is the world’s second-largest after crude oil. It is 15 times the size of all other metals markets combined in terms of metric tons and it is worth twice their . Yet until recently, it was an industry that saw little use for a futures primarily because major steel participants were able to enjoy stable, -term for the materials they needed.

For 40 years the globe’s biggest steel producers were able to negotiate long- term pricing arrangements with their customers. In addition, global demand for steel continued to peak, year-after-year, leaving producers with little concern that manufacturers would walk away from their purchase agreements.

Now, stable prices are a thing of the past. Prices for iron ore, one of the essential raw materials for steel production, have become far more volatile, sending shocks rippling through the supply chain. That volatility has been compounded by the economic contraction in most of the major economies and increased sensitivity to .

42 www.futuresindustry.com hese trends have made steel futures reached between these two groups would term pricing mitigates non-performance on T increasingly attractive to many of the then be a benchmark for the rest of the steel contracts when spot prices differ widely from major players in the steel industry. This year industry in the following calendar year. benchmark prices. has seen a surge in volume in two markets in This benchmark system has been break- Steel industry experts say that because particular—the steel rebar futures market at ing down with participants both on the sup- of this change in iron ore pricing, prices for the Shanghai Futures Exchange and the steel ply and demand side calling for shorter term all products across the steel industry have billet futures at the . pricing. become volatile. According to figures tracked The Shanghai market is by far the “Previously the steel mills and their cus- by the Steel Index, prices for iron ore, hot larger of the two. In terms of metric tons tomers knew what the price was going to be rolled coil in the U.S. and Europe and rebar of steel traded, SHFE volume is 200 times for an entire year. Now the industry is mov- have fluctuated from quarter to quarter since larger than the LME market. But it is avail- ing to quarterly pricing. There is now the the beginning of 2009, with prices in some able only to traders within China, making risk that prices will fluctuate from quarter to segments fluctuating by nearly 30% from it of little use to international steel produc- quarter,” said Chris Evans, head of business one quarter to the next. (See Figure 1, which ers and manufacturers. development at LME. “In the steel market, shows quarterly price changes tracked by the The LME contract, on the other hand, where customers are buying for longer term Steel Index from the first quarter of 2009 was carefully designed to serve as a bench- projects, that level of uncertainty is bad through 2010.) mark for the global steel trade. Volumes are news. Increasingly the market is looking for “There is an inherent volatility in steel still relatively small, but the contract is begin- ways to against that.” prices and this volatility is going to get bigger ning to gain some traction among traders and In early 2010, the world’s three larg- and bigger since there is no such thing as a consumers looking for protection against est iron ore miners—Brazil’s Vale and yearly benchmark,” said Jean-Luc Fioren- price fluctuations. Ford Motor Company, for Australia’s Rio Tinto and BHP Billiton— zoni, director of Stemcor Risk Management, example, has been urging other manufactur- broke away from this 40-year custom. a unit of the world’s largest independent steel ers and producers to embrace the futures Instead these miners, which together trading company. markets. account for 70% of the world’s total iron The ups and downs of the global economy “Steel is one of our largest raw material supply—have switched to index-based quar- has also impacted prices. Prices first doubled buys, and reducing price volatility ultimately terly pricing. This in turn has had a ripple and then halved in a 20-month period, helps us more efficiently produce new vehi- effect on prices for raw, intermediate and according to Hard. “People are really strug- cles,” Lisa Tresigne-King, Ford’s director of finished steel goods, according to Tim Hard, gling with managing their price risk,” he said. global raw materials and stampings, said in a manager of The Steel Index, an independent “If you look at the prices over the last statement to Futures Industry. “A steel futures steel and iron ore price information service year, peaks and troughs have not only come market gives us an additional tool for hedg- that provides weekly reference prices based higher and lower but they’ve gotten closer,” ing price risk.” on actual transactions. said Butch Zeederberg, a veteran steel Iron ore prices may become even less at Balli Steel in Dubai, an independent stable. In recent months BHP Billiton, trader of steel for manufacturers, mills and Why Now? the biggest of the three miners, has called other users. “There has been a lot of volatil- Efforts to build a steel futures market are for monthly pricing. In a September 2010 ity and that always encourages more liquid- not new, but it is only in the last two years presentation hosted by the Steel Business ity.” Zeederberg added that steel industry that the contracts have finally taken off. One Briefing, Mike Henry, the company’s presi- participants are also beginning to better of the main reasons is that steel producers can dent of marketing, noted that with shorter- understand how to use a steel futures market no longer lock in long-term pricing for iron term prices market players “can enjoy prices as a hedging tool. ore. truly reflective of supply and demand condi- Iron ore is the primary raw good used to tions.” In addition, he explained that shorter produce steel. Although many steel products are made from scrap metal, prices for iron ore have the single biggest impact on prices Figure 1 across the entire spectrum of steel supply. These prices in turn impact construction, Quarterly Price Fluctuations in the Steel Industry the auto sector and other key manufacturing industries that are the pistons driving the 2009 2010 global economy. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 For decades, iron ore prices had been Iron Ore (China) 1% 0% 26% 10% 36% 21% -14% 10% decided in private negotiations between a USA Hot Rolled Coil -26% -20% 27% 1% 17% 11% 14% -5% select group of miners and steelmakers that dominated both spot and contract markets. European Hot Rolled Coil -21% -11% 22% 2% 6% 20% -7% 2% Traditionally, the first deal that would be European Rebar -15% -1% 11% -2% 5% 16% -7% 1% Source: The Steel Index

