LONDON: Has the iron ore pricing revolution stalled? Is it even in danger of going into reverse?
Behind those two questions is the general unhappiness with the current embryonic spot market articulated at last week’s Metal Bulletin conference in Amsterdam.
Leading the reactionary charge was Chung Joon-yang, chief executive of South Korean steel group Posco with his call for a return to the old system of annually-negotiated benchmark pricing.
Turkish steel-maker Erdemir wants iron ore miners to change their pricing formulas to factor in both steel scrap, an alternative feed in the steel-making process, and steel final products, according to procurement director Ercument Unal.
Further down the supply chain French automotive group Peugeot Citroen wants steel producers to stop simply passing on their raw materials costs to customers and is considering switching from long-term contracts to something akin to a spot steel price.
What unites such disparate views across the global steel sector is a collective inability to cope with price volatility both in the iron ore market and, increasingly, in the steel sector itself.
The break-down of the original annual benchmark system of iron ore pricing was occasioned by just such volatility in 2009.
As the Great Financial Contraction spread through the manufacturing chain, steel-makers responded to collapsing demand for their products by simply walking away from annual iron ore contracts because the prices were so far out of line with the new reality.
Three years on and what was once an iron ore problem is becoming a steel problem with steel prices now falling faster than iron ore prices, squeezing producer margins to vanishing point.
For example, hot-rolled coil prices in Turkey have fallen by almost $70 a ton in the last two months, or about 10 percent, while iron ore prices have fallen by $9 per ton or about 6 percent in the same period.
Look no further to understand Erdemir’s frustration with the current system.
However, it is in the very nature of revolutions that once unleashed, going back to the status quo ante is not a tenable option, however desirable “the good old days” might appear.
As Jose Carlos Martins, head of iron ore at Vale pointed out, “so long as this price volatility persists, it is really hard to implement pricing systems for longer periods of time.”
Without a more complex formulation, annual pricing means someone loses out, the producer at times of price weakness, the buyer at times of price strength.
Reading between the lines, it seems that Posco, along with some Japanese and Taiwanese steel-makers, has found itself stranded in the half-way house of buying iron ore on a quarterly time-frame basis the average of the previous quarter’s prices.
This was always an unsatisfactory compromise, providing neither the security blanket of the older annual pricing nor the ability to cope fully with faster-moving spot prices.
Iron ore pricing will not revert to the old benchmark system simply because Chinese buyers, who dominate the global seaborne iron market, don’t want it to. And as long as they don’t, prices will remain volatile, disrupting any longer-term pricing mechanism.
The core issue is more one of the limited tool-kit available to the steel sector in managing price volatility.
Recent launches of iron ore trading platforms, both the producer-backed GlobalOre platform and the China Beijing International Mining Exchange (CBMX), may facilitate the clearing of spot cargoes but are more about political pricing power than price risk hedging.
For anything resembling an iron ore hedging tool-kit, the best two options appear to be the Singapore Exchange’s (SGX) iron ore swaps market and the CME Group’s iron ore options contracts.
The SGX offering has been up and running for three years now and volumes have steadily increased, rising another 124 percent over the first five months of this year.
— Andy Home is a Reuters columnist. The opinions expressed are his own.
Those in the CME’s most liquid contract, based on The Steel Index’ assessment of the Chinese market, have mushroomed since launch early last year.
But with the SGX notching up volumes of 7.7 million tons in the first five months of 2012 and the CME’s turnover totaling 6.3 million tons in the first six months, it is clear that most hedging in the 1.5-billion ton steel sector is happening in the over-the-counter market, if it is happening at all.
The problem is the limited geographic scope of the current offerings, most of which are aimed at capturing the physical liquidity of the China iron ore trade, and the limited range of products available.
How, for example, should a Turkish mini-mill producing billet from scrap use an iron ore hedging mechanism?
And how useful in isolation is an iron ore contract to an automotive company purchasing a range of steel products to tight specifications?
Well, actually, Elizaveta Dmitrieva, head of metals purchasing for Peugeot, has a theoretical answer, a combination of moving to shorter-term pricing for steel supplemented by a range of hedges from iron ore through coking coal, the other key steel-making input, to hot-rolled coil.
And, credit where it’s due, one exchange does appear to be rolling out a full spectrum of contracts that might offer the sort of hedging combination Peugeot is looking for.
CME Group’s so-far-successful hot-rolled coil product is being supplemented by the clearing of OTC products such as Black Sea billet and Turkish scrap.
A US scrap contract is on its way. It will be the thirteenth contract aimed at the ferrous sector.
Conspicuous by its absence from the race to tap growing demand for price risk management tools in the steel industry is the London Metal Exchange (LME).
The LME, which boasts of its dominant status in the nonferrous metals sector, made the mistake of trying to shoe-horn a steel product into its existing system of physically deliverable contracts.
As a result the fledgling contract has succumbed to the warehousing shenanigans that characterize the likes of aluminum.
The market is now voting with its feet. Deutsche Bank, an original supporter of the billet contract, is moving its steel derivatives business to CME Group.
The LME’s billet contract is in decline, possibly a terminal one. Volumes in June were 5,811 lots, the lowest monthly level since February 2010. Cumulative volumes dropped 47 percent in the first half of the year.
The potential sale of the LME to Hong Kong Exchanges and Clearing (HKEx) offers a fresh start, given the latter’s explicit promise to launch more contracts, specifically aimed at the steel sector.
That needn’t undermine the CME offering.
The steel market dwarfs any base metal in size and complexity. It is more akin to the global energy market, which is able to support multiple competing contracts, tailored to product and region.
Of course there is the not-so-little issue of whether the LME will muster enough votes from its fractious shareholders to give the green light to HKEx.
But if it does, the two shouldn’t waste any time in looking again at what they could offer in the way of ferrous contracts.
That the industry needs a bigger and better hedging tool-kit is obvious.
Indeed, with both iron and steel prices becoming ever more volatile and margins becoming ever more compressed, the ability to manage price risk is becoming an essential component of the steel sector’s survival kit.
