***SPOTLIGHT: Are You ready?
Japan is at the top of its game. The nation’s collective obsession with excellence means that so much is possible. So much that would be impossible anywhere else in the world. Just look at steel.
For most people, visiting Japan is a pretty special experience.
Looking for an armchair that doubles as a form of transport? Toyota’s has it sorted.
Want a television that will show your favourite soaps in 3D? Talk to Sony.
Fancy sleeping in a capsule that will wake you gently and slowly, only with the use of soothing light? Have a word with Panasonic.
In many ways, Japan is at the top of its game. The nation’s collective obsession with excellence means that so much is possible; so much that would be impossible anywhere else in the world.
Just look at steel.
Producers like Nippon and JFE don’t just rank near the top of the charts in terms of tonnage. They are leaders in terms of quality, technology and the services they offer customers as well.
But scratch the surface and you will discover things aren’t quite as rosy as they seem.
After more than a decade of economic stagnation, Japan is still struggling to strengthen its international position.
A series of seemingly interchangeable premiers hasn’t helped; without strong leadership, Japan has been in the shadow of countries like the USA, rather than exploiting its full potential as an international business hub.
There are problems that affect Japanese steelmakers as well.
Mills here might be pioneers in terms of innovation, quality and services; but many have struggled to adapt to changing market dynamics at a time when China has become pre-eminent.
Japanese steel companies still reign supreme domestically, and in many other markets, but aggressive strategies from companies like South Korea’s Posco means that the competition is catching up.
Tokyo, then, provides a pretty special backdrop for this year’s most important steel industry meeting.
But many of those in attendance need to face up to a harsh reality.
Consolidation over the past ten years coupled with a new breed of manager has made steel companies bankable entities, rising out of the ashes of the loss-making, balance sheet-busting industry of yesteryear.
But there’s still a long way to go; and now there’s a new, far scarier threat.
Let’s start at the beginning. Just the basics, mind — the China story isn’t new.
Over the past ten years China’s economy has developed breathtakingly fast, creating an immense demand for steel. As domestic production has grown and grown, Chinese steelmakers have consumed more and more raw materials.
So, when imports of iron ore into China on the spot market soared in 2008, it triggered a structural change; the three dominant miners have shifted the predominant pricing mechanism away from the annual benchmark system, introducing quarterly index-linked contracts.
Suddenly steelmakers don’t just have to deal with volatile finished product pricing: they now need to keep one eye on the iron ore spot market as well.
They aren’t happy. They’re even less happy now that BHP Billiton, the main market maker in hard coking coal, has also started settling prices for this material on a quarterly basis.
“Chinese spot market iron ore imports only account for 20% of its total imports,” said China Iron & Steel Assn (Cisa) secretary general Shan Shanghua said, speaking at the association’s annual meeting in Dalian last week.
“Contracted prices based on prices that only take a minor share of the market is not practical,” he said.
Unhappy though steel mills may be, the new pricing mechanism now in place is unlikely to change.
“Our position is to give quarterly contracts a chance this fiscal year,” said Rio Tinto md of sales and marketing for iron ore Warwick Smith, who also spoke at the Cisa meeting.
And while the largest steelmakers jockey with miners for a move back to the benchmark system, smaller market participants are accepting the new pricing structure as the norm.
“The trend is clear now that index-linked pricing will go on, and maybe iron ore prices will shift from quarterly to monthly next year,” an Qingdao-based iron ore trader told MB in Dalian.
Quarterly contracts suffer the same issues as the old benchmark system — the discrepancy between spot market and contract prices gives both sides and incentive to switch between the two at different times.
Increased flexibility in iron ore prices looks like a trend that will continue, not disappear. So how will steelmakers cope?
Their biggest problem will keep their own customers happy.
More volatile iron ore prices has already pushed several leading mills to start talks with some of their key industrial clients about moving them onto shorter contract terms for steel.
Germany’s ThyssenKrupp, arguably Europe’s most influential steelmaker, caused consternation when the company said it planned to introduce a surcharge system based on a number of “so-called commodity-based indices”.
ArcelorMittal and Voestalpine will probably do the same; ThyssenKrupp has yet to finalise its plan — it will give a definitive answer by the end of the month — but steel mills seem intent on passing price changes on.
Clearly conscious of how unhappy this will make steel buyers, Tata Steel Europe, formerly known as Corus, is looking to find a solution that will allow it to avoid bearing the full risk of volatility, while providing its customers with stability as well.
This will be a pretty difficult search.
Whatever solution they propose, steelmakers are under intense pressure to get it right — there is a lot at stake.
Establishing an effective model for managing increased raw materials price volatility, without simply passing on more frequent price changes to long-term customers, will mean the difference between companies that flourish and those left raking out a subsistence living.
Getting it wrong bears the prospect of steelmakers claiming progressively less and less of the value captured by steel.
There are 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 last week, members of the International Pig Iron Assocation (IPIA) and the Hot-Briquetted Iron Assn (HBIA) discussed several of these tools, focussing on the over-the-counter market for iron ore swaps and the London Metal Exchange’s steel billet contract.
Many members of both associations are looking at these derivatives closely; some have started hedging already.
Different parts of the supply chain are involved as well. 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 of derivatives markets in anticipation of being forced to accept fluctuations in the steelmaking cost base.
With the world’s first iron ore futures contract set to be launched soon at the Singapore Mercantile Exchange and a variety of clearing mechanisms already available, the iron ore derivatives market is definitely evolving.
So far, this kind of risk management is still a dirty world for 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.
Lakshmi Mittal, for one, believes the involvement of speculators in these markets will take pricing power away from producers and become a destructive influence.
But, now, whether he’s right or wrong, the tide might be changing. More recent comments from steel mill managers betray a softer stance towards the world of steel price risk management. With so many more variables an inherent part of pricing, who can blame them.
When the industry’s top dogs sit down in Roppongi this week at the Hotel Okura, they will have a perfect opportunity to decide how to address the sector’s latest challenges.