Potential Section 232 penalties boost reliance on price risk mitigation tools

The United States’ potential implementation of Section 232 penalties is expected to stoke price volatility across the ferrous supply chain and compel market participants to rely on their best price risk mitigation options, including financial futures contracts.

“The introduction of regulatory changes and trade law revisions that could restrict imports could result in some wild moves in prices, which people are looking to control,” Metal Edge Partners founding partner Tim Stevenson told American Metal Market. The Chaska, Minnesota-based company is a risk management advisory firm for the ferrous industry.

Indeed, potential 232 action - coupled with recent US economic growth, President Donald Trump’s tax reform and steel tariffs that are already in place - will cause end-users to more seriously consider how to manage their pricing risks, according to André Marshall, chief executive officer of Houston-based Crunch Risk LLC. “In the past, they [end-users] might have let it float but that is not wise going forward.”

A Section 232 order of the magnitude envisioned by Commerce Department Secretary Wilbur Ross could boost ferrous scrap prices, domestic steel prices - including those for hot-rolled coil, oil country tubular goods and wire products - and aluminium premiums.

“The clients that we work with - primarily steel processors - have seen a significant increase from their customers asking for fixed prices... [the Section] 232 will bring back some buyers into the market,” Marshall said.

“We are hearing from quite a few customers who are asking what they would need to pay to lock up the second half of 2018 or even as far out as the first quarter of 2019,” Stevenson agreed, noting an increase in inquiries from the machinery and energy-related sectors in particular.

All types of ferrous buyers - from steel mills purchasing scrap to end-users acquiring finished steel products from distributors - will need to figure out how to navigate the potentially rocky Section 232 pricing environment, according to Marshall.

“Buyers have to figure out how to cover themselves with steel futures, fixed-price contracts, a steel price that is scrap based or a producer that is covering scrap prices - there’s definitely a lot of cover going on, or at least starting to, through those various channels,” he said.

Service centers might be able to manage pricing risks via fixed-price physical contracts from their mill suppliers but “someone is taking a risk in that equation,” according to Stevenson, pointing to the mills in this case, who could buy their scrap or iron ore via the futures market as a protective measure.

An alternative solution could be to stockpile inventory, but that is problematic, according to Stevenson. Stocking up on inventory would require significant storage space and working capital, which “just isn’t feasible” for some companies.

“Buying a financial contract means you don’t have to write a check for all of that steel upfront... You then deposit your margin balance in your account and settle those trades each month as they go by. It’s a much more working-capital-efficient way to manage price risk,” he said.

“It is important to realize that if prices move against your financial positions, you may need to deposit additional funds into your account as well,” Stevenson added.

“If a significant portion of my business was contractual with our customers, I would look into futures,” an East Coast distributor said.

The Section “232 today is a threat,” the distributor added. “If Trump puts in quotas or tariffs, we’re all going to know that we have to do something differently - manufacturers and distributors, everybody and anybody. We are going to have to make decisions about where to get our products because the current US production levels of raw materials are not going to sustain manufacturing.”

US ferrous industry market participants are increasingly recognizing the advantages of using financial futures contracts to mitigate their risks. Indeed, trading volumes for CME Group’s US Midwest No. 1 busheling ferrous scrap futures contract continued to gain ground in February. The contract is settled against American Metal Market’s Midwest index for No. 1 busheling.

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