside of the Gulf region. Rusal is hoping for higher prices by year end to counter its rising cost base.

Meanwhile, traders, banks and hedge funds continue to buy and store physical metal in long-term financing deals, a trend that is likely to continue with low interest rates and traders such as Glencore earning off both the forward price curve and the cost of warehousing now that they own the storage companies. Leading analysts such as Harbor Aluminum predict prices could be back up above $2,500 per ton by year-end and suggest now is a good time to be buying forward. Recent firmness taking the price back above $2,400 per ton has more to do with dollar strength than the effects of Chinese production cuts, but eventually these will filter through and impact the market, particularly if the closures spread to other regions.

–Stuart Burns

Yesterday we talked through a couple obvious use cases for daily price data services. Today we review three additional use cases. As the use of price data becomes more ubiquitous, what companies do with the data has become far more strategic. Savvy sourcing organizations have gotten into the business of transforming price data points to actual market intelligence, serving as the basis for specific sourcing strategies. We will continue to explore these uses over the coming days.

Using Price Data for Negotiations

Though the use of price data for negotiations may appear obvious, how companies actually deploy these models suggests a wide range of practices. In addition, pricing data can serve both on the front end of a negotiation process as well as on the back-end. Let’s start with the front-end.

In this case, buying organizations may opt for the use of daily pricing data when they strategically source a metal category in which the metal portion of the total cost “floats against market, but the sourcing organization competitively bids and holds fixed the value-add premium. We have seen this use case used dozens of times in our strategic sourcing engagements.

Often, buying organizations deploy what we call the “3-bid monthly buy, essentially bidding out the company’s total metal requirement on a monthly basis. Under that scenario, the buying organization doesn’t realize that it often places both elements of its purchase up for a spot market bid both the metal and the value-add. More strategic buying organizations bid the category and competitively bid and hold fixed the value-add portion and merely bid the metal premium. Sometimes a buying organization can win using the 3-bid method, but over time, we’d contend that the strategic sourcing process of splitting out the two results in a lower total cost of ownership.

So how do metal buying organizations use daily price data on an ongoing basis? Invariably, they use it when producers announce price increases. Our anecdotal evidence suggests this case presents itself more commonly for steel purchases than other metals.

The scenario plays itself out this way: US Steel recently announced a $60/ton increase on carbon flat rolled steel to the spot market price. Buying organizations began scratching their heads. We received emails such as this: “I’m trying to figure out how much US Steel’s raw material costs have gone up. They just instituted a $60 a ton increase to the spot market price, I don’t see it from a raw material aspect. In short, buying organizations use daily price data to track raw material costs.

Pricing Data Used for Global Sourcing

We see a couple of uses of price data in the field of global sourcing. The first involves the use of the data to monitor global markets and identify when it may make sense to globally source semi-finished products.

Whereas the service centers and distributors take greater advantage of global sourcing opportunities for semi-finished metal products than OEMs (though some of very largest OEMs remain exceptions) by tracking global price points, companies can take advantage of arbitrage opportunities.

We’d argue the bulk of western manufacturers more likely than not buy more value-add metal products from global suppliers (vs. semi-finished products) such as fasteners, sub-assemblies, etc. and for them, the value proposition of using a daily global price data service allows them to keep their overseas suppliers honest in terms of the impact of metal prices increases on the total cost of the particular item sourced globally. We see this in our own MetalMiner IndX pricing service.

In a follow-up post, we’ll cover a couple of advanced use case scenarios for daily metal price data.

–Lisa Reisman

True to our roots as sourcing professionals (once our day job, before we ran this website), we help companies gain a better understanding of the raw material inputs and other costs associated with the purchasing organization’s metal component, sub-assembly or assembly. We do this by breaking apart the constituent elements of whatever the client ended up buying.

Recently, a colleague dropped us a line wondering how the steel mills could raise prices when raw material costs appear on a flat-to-downward trend (we’ll address that issue as well). In the meantime, back in the days (pre-2003) when commodity prices fluctuated within a narrow band, the relevance of price data for industrial metal buying organizations appeared less than necessary. But volatility resulting from emerging market demand and the rise of commodities as major investment opportunities provided the impetus for the development of price data tools. Over the next couple of weeks we will drip out a series of posts examining ten or so methods buying organizations can deploy to get the most out of metal price data as our own service, MetalMiner IndX, has undergone a long-needed overhaul.

