Environment and Energy

Johnson: Last Week in HRC Futures

We are excited to talk about the week that was in US hot-rolled coil (HRC) futures. Before we dive in too deeply into specifics, though, let’s touch on a data point we haven’t talked about extensively in recent reports: volume and open interest. Hard to believe, but about a decade ago the most prominent complaint among prospective clients of ours who might trade in HRC futures was something along the lines of, “We would, but there is not enough liquidity.” Fortunately for the steel industry, it has become increasingly difficult to use this as a justification for non-participation in the financial derivatives markets just about every year for the last seven years.

trading screenIndeed, 2022 marked another year of increased volumes, with 260,885 lots of HRC traded in the calendar year on the Comex exchange (just over 5.2 million short tons). No doubt that is still a small piece of the overall production pie in the US. But it is conceivable that within 5-10 years of steady growth, US futures volumes could match or exceed domestic HRC production volumes, which should be the natural target for growth. While this figure does not include OTC volumes or other exchange products in the same category, it is still a significant metric to keep an eye on.

One of the most important trends in this volume growth is that it was driven entirely by trading in the online platform, Globex. This electronic market is highly transparent and easily accessible, making it the natural, logical place to see more volume going through. Indeed, the telephone market volumes were actually down a tiny bit, 1.4% year over year from 199,372 lots on Clearport in 2021 to 196,548 lots in 2022. Globex electronic volume more than made up that small gap and posted a 35.6% bounce from 47,445 lots traded in 2021 to 64,337 lots traded in 2022. This electronic volume growth has also given rise to growth in another important new market for HRC: options.  

In 2022, total traded options volume (HRO) increased a staggering 286% from just 4,855 lots in 2021 to 18,770 lots in 2022. All signs point to a continued uptrend in 2023. Pricing conditions will likely continue to make options a consideration to all parts of the steel supply chain looking for new approaches to risk management. The option, but not the obligation aspect, will still be met with a learning curve. Steel futures themselves have only been taking hold in the industry more firmly in recent history. After all, the contract has existed now for just 15 years, a blink of the eye compared to more mature markets. That said, the year-over-year growth would seem to encourage optimism. The growth of other products is not hurting the outlook, either. Consider EHR.

EHR (or European HRC futures) also made big moves in 2022. They moved from a meager 11,820 lots of Clearport volume in 2021 to over 35,000 lots in 2022, a 197% increase. Electronic volumes also jumped 379% to 10,622 lots! This is particularly impressive given that it was not too many years ago this contract’s odds for success were pegged as low. Apparently, the fear was that the historical correlation to US HRC would be too high to attract divergent interest. Well, trade wars and price dislocations have resolved that fear , and the contract seems to have met an audience with hedgers. They truly need it, which is exactly what you would like to see. The only laggard in the group was HDG (Galv premiums). Even BUS futures (busheling scrap) made a hefty gain in overall Clearport volumes of 223%, moving from a pretty dismal 9,013 lots in 2021 to an actually impressive 35,113 lots in 2022.

We really think the successes in EHR, options, and other products are also a likely (although only in part) explanation of the overall decline we did see in open interest. If you compare year-end 2021 with year-end 2022, it’s stark, End-of-year (EOY) 2021 was 37,983 lots vs. just 21,916 lots on EOY 2022, a 42.3% drop. But there are a number of lessons in that. In addition to attracting away interest from other products or from options, open interest can be a fickle beast relative to price. This can often help determine how long and how much of a position various clients may choose to hold, naturally. Consider that from the 21,916 low point, the exchange report for Jan. 19 shows open interest has already grown by over 10% from that point, and now stands over 25,263 lots. Also, year end may not be a seasonally high watermark for position holders for various possible reasons.

So open interest is growing and prices so far this year…? Not too exciting, really. March has made some moves, but nothing that would get anyone’s attention. They’re rallying from a low to start in the month at 780, up to 802 at the high mark this month. And back down Friday trading around 780 again. This week’s index print was a pretty massive disappointment, which explains the dropoff in the spot January futures. They sank from 730 to 715 on the news that mills weren’t getting it done just yet, and prices actually slipped a few dollars week on week. Naturally, the market continues to price in the modest success of mills near term. But outlooks beyond March remain extremely cloudy, and opportunities look difficult to see clearly. This is likely because of how flat the forward market has become. From a March price of 780 there is only a 22/t premium out to June at 802 basis last trade as of trading Friday. All the way out to December 2023 it looks no higher than 815, showing skepticism that an extensive rally is possible. But this also gives the mills the benefit of the doubt on a “higher-for-longer” price outlook, given spot indications still slightly below this mark.

Here is a quick recap of some of those key volume metrics we mentioned above. Thanks for reading! 

SpencerX 2023 01 20 at 3.21.34 PM

Editor’s note: Spencer Johnson has been trading HRC futures for 14 years at StoneX (previously FCStone).

Spencer O. Johnson
LME/Ferrous Trading
StoneX Financial Inc.
O- 212-379-5492

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