January 2011 43 There is still some opposition to steel the product,” said Stemcor’s Fiorenzoni. on the exchange. During the first three quar- futures among steel producers, however, His firm provides services for every step in ters of 2010 volume rose to 180 million con- partly out of concern that it will become the steel supply chain, including financing, tracts, up 160% from volume of 69 million an entry point for financial speculators. For providing raw materials, trading, distribut- contracts during the same period in 2009. example, the German Steel Federation issued ing and stockholding of steel for the retail (See Figure 2 which shows SHFE volume.) a statement in 2007 defending traditional sector. “Steel futures are another tool in the Each Shanghai repre- customer-supplier relationships. “It makes tool box to manage our volatility, to man- sents 10 metric tons. Though it is much no sense to trade steel on futures exchanges,” age our risk,” he said. smaller than the LME billet contract (65 said the federation. More recently, execu- metric tons), SHFE dwarfs the LME in terms tives at ThyssenKrupp Steel Europe, one of of both volume and . In terms the world’s largest steel companies account- China’s Steel Futures Market of metric tons traded, SFHE saw volume of ing for roughly 7% of global production, Shanghai has the biggest steel futures 1,800 million metric tons for the first three asserted it would be , not producers, market in the world. It is more than 200 quarters of this year versus 8.3 million metric who would benefit from the development times the size of LME’s. While heavy trading tons at the LME. Open interest in the SHFE of a steel futures market. “The sceptical atti- activity there reflects the fact that China is rebar contract was 5.7 million metric tons tude of ThyssenKrupp Steel Europe towards the world’s biggest consumer of steel, steel at the end of September versus just 147,680 activities in the steel area has not industry experts say much of the volume at metric tons at the LME. changed,” the company told Futures Industry the SHFE is among retail investors speculat- One key characteristic about Shanghai’s in a statement. ing against price moves. steel futures market is that it is only open to But key steel industry traders say the Steel futures trading is not a new idea in Chinese investors, with all delivery points recent price volatility has made a futures China. A similar rebar contract was traded located in China. Until this market is open market a critical tool. in the 1990s but the government shut down to foreign investors, there is little way global “What you have is what actually had trading amid rampant . steel market participants can use this con- been predicted, more volatility on the sup- The SHFE’s most recent steel rebar con- tract as a hedging tool. At present, experts ply side. On the other side you have people tract was launched in March 2009 and it has say the market is comprised mostly of retail who wanted more visibility of prices for grown to be the most actively traded contract investors and China’s government, wary of excessive speculation, has already has taken measures to restrict trading. Figure 2 In response to government concerns, SHFE in November imposed a number of Steel Rebar Futures at SHFE new rules including more fees and rules limit- Number of contracts traded per month since launch (March 2009 - September 2010) ing the number of times a client can engage in self-trading, or crossing, to five orders a day. In addition, there is a limit of 500 order cancel- lations a day and the size limit for big order cancellations is capped at 300 contracts. While SHFE’s steel rebar contract is only accessible to Chinese investors, linking to China’s markets is a top priority for many firms. Newedge for example announced a partnership with trading software provider FFastFill to connect to Chinese futures mar- kets. “We have a single trading platform where qualified clients can trade in a man- ner consistent with local laws. If you are a corporate that has a Chinese entity and you have Chinese exposures you are looking to hedge and simultaneously you need to hedge elsewhere, whether in North America or in London, you can trade any number of mar- kets through a single platform,” said Mike Frawley, global head of metals at Newedge. The platform is still subject to regulatory approval and all access would be available to qualified clients who would have to trade in Source: SHFE a manner consistent with local Chinese laws.