Primary Uses of Pricing Data

The methods range from the obvious, two of which we will cover today, and also the less obvious, which we will cover in follow-up posts.

The primary use of price data services, in our humble opinion, serves as a means for a company to track their purchasing performance against the market. In other words, daily price data helps sourcing managers and procurement professionals identify and track market trends and allow them to “time purchases whenever possible in the dips, as well as track company performance against the market.

Perhaps more importantly, daily pricing data allows the buying organization to explain to management why it took the buying decisions it did. Ten years ago, buying organizations barely tracked these kinds of movements, but today this represents the likely first step of any metal procurement organization.

A second rather obvious use of daily pricing data involves price escalator and de-escalator clauses used for contracting purposes. In rapidly rising markets, the use of these types of clauses within contracts grows, but when markets decline, so too does the use of these tools. Whereas price escalator and de-escalator clauses certainly offer buying organizations some assurance in terms of how their own contracts will follow underlying market price trends, distributors and producers often complain how they get deployed in practice, particularly when market conditions can make their use problematic.

Furthermore, indexes work well for certain products — particularly semi-finished aluminum and copper products and stainless products — when surcharges and volatility tie directly to base metal markets, but price correlation becomes weaker for items with higher value-add where the metal price falls below one third of the total cost of the item (e.g. pipe and tube products often fall in this category).

Moreover, if an organization consistently buys under market year-in and year-out, the use of these types of clauses would not help the buying organization’s cost position (though we’d argue most organizations don’t beat the market over time).

Pricing Data Not Accepted Here

Perhaps a trickier issue for buying organizations to manage involves the buyer and supplier to agree on the price index to use. Whereas the Midwest aluminum ingot price has become the de facto standard for pricing aluminum contracts, a steel contract has not become industry standard (we have seen buying organizations use CRU, the Steel Index, SteelBenchmarker and others) so gaining two-party agreement can become a challenge.

Nevertheless, as time goes on, we believe pricing standards will emerge.

–Lisa Reisman

Novelis, the global leader in producing rolled aluminum products, posted record profits last quarter totaling $62 million, compared with $50 million in the same period in 2010, according to a Novelis press release and conference call. Novelis has a pretty bullish outlook on the aluminum market, betting that demand will be hearty enough to sustain its plans for expansion worldwide.

The 24-percent year-over-year increase in profit and 16-percent year-over-year increase in adjusted EBIDTA (up to $306 million) puts Novelis in sound territory going into H2. Sales during the quarter were up 23 percent, to $3.1 billion. Novelis buys 3 million tons of aluminum per year. And according to their CEO Phil Martens, they’re just getting started.

“We are on track and on budget with all of our global expansion projects, including our Brazil and Korea mill expansions and our strategic automotive investment in the U.S., Martens said via press release.  “These expansions, coupled with our debottlenecking initiatives, will add 1,000 kilotonnes of additional capacity and position us well to meet our customers’ needs today and well into the future.”

Last quarter, the company posted 767,000 tons of shipments, up 3 percent from the 746,000 tons during the same quarter in 2010.

Looking Ahead

Later, during a conference call, Martens said that Novelis “expects aluminum demand from the auto industry to increase by 25 percent by 2015, with demand from the electronics sector growing 10 percent to 15 percent and demand from the beverage can sector growing 4 percent to 5 percent. Although electronics and beverage can demand has slowed down in Europe, they’re still quite bullish on the car industry; furthermore, they indicated that expansion plans would not be hampered by global volatility surrounding stock and commodity markets.

One should look no further than my colleague Lisa’s series on The Car Wars to see that aluminum sheet and coil are taking more prominent places in the various sectors, replacing steel in the auto sphere and glass in beverage packaging.

Of course, one must also keep an eye on the rising demand and increase in price of aluminum scrap. A big part of Novelis’ strategy is to increase their use of recycled aluminum scrap from 34 percent now to 80 percent by the end of the decade, as Senior Vice President Erwin Mayr told us at the Harbor Aluminum Outlook Conference. (For an excellent rundown of Novelis’ macro outlook, click here.)

