STEEL SUCCESS STRATEGIES: Four lessons on ferrous hedging

Ferrous hedging was a common topic at the Steel Success Strategies XXXIV conference in New York this past week, with record-low market prices and the need to increase efficiencies continuing to mandate a new way of thinking.

Here are four key takeaways on risk management from the event:

What it costs
Hartree Partners trader Karl Schmidt told delegates during a panel discussion that it costs him less than $1 per ton to trade CME Group’s futures contracts.

“That’s a nominal cost for the privilege of being able to manage that risk,” he said. “It’s incremental.”

For example, Schmidt said he pays about $3 per lot if he’s using CME Direct, a front-end trading platform that allows participants to trade via CME Globex or submit over-the-counter (OTC) trades to CME ClearPort via the exchange’s clearing house, CME Clearing. He pays $4 per lot if he’s using OTC Clearing, the exchange’s platform that allows clients to clear OTC trades.

One lot equals 20 gross tons for CME’s busheling scrap futures contract and 20 short tons for its hot-rolled coil contract, thus equating to 15-20 cents per ton, depending on the trading method.

Non-cleared members using CME ClearPort are charged $5 per lot, or 25 cents per ton, Spencer Johnson, risk management consultant at brokerage INTL FCStone, noted during a hedging workshop at the conference. 

On top of the exchange fees is the cost of using a broker, which is based on “whatever arrangement you come to with the broker, normally in the range of 50 cents [per ton],” Schmidt said.

Indeed, using a futures commission merchant (FCM) – a type of brokerage that can trade on behalf of its clients, collect margins and clear trades – typically costs about 50 cents per ton, Johnson confirmed.

“If you used us for brokerage, execution and clearing, it’s 75 cents [per ton in total],” he added, noting that “25 cents goes to CME and 50 cents for the FCM.”

If customers renege
Panelists were asked what might happen if a seller offers a customer a forward fixed price and hedges that exposure but then the customer refuses to take the tons at the agreed upon price.

“We’ll sell the tons to another party, or if there’s a loss we’ll sue that customer for the loss,” Jeremy Flack, founder and chief executive officer of service center Flack Global Metals, told the audience. “We’re not going to play the old steel business game – there’s no discipline with that. If a customer does that to us, we don’t want them as a customer anyway.”

But Flack noted that they have helped customers get out of unfavorable positions in the past.

“The nice thing about using futures… is you can wait to buy the physical [product] until you’re closer to the delivery date,” he added.

Speculating isn’t bad, and isn’t the same as hedging
“You need to have some speculation in the market in order to generate liquidity… Speculators don’t cause prices to rise… the market cannot fight where the fundamentals are,” Schmidt said.

“Ultimately, the driving ethos is for us to de-risk the business,” Big River Steel head of risk management Bradley Clark said during a panel. “We don’t do anything with the paper that adds risk to the business; all we do is take risk off our business. That allows us to give our customers solutions in what they need in terms of pricing, or allows us to take advantage of forward-moving raw material purchases.”

Although some critics of ferrous derivatives say that hedging brings speculation into the steel supply chain, hedging and speculating are not the same.

Be prepared
“People call me with a high sense of urgency because they see an opportunity to hedge but they aren’t set up to do so,” Sean Kessler, manager of metals products at CME Group, said during the hedging workshop. “Find a clearing firm and a broker… Put the plan in place. You can get set up for just six months, so when the moment arises, you’re ready.”

Interested parties should select a front-end trading application and have a trading plan in place too, he advised.

“Use the exchange as a resource,” Kessler said. “We are constantly putting out educational materials.”