44 www.futuresindustry.com It will remain to be seen what, if any, In November the London Metal Why LME Steel access foreign investors will have to the Exchange announced that 10 million met- Took a While to Take Off SHFE rebar contract, but firms are closely ric tons of steel had been traded year-to- The idea of establishing a futures market watching as demand for steel in China con- date, equivalent to 153,977 contracts. That at LME for the world’s second largest com- tinues to grow. is small compared to the excess of 100 mil- modity is not a new one. According to forecasts from the World lion metric tons of steel that is produced LME worked on the idea for more Steel Association, China’ accounts for and sold globally, but it was the first time than eight years. In 2005, the exchange roughly 45% of all global steel use. That this milestone had been reached in a single formed a special committee comprised of far surpasses demand from the U.S. and calendar year after the contract’s launch steel industry professionals and exchange European Union economies. “You’ve got a in 2008 and it was a critical sign that the members to study the feasibility of a steel two-speed recovery. There is actually good steel industry may beginning to embrace a futures contract. demand for rebar in the far east and the futures market. One key decision was what type of con- middle east. Conversely, in the developed “We are very pleased with the way the tract to offer. In steel there are two distinct world there are not many cranes going up,” contract has gone this year. Clearly, it does types of product: rod or reinforcement bar said The Steel Index’s Hard. take time for new contracts to gain trac- (rebar) products, which are used in construc- tion in the market and I think that there tion, and flat or hot-rolled coil products, is still a ways to go before steel futures are which are used in manufacturing for automo- LME’s Steel Billet accepted through the market. But clearly biles and other goods. Contract Takes Off there are people using these contracts now,” Constructing a workable steel con- After many years of work, the London said LME’s Evans. tract was not an easy task. Steel is a com- Metal Exchange’s efforts to create a steel LME has forged an alliance with the plex metal with many different grades futures contract are finally beginning to show Singapore Exchange and plans to cross- and, because of the varying shapes and some success. The contract turned the corner market steel along with other metals at that grades it is hard to ship and it can dete- in March 2010 and is now rapidly gaining in Asian exchange. riorate in storage. volume, hitting a record 27,788 contracts in September versus 3,058 in September 2009 and 4,203 in September 2008. Volume for the first three quarters of 2010 surged to 129,153 contracts from a Figure 3 meager 22,442 contracts during that same period last year. That represents a 475% LME Steel Futures increase. The LME contract is still a long Number of steel futures contracts traded (January 2009 - September 2010) way from being a full-fledged success, but there are signs that this is being used as a long-term hedging tool. The bulk of the open interest is in the first three calendar months, but there is some open interest stretching out to the end of 2011. Because of its global access and delivery points, there are good reasons to believe that if the contract continues on its present path, it could become an important international benchmark for steel and the focal point for a new asset class. “We are very excited about the oppor- tunities in the steel market for our com- mercial clients who have an opportunity through the liquidity that is now evident in the market place,” said Newedge’s Mike Frawley. “If you look at steel in relation to all of the in the world it is sec- ond in size only to the energy market and I see tremendous growth opportunities,” said Frawley, adding that the firm recently hired John , a top steel market specialist, as director of steel products. Source: LME