A recent WSJ article highlights the scrap shortages in copper and steel markets, as well as in aluminum, saying that it may not be until the end of the decade that we see replenishment in global scrap supply. US shredded steel scrap is up about 33 percent since last year, and finished HRC is up 25 percent, according to the article.

If anything, Novelis’ sheer size and reach across the globe is a good indicator that industrial demand in the aluminum market should only grow, as the replacement factor and rate of recycling both drive its popularity. While a good thing for producers (including the likes of competitors Alcoa and Norandal), buyers should make sure they have forward sourcing strategies firmly in place to ride out any price increases.

–Taras Berezowsky

So many issues in the global economy are colliding that conditions may be ripe for a perfect commodity firestorm.

Europe continues to battle its deeply mired sovereign debt problems; the Middle East crackdowns seen in Syria of late are worrisome for a region primarily paid attention to for its oil; and the still-largest economy in the world has seen a protracted struggle between its two beleaguered political parties over how much more debt the country can afford. (“Sure, the primary season is months away, but who cares? Hope you enjoyed this pre-election-year spectacle, folks!)

Because of all this, gold is the highest it’s ever been. Safe-haven precious metals are spurring investment interest, as they tend to do when currencies are in danger of diving. Exposure to physical gold, silver and others through ETFs is equally hot. But what about physically backed industrial-metal ETFs?

Focus: The Aluminum ETF

With all the media coverage on how the LME is handling the situation with its certified warehouses in Detroit, it’s hard not to keep our focus trained on the metal. ETF Securities released an aluminum ETF back in early May, and, interestingly, since then, only 2 warrants have been created, according to the ETFS daily-updated warrant list. The first deposit was made on May 3, and the second on June 13; no activity since then. (One warrant of LME aluminum equals 25 tons.)

As we began looking at the other five industrial metal products, we noticed a falling-off in activity the past two to three months:

Graph: MetalMiner. Data source: ETF Securities

Although the copper and tin ETPs each saw increased inflows in the beginning of the year, pretty much all metals have seen virtually no activity since May. (Forty-two warrants of copper were withdrawn from May to June.)

Yet investors have shown the least interest in aluminum overall.   Also, interestingly, one of the two aluminum warrants in the ETP is housed in a warehouse in Detroit.

So this begs the questions: does the Detroit warehouse debacle have any direct correlation with the interest (or, rather, lack of interest) in the aluminum ETF? And are ETFs in general an alternate option for metal buyers to hedge their price risk in a volatile commodities market?

No and no, according to Townsend Lansing, the London-based head of product development at ETF Securities, which offers some of the oldest and most extensive physically backed metal funds.

MetalMiner spoke with Lansing to try and get to the bottom of the aluminum issue. While he declined to delve into the process by which ETF Securities acquires metal from the LME that goes into the ETP contracts due to confidentiality concerns, he did say that since the primary investors are not buyers or producers, but rather folks simply with a desire for exposure to the metal. Therefore, he said, the inventory bottlenecks are “not something that would necessarily affect us.”

The impacts are on the premiums as opposed to the LME spot price, Lansing said. He also said that the ETFs are focused on acquiring LME warrants, and whether warrants are created, traded or decreased, the metal itself won’t be moving out of warehouses into the investor’s physical possession.

“ETCs (exchange-traded commodities) would not provide additional benefits it wouldn’t make sense from the buyers’ perspective, since they will continue to buy directly from producers in existing bilateral arrangements, Lansing said. Physically backed metal ETPs may only make sense for investors choosing between that and futures. If the contango curve is steep enough, then the roll costs for a futures contract would be higher, he said.

In other words, there is no play for metal buyers in the physically backed sphere since the ETFs deal with LME warrants if industrial buyers wanted to circumvent the LME for their metal, they’d be better served to “move off-exchange.”

So if the warehousing issue doesn’t impinge on the ETF flows, what is to blame for the lack of investor interest in the aluminum ETF? Our guess would be that the combination of oversupply and relative inexpensiveness of the light metal is preventing investors from buying up those warrants. The sheer tonnage of aluminum one must amass to equal the relative value of precious metals or other scarcer base metals likely serves as a turnoff.

