Is it the right time to avoid risk?

Is it the right time to avoid risk?

Available steel and ferrous scrap futures contracts can protect profit margins and cash flow.

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April 15, 2019

Buyers and sellers of finished steel and ferrous scrap can greatly reduce risks to their profitability by locking in a price range for the materials in some of their transactions, according to presenters at a workshop hosted by the Houston-based Mobius Risk Group in April.

The workshop was held in downtown Los Angeles during the same week as the ISRI2019 scrap recycling convention in that city. It featured speakers from the Mobius Risk Group and a presentation from Alberto Xodo of the London Metal Exchange (LME), which offers ferrous scrap and steel rebar trading contracts.

Xodo said the LME’s trading platform and technology is not designed to facilitate high-speed or speculative trading in steel or ferrous scrap. At the same time, the trade lot size, at 10 metric tons, is small enough that smaller buyers, sellers and traders can take part. He said the LME has kept both the lot size and fees low to appeal to smaller scrap recycling companies.

Xodo said some 5 million metric tons of ferrous scrap was traded on the LME’s contract in 2018, marking the contract’s busiest year. (The volume also is much higher than the 600,000 metric tons of steel rebar traded via LME contract.) About half that volume has been placed by traders in Europe, while North America and Asia have accounted for 25 percent each.

Xodo anticipates a volume boost in 2019, citing increased familiarity of the industry with these price management tools and “historical rollercoaster ride” price volatility as good reasons for scrap processors and steel mill buyers to seek “insurance for high-risk dangers.”

Paul Smith, the chief risk officer of Mobius Risk Group, said there likely is more trading taking place than is tracked by the LME, since there also are over-the-counter trades tied to the contract.  A sample trade reviewed by Smith and his colleague Mohit Arora showed how hedged trading could reduce the risk of margin compression by some 75 percent on finished steel and ferrous scrap traded by a fictitious company during a given month.

Fixed pricing tied to contract trading can provide “confidence, profitability, a margin” and can “normalize” cash flow, said Smith. Smith said service centers are beginning to reward customers who hedge part of their ferrous trading portfolio, and lenders are considering tying a “reduced cost of capital” to steel and ferrous scrap contract trading.

Also at the seminar, Joe Eckelman, a senior pricing specialist at S&P Global Platts, commented that 2018 witnessed nearly unprecedented spreads between the price of ferrous scrap and that of finished hot-rolled coil (HRC) steel.

While the spread often is in the $270 to $330 per ton range, Eckelman said it “got away” and soared above $500 during part of 2018. If 2018 was a picnic for scrap dealers, said Eckelman, it was “a massive house party” for steelmakers, many of whom recorded record profits during the year.

Eckelman said the healthy electric arc furnace (EAF) steel sector in the United States should “drive the need for prime scrap, direct-reduced iron (DRI) and hot briquetted iron (HBI) in the future.” The DRI facility in Louisiana operated by Nucor Corp., after struggling with technical issues in 2016 and 2017, is now producing at levels to help supply that company’s furnaces in the U.S. Southeast.