***REVISITED: One small change

Steelmakers should brace themselves for more upheaval in the way their raw materials are priced.

By now, they should be used to change. In 2010 the annually agreed long-term prices that were once traditional in iron ore and coking coal all but disappeared. In their place are quarterly settled contracts.
But less than a year into their life, these contracts could be set to change too.

BHP Billiton, the world’s largest seaborne coking coal supplier and third-largest seaborne iron ore supplier, says customers have already asked about monthly coking coal prices next year.

The diversified miner would certainly support this move – for several years, BHP has pursued pricing closely linked to the fundamentals of the markets in which it has interests.

MB understands several steelmakers have already started buying iron ore from BHP using contracts with monthly invoices attached.

It can’t be long before the company’s coking coal contracts go the same way.

Through its alliance with Mitsubishi Development, BHP is a price-setter in physical coal. So other suppliers will find it hard not to follow.

For steel companies, this isn’t the best news. Three fiscal quarters in to the new pricing systems, they are starting to get to grips with increased volatility.

Some, like Germany’s ThyssenKrupp, have gravitated towards asking raw materials surcharges on top of annual contracts in Europe.

Other steelmakers are likely to follow suit, if they haven’t already.

“The iron ore price change from quarter to quarter has to be invoiced to the customer,” Michael Pfitzner, ArcelorMittal’s vp for commercial coordination, told MB in May.

Producers are moving away from offering fixed prices. This reasoning behind this shift is simple – more flexible iron ore pricing terms leave steelmakers carrying more risk.

This is a risk they’re not prepared to wear, so they plan to pass it on.

“All steelmakers are being forced down the route of more volatile pricing arrangements on the supply side and have got very little choice but to pass it on,” a source said.

“The most solid opinion is to avoid six-month and yearly contracts in future and to negotiate on quarterly base [prices] with automotive and home appliance [markets],” another market participant said.

This won’t make steelmakers popular with end users, particularly manufacturers.

Establishing an effective model for managing greater price volatility, without just passing on frequent prices changes to long-term customers, will mean the difference between companies that flourish and those that cling onto survival.

Getting it wrong will lead to steelmakers claiming less and less of the value created by steel.

There are other options.

In the market for pig iron and hot-briquetted iron (HBI), participants, including producers, have started to explore risk management tools that have been designed to offer protection from price volatility.

Meeting in Athens in September, members of the International Pig Iron Assn (IPIA) and the Hot Briquetted Iron Assn (HBIA) discussed several of these tools, focusing on the over-the-counter (OTC) market for iron ore swaps and the London Metal Exchange steel billet contract.

Some have started hedging already.

Different portions of the supply chain are involved as will. Brokers say leading iron ore miners are already helping liquidity in the OTC iron ore market, hedging quarter-on-quarter contract price changes against the spot market.

Others say they are in discussions with end users, who are testing the waters in derivatives markets with the aim of managing steel price fluctuations.

With the world’s first iron ore futures contract launching soon at the Singapore Mercantile Exchange and a variety of clearing mechanisms already available, the iron ore derivatives market is definitely evolving.

This kind of risk management is still a tainted concept for many steel mills. Over the past few years, most of the sector’s leaders have been united in opposition to ferrous futures and other similar derivatives.

But the tide might be changing. Recent comments from steel mill managers betray a softer stance on steel futures trading. With so many variables an inherent part of pricing, who can blame them?

“It is clear that no one, including us, is happy about [increased raw materials price volatility],” Pfitzner said in May.

Happy or not, steelmakers have a duty of care in ensuring that the transition to a new steel pricing system for their leading customers is handled well.

Everyday consumers aren’t likely to tolerate extreme volatility in the price of manufactured goods – particularly in the current economic climate.

There hasn’t been outcry yet. Many car makers, white goods manufacturers and OEMs are still buying material on contract terms agreed last year. Next year will be the test.