The number of held warrants in ETFS’ industrial metal funds, ultimately, seems proportional to the market value of the metal. To boot, the disinterest in the aluminum product owes itself to proportionally higher warehouse rent for storage, according to Lansing. Perhaps if aluminum (hanging out in the $2,000 to $2,500 range the past six months) traded in the range of copper or tin (in the $10,000/ton range), it would be a different story.

–Taras Berezowsky

Continued from “Commodity Review and Second-Half Outlook – Part One”:

Aluminum, Zinc and the LME

Although aluminum by some standards has been in the dumps lately (i.e. throughout Q2), we can encapsulate much of the light metal’s activity to the LME warehousing issue. Even though the LME has just doubled the amount of tonnage that may be removed per warehouse per day, it won’t be effective until next April.

While that might operative word, might alleviate some supply- and lead-time bottlenecking, what does it mean for the rest of 2011? Higher prices?

Perhaps not, as intimated by Harbor Intelligence at their recent Aluminum Outlook conference. Jorge Vazquez and his team look at hundreds of indicators daily, and their overall assessment is that aluminum prices may reach much higher into 2012 and beyond but will likely remain at today’s levels, perhaps lower, until then.

Source: Reuters

However, LME issues have bled into another metal market that of zinc. Reuters recently reported that, according to several firms’ analysts, zinc prices will likely rise significantly in the second half of the year despite record-high inventories. Not only that, many estimate some 60 percent of zinc stocks in LME warehouses are “tied up in financing deals.

This forces buyers to try and get around LME-warehoused metal, but in turn, they must pay higher premiums. According to the article, physical premiums are at about 8 cents per pound, whereas last year the premium hovered at 4.5 to 5.5 cents. European premiums are also reaching highs hit in 2008.

Oil, M&A and OEMs All Worth Watching

A few other points to consider looking toward H2 of 2011:

  • OEM/producer profits and outlook: In terms of the producers, we’ve been hearing some nice profits being reported for the second quarter. Using three firms as an example, Caterpillar, Nucor and SSAB, the Swedish steel producer, all reported higher net earnings; all three, however, voiced concern that higher raw material costs and potential demand slowdown may hamper their bottom lines in Q3. Producer and OEM activity could be something to watch.
  • M&A activity in mining sector surging: Speaking of those raw material costs, mining firms are driving to consolidate to make greater plays on coal, gold and iron ore. Ernst and Young reported that so far in 2011, total deal value clocks in at $96.3 billion, which is nearly equal to 2010’s total, according to Reuters. E&Y’s global mining and metals transaction advisory leader, Lee Downham, said he expects the 2011 total to reach nearly $200 billion.
  • Oil price forecast shows no sign of slowing down: Fuel costs will remain high as far as we can see, according to several analysts, as political fractiousness and rapacious emerging world demand continue their upward trends. “Oil industry analyst PIRA estimates incremental demand will outpace supply by 1.1 million barrels per day on a year-over-year basis during the third quarter of 2011, writes San Antonio-based investor analyst Frank Holmes. He also notes that the International Energy Agency (IEA) expects oil to average $98/barrel this year, and $103/barrel next year:

Source: International Energy Agency

*Check back in with MetalMiner for a look at how quarterly pricing contracts have changed the iron ore world for good.

–Taras Berezowsky

 

The notion of “Made In America” takes on new meaning when one considers the evolution of a story that first appeared in the New York Times on June 25. That story examined the rationale behind the State of California’s decision to source the San Francisco-Oakland Bay Bridge largely from China (at least the materials; e.g. steel and the structural fabrications).

On July 4 we wrote about that project, specifically calling out the fact that arguably the most tree-hugging state in the nation thought nothing of either sustainability or carbon footprints when deciding to accept the project bid from American Bridge (yes, that moniker is somewhat ironic given the story) and Fluor Enterprises.

Not surprisingly, Roger Ferch, executive director of the National Steel Bridge Alliance, submitted an open letter to the NY Times (that was not published) in which he cited large cost over-runs, the loss of US jobs as well as poor environmental stewardship in the Caltrans award decision. MetalMiner reviewed both the NSBA letter to the Times editor and spoke with Brian Raff, NSBA’s marketing director, to verify how the trade association calculated the cost over-run.

