Steel hedging tools allay bank concerns, WSEM executive says

Steel futures contracts are helping to allay bank concerns over financing the sector amid improving forward price transparency and more efficient risk mitigation, according to Mike Frawley, chief executive officer of World Steel Exchange Marketing (WSEM).

Frawley told Metal Bulletin in an interview that banks are increasingly seeking to quantify the forward value of manufacturers’ raw materials when they lend to those industries, and that the lack of forward price transparency has until now broadly disadvantaged the steel industry due to an absence of hedging tools.

“The steel industry has traditionally been valued poorly in relation to other industry sectors, and one of the reasons for that has been the lack of forward price transparency. Steel futures provide lenders with third-party price validation. Raw material sector companies often enjoy higher credit ratings when forward price transparency is well established,” he said.

“I believe the steel, steel scrap and iron ore forward price curve is going to be increasingly important to the steel industry. The steel industry will find it easier to borrow within the supply chain as hedging becomes an operating principle,” Frawley added.

Founded by Peter Marcus, WSEM is working with Nasdaq Futures Inc (NFX) to list futures and options in a number of markets. NFX’s first steel contract, for Midwest US shredded steel scrap financial futures, was developed for mills and steel scrap processors in the Americas.

The contract was launched in mid-December and is financially settled against the US Midwest shredded steel scrap index price, published by American Metal Market. The 10-gross-ton contract is offered electronically and by telephone from Sunday at 7pm New York time through Friday at 5pm New York time, with listings up to 15 months forward.

NFX US shredded steel scrap futures recorded its first trade on Friday January 12, for a March 2018 futures contract priced at $360 per ton.

According to Frawley, the US shredded steel scrap price is not only an excellent proxy price for most steel scrap generated in the United States, its price directly affects the price of all US long steel products - and, to a lesser extent, flat products as well.

“Steel is a significant market; with annual consumption of 1.6-1.7 billion tonnes, steel is the second-largest commodity in the world next to energy,” he said.

“The steel industry is looking for more than a single published price to benchmark purchases and sales. Today there is still considerable physical volume bought and sold basis the industry published ‘buy week price.’ This leads to considerable lost opportunity when there is a significant price move outside of the buy week price,” he explained.

The steel industry has been slower than many other commodity sectors to adopt futures hedging - a situation Frawley attributed to a prior lack of understanding of how to commoditize the market. But this has changed, as evidenced by the successful launch of steel futures contracts in the last few years.

“The steel industry has become more comfortable with indexes as a pricing benchmark for futures contracts, in particular with the advent and evolution of exchange-traded funds. The marketplace today is much more comfortable with a futures curve that is financially settled via an index,” he noted.

Frawley expects an increasing number of unique products to be developed over time, and WSEM is working with NFX to introduce and market additional markets for the global hedging and institutional investor community.

“There are increasing numbers of financial players and physical trading companies attracted to the steel industry. Hedging is an operating principal for most firms in the non-ferrous, energy and other raw materials sectors. The price correlations between steel scrap and other ferrous products means arbitrage opportunities will also be very attractive within the ferrous marketplace,” he said.

“There’s no question in my mind that all sectors of the money management business – CTA [commodity trade advisory funds], hedge funds, algorithm trades – will participate in the steel futures market in a substantial way,” Frawley continued.

Ferrous metals are not new to Frawley, who was global head of metals at Calyon Financial, which later became Newedge, as well as global head of metals at Jefferies Bache and head of metals at Cargill Inc, his LinkedIn profile shows. Having been a supporter of the concept of steel futures for many years in his dealings with various exchanges, there was “no doubt in my mind that steel futures would become important to the steel and futures industry,” Frawley said. 

“Markets are often slow to catch on from their infancy to maturity. This transition to broad industry acceptance generally takes several years, and I believe we’re on the tail end of that now,” he concluded.

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