Hot Rolled Steel Futures & Hedging Steel Price Risk
The steel market volatility has been growing over the past few years. Understanding steel price risk and how to hedge against steel pricing volatility is a growing concern in the North American steel industry. Steel Market Update is producing a number of articles about the hot rolled futures market and hedging instruments as a service to our members. The article below is the first of a series currently being published in our Steel Market Update newsletter.
Part One: The customer has a number in mind
Steel Market Update spent time with Joe Reinmann, CEO of Kataman Metals and an active ferrous and non-ferrous merchant (as well as a contributing writer to Steel Market Update about the futures markets) along with Andre Marshall of Crunch Risk and other interested parties at a luncheon earlier this week in New York. We had set up the meeting in order to discuss hedging strategies with one of our members who is seriously interested in participating in the hot rolled futures market.
As many of our active members know, Joseph Reinmann is the CEO of Kataman Metals, a company which actively manages thousands of tons of customer’s price risk utilizing various hedging strategies. Kataman Metals is an active trader in steel and metals, buying and selling primary and secondary copper, brass, zinc, aluminum and steel. Mr. Reinmann is a contributing writer to Steel Market Update and we rely on his expertise along with others within the industry to help us, and in the process to help our members understand the hot rolled futures market and the hedging of risk.
Mr. Marshall is the CEO of Crunch Risk and he is a steel/iron futures broker who works with Mr. Reinmann to facilitate trades.
SMU has participated in two educational sessions with Jon Putman of Birmingham Futures Exchange and we look forward to offering educational seminars for our members with Mr. Putnam in the near future. What we have learned is the concept of hedging and how, when and whys behind hedging take some time to understand. SMU has been using ourselves as a Guinea Pig in this process of educating ourselves to the point where we can begin to speak intelligently on the subject. It will be even more important to actually watch the process happen and we are hopeful through the luncheon we had earlier this week we will be allowed to watch both sides of the contract and then track on a monthly basis the settlement process.
It is our opinion (Steel Market Update) the extreme volatility in steel prices will continue to exist for the foreseeable future. This is good news for SMU since we track pricing, trends and then analyze markets. It is probably very troubling for many of our members be they manufacturing companies, service centers, trading companies or steel mills. Volatility equals risk and with risk comes the potential for both reward and pain. Managing risk will become more and more important not only for large companies but for smaller operations who traditionally have absorbed the risk internally (or have passed on doing the business).
As we spoke about the way the hot rolled futures market works as well as hedging strategies on various products it became apparent to Steel Market Update of the need to take the subject of hedging in small bite size pieces.
During our lunch meeting we discussed the relationship between an end user (manufacturing company or end customer), a service center (if one is being used for the business) the steel mill and the futures “merchant” who works with futures contracts on the CME/NYMEX hot rolled futures exchange
First, why does a company want to consider hedging their risk?
From an OEM/Manufacturing viewpoint their interest is usually in receiving “stable” pricing from which they can understand their costs for the product being produced, and then understand the margin they can gain once they sell their product into the market. Most buyers at the manufacturing end want “firm” prices.
We were rather surprised to learn that several OEM’s have already been quite active using steel futures to convert their floating price HRC, CRC and galvanized contract risk to fixed prices. Additionally we learned that a few pioneering service centers have started to embrace steel futures too by incorporating fixed price offerings – quarterly, semi-annual or annual fixed pricings – as part of their suite of product offerings. By offering fixed pricing options, these pioneers or first adopters are finding a competitive advantage as they can now offer something that their competitors cannot – fixed pricing.
SMU starting point is from there: we have an end user who wants “fixed” pricing for an extended period of time.
One of the “aha” moments for us, during yesterday’s lunch meeting with Mr. Reinmann, was there is a “number” at which the end customer is willing to commit to over a long period of time. This number, especially at the OEM level, may be fairly constant (example: $600 per ton hot roll firm for a year). At the same time the physical market and the futures market are in constant motion. But frequently there does come a time when futures prices align with the end customers target number. When the futures market aligns with the end customers “number” this creates the opportunity to arrange a fixed price contract.
The second “aha” moment was when we learned that steel industry participants can hedge products other than just Hot Rolled Coil. We learned that markets are actively being made available today for hedging Cold Rolled and Galvanized. The futures merchant can extrapolate the amount of zinc in a galvanized coil and by using the zinc futures market together with the HRC futures market they can tailor a hedging product to those wanting fixed pricing for galvanized coil.
The interested party at our luncheon happened to be a service center CEO and he was quite excited to learn of all of these new steel hedging developments being used today. He has a particular end user who is quite keen on buying from his service center a fixed price. The process of hedging became quite clear to this CEO at our luncheon. It goes like this: The service center would still buy his physical HRC from his usual mill supplier at his customary discount to CRU (or at their negotiated price for this specific piece of business which is then compared against the CRU number). At the same time the service center enters into a financial contract with the futures merchant to insure that he is able to offer fixed pricing to his end customer and assume no price risk (service center preserves his original margin). All of which enables him to conclude his sale to his end user at a fixed price for an extended period of time.
The hot rolled futures market settlement prices are based on the CRU hot rolled index. The contracts are settled on the last Wednesday of every month based on the average of the CRU weekly hot rolled Index for that month. In other words the month of June will be settled next Wednesday (June 30th) and the final settlement price is based on the CRU average of the five price points on HR for the five weeks (five Wednesdays) during the month of June.
This is but an opening salvo from Steel Market Update as we work toward not only understanding the hot rolled futures contracts (and how the market works) and how to use a futures contract as price protection in a volatile marketplace.
SMU intends to work with Jon Putman of Birmingham Futures Exchange to offer educational programs to our members (or interested parties) regarding the hot rolled futures market and hedging risk. We are working on selecting dates. One option would be having a workshop as an add-on to our conference in Las Vegas on either October 20th or 21st (or both). Please let me know if you, or your company, has interest in participating. We are also looking at other cities such as Chicago, Atlanta and Los Angeles. Please watch our newsletter and website for more details.
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