He pointed us to this article and quote: The SF Public Press (December 2009) states, “the stated price of construction has grown nearly fivefold, from the $1.3 billion estimated in 1996 to more than $6.3 billion today. A year and a half later, the NYT article specifically mentions that, “at $7.2 billion, it will be one of the most expensive structures ever built.” This reasoning led us to state an overrun of $5.2 billion ($7.2B (NYT) 1.3B(SF Public Press) = $5.2B).

This video highlights the delay with the steel shipments:

From a Sourcing Perspective

Call us crazy, but based on our own personal experience in the area of strategic sourcing with dozens of global sourcing projects under our belts, we would argue that statehouses lack the understanding needed to make TCO (total cost of ownership) decisions. In fact, we’d submit that our own home state of Illinois likely leads this list. So we thought we’d reiterate the high-level sourcing criteria states ought to consider in greater detail when sourcing mega infrastructure projects:

  1. Materials (the obvious place most organizations will examine)
  2. Labor costs — let’s not just look at a wage comparison chart, but rather factoring in the cost of quality (QA trips to China ought to be part of the equation)
  3. Contract administration costs
  4. Project management costs (particularly in light of potential delays)
  5. Inspection costs — both US QA personnel and also third-party inspectors
  6. Freight/logistics costs
  7. Duties/tariffs
  8. Inventory carry and finance
  9. Carbon footprint as measured in output of emissions associated with the movement of the materials (raw materials and otherwise), transportation costs (fuel, pollution costs)
  10. Sustainability use of recycled materials for the production of steel (China mostly uses blast furnaces as opposed to electric arc furnaces)

Somebody once told me the best items to source from China ought to fit in shoe boxes. Whoever thought this would save California money had a screw loose.

Undoubtedly, other major domestic infrastructure projects will come to fruition soon. Hopefully, state procurement offices will do a better job sourcing those projects than Caltrans did.

–Lisa Reisman

Late last week the London Metal Exchange announced a rule change impacting any warehouse holding over 900,000 tons of inventory. The new rule would require those warehouses, beginning in April of next year, to load out a minimum of 3000 tons per day rather than the current 1500 tons per day. The rules primarily impact the Detroit Metro warehouse, owned by Goldman Sachs, said to hold about 25% of the world’s aluminum supply. Early indications suggest some large metal buying organizations do not believe the rules go far enough to address what they see as a market distortion perpetuated by warehouse owners (e.g. Goldman Sachs in the case of Metro, the warehouse with 7-10 month delays, but also JPMorgan, Trafigura and Glencore).

Most of the press accounts of the story paint the Wall Street bankers/warehouse owners as “more accountable for the market distortion than industrial metal buying organizations, though we did recently interview Jorge Vazquez of Harbor Aluminum who articulated several points worth repeating. We summarize the key points here:

  • The market distortion (and subsequent delays) affect those buyers who are “short the metal and those who hold LME warrants in the Detroit warehouses.
  • Any new rules should apply “to the margins only meaning load out changes should only impact new metal coming in, not metal already sitting in warehouse
  • Consumers suffering the most from today ´s high prices and premiums and long lead times were probably the ones that first decided not to approach their vendors/producers to lock in metal but to stay short or play it via the LME.

The LME arguably made only modest tweaks to the rules. According to the Financial Times, on Friday, Martin Abbott, chief executive of the LME cited a Midwest critical truck shortage as an issue impacting the decision on the minimum load out rate. We talked to Sean Devine, Co-Owner and Founder of Partage LLC a partial truckload brokerage firm here in Chicago. Sean reiterated Abbott’s comment regarding a truck shortage, ” the flatbed trucking market is much tighter now than it was at the beginning of 2011. National spot prices are up at least 15% before fuel surcharge, and price increases have been even more dramatic in the mid-west, he continued, while a sudden surge in demand could be disruptive, we believe that problems could be avoided through a phased ramp up in the minimum loading out rate. Carriers would respond fairly quickly.

The LME announcement did not discuss a gradual ramp-up in load out rates.

