More futures in the future

Recyclers and traders of copper and aluminum scrap have become thoroughly familiar with using COMEX and LME (London Metal Exchange) contracts to hedge or manage risks caused by volatile pricing.

The ferrous scrap sector has been far slower to embrace the idea, in previous decades seldom turning to any proposed contracts that might allow them to spread the forward risk caused by a rapidly dropping price. (Or by a rapidly rising price, in the case of mills, foundries and other buyers.)

The closing years of this decade could bring about a change in that nonferrous versus ferrous divide, with entities including the Nasdaq Futures Exchange (NFX) in New York and the LME offering contracts specifically designed to allow ferrous scrap sellers and buyers ways to reduce the risks caused by price volatility.

FINDING THE PEG

Ferrous scrap is traded in several different grades and flows across international borders in considerable volumes. Thus, finding benchmark grades and destinations to serve as a peg for scrap contracts becomes one consideration.

Two different organizations, however, have identified what they see as the right fits for ferrous scrap trading contracts.

In November 2015, the London Metal Exchange (LME) introduced its Steel Scrap contract, which is based on a surveyed price calculated by the S&P Global Platts company. Specifically, says Alberto Xodo, deputy head of ferrous at the LME, the contract is tied to the Platts TSI (The Steel Index) price for 80 percent No. 1 heavy melting steel (HMS) and 20 percent No. 2 HMS bound for Turkey.

“The steel market is a truly global market, and the Platts TSI index for HMS 1&2 80:20 CFR [cost and freight] Turkey is the global benchmark for steel scrap, making it relevant for all companies with exposure to scrap prices, regardless of their location,” says Xodo.

In December 2017, the NFX began trading its Midwest Shredded Steel Scrap AMM (American Metal Market) Index futures contract. According to John R. Conheeney, president of Englewood Cliffs, New Jersey-based World Steel Exchange Marketing (WSEM), “WSEM is working with NFX to develop and promote ferrous futures products. U.S. shredded steel scrap is the first ferrous product of several we expect NFX to roll out.”

Adds Conheeney, “The NFX United States Shredded Steel Scrap futures are priced on an FOB (free on board) mill basis. Its delivery footprint is Wisconsin, Iowa, Illinois, Indiana, Ohio and Michigan. Shredded steel scrap prices have an extremely high correlation with the other domestic obsolete grades.”

Scrap trader Nathan Fruchter of Idoru Trading Corp., Lawrence, New York, who has accepted an advisory role with the LME on its new contract, sees each of the new products as being of use to scrap generators, processors, sellers and buyer wherever they may be. “These contracts are really for everyone, domestic or international, it doesn’t matter what country they’re in. It’s a form of protection for the scrap metal recycler, steel producer and trader.”

Conheeney says the NFX contract “provides long product steelmakers and users with a good risk management tool, as their prices are directly impacted by the price of shredded. Also, demolition contractors will now be able to hedge the price of the steel they recover, and roadbuilders can know the price of their rebar before they bid on a job.” On the global trading front, adds Conheeney, shredded ferrous scrap “is being shipped in containers to countries like India.”

RISKY BUSINESS

For as long as it has been traded, ferrous scrap pricing has risen and fallen based on supply and demand considerations that can change significantly from month to month.

Backers of the new ferrous contracts, however, say the per-ton prices have risen and price volatility has increased as the world economy has grown more interconnected, providing valid reasons for ferrous scrap sector participants to hedge their now greater risks.

“Hedging can provide a lot of benefits, which derive from gaining the ability to bring a higher level of certainty to a very uncertain and volatile trade,” says Xodo.

Veteran trader Fruchter comments, “Physical traders, recyclers and steel mills don’t want these big sudden market swings ruining a year’s worth of hard work and profits. Nobody has [that much] appetite for risk. Also, the marketplace today is not what it was 10 or 15 years ago. We have seen far more volatility in the ferrous scrap industry in recent years.”

Any time scrap processors hold ferrous inventory for more than 30 days, they are exposing themselves to risk, says Conheeney. “If they are holding unhedged inventory into the next month, then they are speculating. If they want to speculate, they may find that using the futures is an easier and cheaper way to be long the market; and the futures provide a way to get short that is not available to them now.”

The past two decades have provided several examples of this, according to Conheeney, with the steel industry in particular experiencing circumstances that led them to do more hedging. “Before 2003 there just was not that much volatility in steel or in raw material prices [so] there was little incentive to hedge. Hot-rolled coil (HRC) steel prices jumped from about $280 per short ton in August 2003 to $750 just 12 months later. Between July 2007 and July 2008, HRC rose from $520 to $1,080 only to fall in June of 2009 to $400. This volatility made it hard for mills to offer customers fixed price contracts. Thus, supply contracts priced to a published monthly index or pricing formula has become the norm for many.”

FORWARD THINKING?

Will the ferrous scrap industry follow the steel industry and the nonferrous sector into a future where more trading is hedged and pegged to a futures contract?

“We’re in a different world economy today and need some tools to help us navigate carefully,” says Fruchter. “Call it protective measures if you have to, but as a physical trader who has spent 34 years in this industry, I cannot stress the importance of proper risk management. I advise it today to all my clients and business associates. I cannot stress it enough. It’s the way of the future.”

As of mid-November 2017, more than 3.25 million metric tons of ferrous scrap had been traded on the LME contract since its launch, according to Xodo. Conheeney’s comments to Recycling Today were made the week before the NFX contract launched, but he expresses optimism in its future.

“We’ve seen a growing acceptance of futures at least in concept in the industry, and I expect to see an accelerating adoption of these financial tools over the next few years,” says Conheeney. “Every commodity I can think of has a futures market. The ferrous product [sector] is second only to petroleum in size, and I can’t imagine that the industry won’t be regularly monitoring and placing trades in steel scrap, HRC and any number of related products 10 years from now.”

Xodo offers his core business reason why the new contracts may be the best path forward for ferrous scrap recyclers and mill buyers alike who want to reduce their market exposure risk. “Risk is like matter,” he comments. “It can’t be created or destroyed, only transferred.”