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Anybody wanting an example of an imperfect pricing mechanism in an imperfect world should look no further than the alloy surcharge.
It was established decades ago with the ostensible purpose of enabling stainless steel mills to pass on the volatile prices of crucial raw materials such as nickel, chrome and molybdenum at a time when the price of iron ore was fixed on an annual basis.
Back in 1999, for example, Metal Bulletin was reporting that it was “noteworthy that mills are reporting growing acceptance… [of] the reintroduction of the alloy surcharge”.
For the surcharge has a chequered history.
In 1999, “the reintroduction” followed the European Commission’s ruling in 1998 that a cartel of stainless steel mills in Europe had fixed the alloy surcharge between 1993 and 1994.
There is no suggestion that any company is acting in an uncompetitive way in Europe now.
And, previously, mills have insisted that there is not a profit component to the surcharge, which has probably been angering consumers for as long as it has existed.
But the combination of the quarterly ferro-chrome benchmark, on which discounts are widely available to mills, with the alloy surcharges, whose quantums are far clearer than the equations that drive them, raises questions.
First of all: what is it worth to stainless mills?
The $540 million figure that Metal Bulletin has floated this week is hypothetical.
It is based on a number of broad assumptions: that there is an average 15% discount on ferro-chrome purchased on term contracts in Europe at an average basis of $1.25 per lb; that mills do not pass on any of the discounts; and that stainless steel in Europe contains an average 17% of chrome.
Sources do not question the logic of the calculation, though they are sceptical that so much money could be at stake.
“Your general statement is certainly correct, but I doubt the magnitude of the ‘subsidy’,” one close observer of the stainless steel industry said.
In other words: you can play with the calculation and the answer may not be half a billion dollars — but it could still be considerable.
(“And even with this benefit the EU mills are not sufficiently profitable,” he added, pertinently.)
Second: will the comparatively fragmented industry downstream of the steel mills have the power to propose a different system than the alloy surcharge system, and behind it the ferro-chrome benchmark, given that such large sums of money are potentially at stake for the struggling stainless steel mills?
If not, will the stainless steel industry itself be prepared to abandon the opaque and unsatisfactory alloy surcharge, to replace it with more transparent and hedgeable pricing?
Third: what would it be replaced with?
Metal Bulletin has some ideas, so watch this space.
If you have suggestions of your own or observations about the way in which the benchmark and surcharge work, or how they should work, contact the editor, Alex Harrison, on aharrison@metalbulletin.com POLL: Will the ferro-chrome benchmark price last the rest of this year? Take the poll now and see the results on the Metal Bulletin homepage or on LinkedIn.
Alex Harrison aharrison@metalbulletin.com Twitter: @alexharrison_mb