Regardless of Cause¦

Industrial metal buying organizations have a number of spend management solutions available to them to avoid the aluminum warehouse bottlenecks. We see some of those solutions as obvious (“hedge more) to less obvious (form a consortium/buying group with non-competing firms to book capacity and volumes at a negotiated rate with producers to avoid having to purchase metal on the spot market [e.g. LME].) Taking a leaf from Goldman-Sachs industrial buyers can pay a premium to direct supply to its own warehouses when needed as opposed to buying on the LME.

Though we haven’t read an independent study conducted on behalf of the LME, undoubtedly the LME wanted to address criticism proactively lest businesses start to move aluminum purchases “off exchange. And yet, wearing our sourcing caps, that solution moving off exchanges represents an interesting, viable scenario. By calculating the TCO (total cost of ownership) of paying the “Metro bottleneck tax aka the “Goldman price premium, buying organizations may wish to aggressively look to manage that risk and seek alternative sources and/or hedge their purchases.

We certainly can’t blame the Wall Street firms for seeing an opportunity and seizing upon it but that doesn’t mean industrial buying organizations need to play by the[ir] rules.

–Lisa Reisman

Yesterday, we published a piece by Brad Clark discussing the opportunity contango steel markets present to traders and hedgers. But as MetalMiner readers know, industrial metal buying organizations rarely and we’d argue if ever, have the opportunity to hedge for the sole purpose of making money. In fact, we’d argue that most corporate treasury groups and/or risk management organizations view hedging as a means to mitigate risk either in terms of locking in margins and or providing some price assurance in otherwise volatile markets. Playing the market so to speak is a no-no. Certainly, some small percentage of industrial metal buying organizations can and perhaps do have the technical competence to “make money by playing the market but we’d argue that still represents the exception and not the rule.

Regardless of his angle, we thought Brad did an excellent job of explaining to readers how one in theory could “make money in contango markets. However, we’d like to frame the issue in terms of how both distributors and industrial metal buying organizations may wish to modify their particular sourcing strategy given current prices. Let’s begin with the three scenarios laid out in Brad’s post:

Scenario One:   If your steel intelligence suggests to you that steel prices today may appear in a seasonal trough or sit lower than one might expect prices to go later this year, one can buy HRC close to $700 ton today. At the same time, the buying organization (distributor or otherwise) would buy $700/ton physical coil and sell the futures contract for Q1 at $780, locking in $80/ton.   Assuming the cost to carry this physical coil, financing plus warehousing costs at five dollars per month, you could lock in $50/ton virtually risk free. That statement contains an assumption so the buying organization would have to evaluate if it could indeed finance and warehouse metal at five dollars per month. The larger distributors, with a low cost of capital may have a greater opportunity to take advantage of a contango market than say a smaller player with higher finance costs.

Scenario two: Perhaps a more realistic scenario looks like this one, “as a physical steel player who say sits on inventory (we’d posit that either larger industrial companies and/or distributors often sit on inventory) in a falling spot market, that organization could sell forward the Q1 futures contract at $780/ton and protect the company’s profit¦almost like insurance. Playing this angle more from a risk mitigation standpoint, if a company’s inventory exceeds its order book, it could sell forward a portion of its inventory via a futures contract to “lock-in a favorable margin.

Scenario three: If you have no position, but believe the spot market will pick up and/or sentiment will change sometime before Q4 you can buy Q4 futures at $740/ton and sell Q1 at $780/ton and lock in a $40 dollar time spread.

Scenario four: This scenario doesn’t actually involve “playing the steel futures market. In highly liquid markets, a contango situation tends to provide intelligence as to the direction of the underlying commodity. Though as Brad points out, in markets with less liquidity, anomalies can occur yet still the forward price curve does suggest where markets may head. So the question steel buying organizations may wish to consider involves the timing of purchases and the average price paid for steel throughout 2011.

Buying organizations may wish to consider taking some price risk off the table buying on the spot market now to cover booked demand. That strategy could help lower the organization’s average cost. Savvy organizations and organizations with sizable metal spend have begun to play in futures markets. We’ll see where prices go by the end of Q3. As the old trader’s adage goes buy low and sell high.

–Lisa Reisman

Disclaimer: The author is long ArcelorMittal, ThyssenKrupp, Nucor, Vallourec and Voestalpine

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