January 2011 45 Over several years, and with the help of a in this market from its members. “We are per ton. dates are daily from cash broad range of steel industry experts includ- seeing about 20 participating each month to three months, weekly from three to six ing producers, rerollers, merchant traders and or so.” months and monthly from 7 months out to the construction industry, the LME devel- The LME contract is still a work in prog- 15 months. oped the billet contract. Billet is a long or ress and even in recent months the exchange Delivery points and warehousing are rod-shaped product used in construction as has made some major changes to the contract also critical aspects of the contract. At rebar. It is made up of scrap and other goods specifications. For example, last August LME present there are three delivery points but most importantly, it is designed not to merged the two separate regional contracts— in the U.S.—, Detroit and degrade in the warehouses. Far East and Mediterranean—into one global New Orleans. Other delivery points The contract was first launched in contract. In addition, LME continues to add include Dubai, South Korea, Malaysia, February 2008, and volume for the entire delivery points, including two more in the Rotterdam, in Belgium’s Antwerp and year was 15,966 contracts. LME officials U.S. this year. two locations in Turkey. (See map of acknowledge this was a slow start, but “For the first time in the marketplace, the delivery points.) Officials at LME are they assert that the steel billet contracts financial services industry has been able to constantly reviewing the traffic coming performed better in their first year than commoditize steel,” said Newedge’s Frawley. in and out of the various delivery points the exchange’s most popular contract— Looking at all the different characteris- with an eye toward adding more delivery aluminum futures—did in its first year of tics and specifications of the LME contract and storage points. launch. is like reading a lab report. The contract is “LME contracts do take longer to get offered in several different brands and vary- going because we are not cash-settled, we ing shapes, weights and lengths. The ingre- Acceptance are physically settled. It requires there to dients of each grade of billet must be very among Commercials be metal or steel moving in and out of our precise. The LME has a detailed report on its Slowly, steel producers and manufactur- warehouses and we started to see that hap- website about the required chemical makeup ers are beginning to accept the benefits pen this year,” said Evans. He added that for each grade in the contract. Each contract of a steel futures market. This acceptance the exchange is seeing more involvement size represents 65 metric tons of physically comes after the combined effects of the delivered product delivered in U.S. dollars recession and the mismatch between spot

LME Delivery Points

46 www.futuresindustry.com

and benchmark prices that left some produc- Although the LME does not disclose the ers with cancelled contracts. Credit risks makeup of investors, market participants say Joanne Morrison is deputy editor of Futures Industry have heightened, making a centralized and nearly all of the volume thus far is comprised magazine. cleared market place attractive over privately of commercial hedgers, steel traders and arranged OTC contracts. financiers using the billet contract to hedge “There is a lot of nervousness around,” against price and supply risk. Participants agreed Balli’s Zeederberg. expect this will eventually change as a For some of the world’s largest steel pro- broader range of investors look to the com- ducers, there is not enough volume yet for modity markets. them to use this market as a hedging tool, but “We believe that it is mainly a physical they are using the pricing as a reference. industry using the contract. I think that it’s “Of course we are following it and we going to take a while for the fund side of the are using it as a pricing tool, but for hedging business to have confidence enough to use it. purposes the volume is not enough for our The real trading volumes are yet to be seen,” size,” said Taylan Karagül, a marketing direc- predicted LME’s Evans. tor at Erdemir Group, Turkey’s largest steel For the time being, officials at the LME producer and ranked 19th among the world’s are focusing on building volume in the bil- top steel producers. let contract and adjusting the contract by, Not only is the LME contract a critical among other things, adding more delivery hedging tool, but as a market of “last resort” points. LME officials do not rule out the pos- the steel industry can use the LME’s delivery sibility of developing another steel contract to sell excess in times of over- linked to flat or hot-rolled coil contracts, but supply and as a source of material in times of at the moment the focus is on building the extreme shortage. In reality, physical deliv- billet contract. ery occurs in a very small percentage of cases “To ensure that the billet gets off to the on the LME as most organizations use the best possible start, we don’t want to distract exchange for hedging purposes. However, ourselves with other products. However, in the small percentage which does result in talking to the industry about risk manage- delivery plays a vital role in creating price ment, it is clear that they are looking for convergence. products that we don’t currently have so we do see a potential there,” Evans said.

January 2011 47