One of the overriding themes at June’s Steel Success Strategies conference in New York was steel price hedging. Peter F. Marcus and Karlis M. Kirsis, managing partners of World Steel Dynamics—cosponsor of the event along with American Metal Market—contend price hedging is the future of the steel business.

The WSD duo believe the ability to hedge is particularly important to service centers and end-users. “Huge, and in some instances increasing, volatility in steel prices and ever-more-aggressive action by steel mills to quickly boost home-market prices have created an enormous need for steel buyers—middlemen and end-users—to hedge the steel price risk,” they wrote in a presentation that accompanied their remarks.

To accelerate the introduction and acceptance of hedging, WSD launched the SteelBenchmarker system in April 2006. The SteelBenchmarker process involves the collection of prices from steel mills, traders, service centers, steel users and scrap processors on four fronts: the United States, China, Western Europe and the world export market. Twice monthly, SteelBenchmarker publishes the prices for hot-rolled band, cold-rolled coil, plate and rebar. In the United States, the system will also publish a price for shredded scrap.

Ultimately, the goal is to collect information from thousands of providers each month. “The benchmark prices generated are expected to accurately reflect steel market spot prices,” Marcus and Kirsis wrote.

Step 1 in the SteelBenchmarker system has been warmly received by the steel industry. Executives welcome the collection of data that will give them greater insight and aid decision-making.

It’s steps 2 and 3 of the process that give steelmakers and service center executives cause for pause.

The second step of the SteelBenchmarker process is to “work with a futures exchange and OTC brokers to develop a series of financial transactions—those without physical delivery—that will use the benchmark prices as their settlement mechanism.”

Following that, Marcus and Kirsis expect extraordinary growth of steel financial transactions (as much as 20 billion tons traded annually) that will permit steel buyers and sellers to hedge forward the steel risk. Financial investors, such as hedge funds, will be eager participants in the system, the analysts predict.

“The system will be an important ‘win-win-win’ for steel sellers, for middleman companies and for steel users,” they wrote.

At the Steel Success Strategies conference and beyond, that opinion was not universally shared.

Marcus, moderating a panel with five North American steelmakers, solicited opinions on the future of futures. Only one, Severstal North America’s Vadim A. Makov, was not outright opposed to the idea. Steel Dynamics’ Keith Busse, Nucor’s Daniel R. DiMicco, Stelco’s Rodney Mott and Mittal Steel’s Lou Schorsch saw little to no benefit of a steel futures market.

“There’s a difference in trading physicals and people trading dollars around on the computer,” Busse said in framing his opposition.

“That win-win-win you’re talking about is a lose-win-lose,” DiMicco said. “The folks that make the money off this deal aren’t in the steel business, they aren’t in the manufacturing business. They’re in the funny money business.”

Lou Schorsch said futures trading is a solution in search of a problem. “I look at our company. We’re 50 percent contract, 50 percent spot. That’s a built-in hedge, and it’s similar for our minimill friends.”

Steel trading did have some supporters at the conference, including a few not connected to World Steel Dynamics. A panel discussion, “The Futures is Now: Is Hedging the Steel Price Risk the New Ace in the Hole,” featured LME Director Neil Banks and Jeffery Kabel, vice president of Koch Metals Trading, U.K., both of whom are big supporters of hedging.

Kabel’s London-based company, the largest privately owned firm in the world with revenues exceeding $80 billion, is already engaged in steel hedging. He’s a firm believer in its merits.

Kabel says the benefits of steel hedging include securing an alternative form of price stability; the opportunity to fix a price at any time of year (particularly at inopportune moments in the price cycle); financial contracts that are unbreakable and are transacted with a strong well-rated entity, increasing credit quality; and hedge prices that are known only by the company handling them and the counterparty, allowing customers to fix a price without sending a signal to customers or suppliers.

He acknowledges that some challenges persist, including trying to trade off a non-strategically beneficial price; efforts to call the top and bottom of the market vs. anticipating market direction changes; and resistance among members of the steel market, who believe steel is different than other commodities.

Among the resistors was panelist Lourenco Goncalves, president and CEO of Houston-based Metals USA, who offered this counterargument.

“Steel is not similar to gold, silver, aluminum, copper or natural gas. Steel is a material with the characteristics of a manufactured product, and therefore much more complex than a tradable commodity,” Goncalves said.

Steel end-users, even the most cost-conscious ones, recognize that issues other than price factor in to their decision-making, he said. Reliable deliveries, quality variations and inventory management are variables outside of price that play a role in the choice of steel provider. Thus, companies that hedge will only be shifting risk, not replacing it.

“If we assume as a true statement that a widely accepted hedging mechanism can be established for steel, we would also have to accept as true that one can make a market for virtually everything. As we all know, the ‘smartest guys in the room’ have already tried that before, and they failed badly,” he said, in an allusion to Enron.

Goncalves added that a hedging mechanism would be beneficial if it reduced cyclicality, but like the mill executives, he believes changes within the industry have already launched that trend. “Consolidation of the industry has already started to positively affect the historical cyclicality in our business.”

To supporters of hedging, such as Kabel, its greatest feature is the ability to eliminate risk. But where Kabel sees hedging, others see risk-taking.

“I don’t like gambling in our business,” said O’Neal Steel President and CEO Bill Jones from his Birmingham, Ala., office. “Whenever we’ve hedged, it hasn’t been speculation, it’s been insurance.”

But his company has done very little of it, even with metals where it’s more common.

“The most active traders in it are speculators, who artificially, abnormally disrupt a market,” Jones said. “They get involved and drive pricing, instead of letting supply and demand do the same.”

Goncalves said the steel supply chain simply requires more consolidation, not speculation, to remove even more cyclicality from prices.

“There is no win-win-win situation,” Goncalves said. “We may not be the smartest guys in the room, but we’re smarter than that.”

Of the presenters at the Steel Success Strategies conference, possibly the most even-keeled approach to the subject was taken by Antonio Marcegaglia, CEO of the family owned industrial and financial company Marcegaglia in Italy.

Marcegaglia said that certain pre-conditions must exist before hedging can take place, including reference prices, easily defined products, regional price knowledge and the nature of price volatility. Other questions, including how it is applied, how it affects the supply chain, and how it affects consumption, must also be weighed.

He offered five conclusions on the near-term future of hedging in the global steel market:

• Hedging on steel will develop for select products in selected markets.
  
• Selective players may take advantage of hedging.
  
• Not all conditions for hedging are present in the global steel market.
  
• Some of the pre-conditions for hedging opportunities also present significant risks.
• A gradual, conscious approach in the vast use of hedging is recommended in order for most players in the industry to take real advantage of hedging opportunities.

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