A game with few contestants

The commodity exchange platforms CME Group, based in the United States, and the London Metal Exchange (LME), based in the U.K. have been offering ferrous scrap contract trading for five or more years. Although some activity occurs monthly on these contracts, the volume of trading and hedging attached to them likely is viewed as disappointing by the CME and LME, with the steelmaking and ferrous scrap recycling communities not yet making hedging a regular part of their routines.

In 2017, as some of these contracts were being introduced or repackaged, Recycling Today spoke with Nathan Fruchter of New York-based Idoru Trading about the prospects for the ferrous sector to follow the nonferrous sector in adopting hedging. Four years on, we have reapproached the veteran trader and consultant to see what he makes of the current and potential future status of ferrous scrap hedging.

Recycling Today (RT): Since we last spoke about this in 2017, how would you describe the progress of ferrous scrap hedging and exchange-based trading in the subsequent three-and-a-half years?

Nathan Fruchter (NF): LME statistics had been showing increased volume trading tied to its steel scrap contract between 2016 and 2019. Unfortunately, in 2020 the 280,600 lots traded represented a 13.5 percent drop compared with the 324,500 lots traded in 2019. I am going to assume that this may be as a result of the COVID-19 crisis. Overall, traded ferrous futures scrap volumes are regretfully trailing behind the volumes of contracts for well-established nonferrous metals. (Editor’s note: In 2020, more than 60 million lots of high-grade aluminum were traded on the LME futures market, along with more than 30 million lots of copper and more than 20 million lots of zinc.)

I think the intentions of this contract were to offer scrap metal recyclers, traders and steel mills a hedging mechanism, allowing them to reduce their exposure of unsold stocks and open contracts to moving prices. The ultimate goal was that the industry would one day adopt the LME price as the benchmark for the physical ferrous scrap contracts, as can be the case with copper, aluminum and other nonferrous metals. But I don’t see that happening any time soon. I don’t really know of a spot scrap contract sold to Turkey or elsewhere that was priced based on the LME Turkish contract. If I am mistaken, then I would venture to say that it’s a rare exception and was probably done to test the waters.

RT: You seem to say that confidently.

NF: I have yet to hear one high-volume metal recycler or trader say to a steel mill or vice versa during the negotiations, “Let’s price based on the LME.”

RT: Why is that?

NF: Ferrous scrap is a totally different animal than nonferrous metals or nonferrous scrap. LME or Comex hedging is in the DNA of every nonferrous trader. Unfortunately, it is not part of a ferrous trader’s DNA, therefore the ferrous folks are not really in tune to it or familiar with the process. They are also very set in their ways.

RT: There must be a younger generation of traders willing to consider new technology and techniques available for different aspects of the industry. Is hedging on their radar screens?

NF: I fully agree with that thought, and I have come across many young, talented and brilliant traders who are thinking this; but many of the younger folks are also the sons and daughters of their parents, whose businesses they eventually take over one day.

More importantly, though, the nonferrous arena is not the same as the ferrous arena. For starters, an LME nonferrous metal quality or spec is exactly that. It either meets the spec or it does not. It can be stored in an LME warehouse anywhere in the world and can change title from one buyer to the next, simply with an email release and without ever leaving the warehouse.

This is not the case in ferrous scrap. To many derivatives traders who are not familiar with the intrinsic characteristics of ferrous scrap, heavy melting scrap (HMS) Nos. 1 and 2, 80/20 cargo is exactly that: 80 percent No. 1 HMS and 20 percent No. 2 HMS. But in reality, it is not.

Take 10 respectable scrap recyclers, line up a 500-ton pile of scrap from each one, and you will have 10 distinct different piles of scrap and 10 different inspection reports issued by the same surveyor. One pile will contain a lot of cut rebar that some steel mills don’t want in their furnace. Another pile will contain a lot of light material, i.e., more HMS No. 2, and the seller will upgrade the quality with some extra heavier material. Another pile will be heavy on pressed and sheared material. Other piles will have cast iron or some railway scrap in it, which some steel mills don’t want (yet, others don’t mind it). I have not even started on the dirt and dust content, other impurities, oversized material or heavier than allowed pieces.

RT: Who are the buyers and sellers of these contracts of the volumes that we have seen traded on an exchange?

NF: You have financial institutions whose traders buy and sell the futures. To the best of my knowledge, they are not in physical scrap trading, i.e., buying a cargo from a recycler, selling and exporting it to a steel mill on a regular basis. I would think that most of them have never sold and shipped a 30,000-ton cargo. Then there are a very select few recyclers and steel mills, and I really mean very select few, who support or want to be seen supporting this, so they trade some tonnage every month, but their physical volume dwarfs their futures volume.

One respectable Turkish steel mill that is known to be supportive of futures contracts pointed out recently that “there are obstacles” in the process. They complained that there was not enough volume being traded. Another observation made by someone else was that the price quoted on any given day bears no resemblance to the physical sales price concluded that day for the same month. When I heard that, I took a look and noted a $30 to $40 difference for May tonnage on April 8.

RT: To what extent will the volatile scrap and steel pricing of 2020 inspire mill buyers, brokers or processors to expand hedging activities going forward?

NF: Scrap prices have fluctuated $50 to $100 some years and $50 to $150 others. Every once in a while, we get a year like 2020 where we see more like $50 to $250 fluctuations.

But it still hasn’t changed the mentality of recyclers and steel mills. Until certain changes are made, I don’t see much change going forward.

RT: When you talk to processors who say no to exchange-based trading, what are their predominant reasons?

NF: I have had this conversation many a times since I was first introduced to the ferrous scrap futures in 2016. Their reasons range from being very set in their ways to preferring the comforts of maintaining that physical pricing element to not being familiar with the hedging system. By the way, most buyers of these cargoes also show the same lack of enthusiasm. Also, the 10-ton contract size requires many hedged lots to cover a typical 30,000-ton Turkish cargo.

As I answer this question, an Argus market update flashes across my inbox, and the title reads “Turkish mills buy 19 May shipment cargoes to date,” and it’s only April 12. Any idea how many LME lots are needed to cover this volume?

The U.S. East Coast export recyclers also sell scrap into the domestic market. Many of their subsuppliers have a choice to make every month, i.e., to sell domestically to a steel mill or to an exporter’s yard or dock. The export recycler does not buy scrap that comes into his yard based on the LME. So why should he sell it basis the LME?

When an dealer gets feed into the yard, he does not necessarily know if that tonnage will be exported or sold domestically. The line of thinking here is: What good will buying based on the LME be if it is sold domestically?

Talking of the domestic market, the CME has ferrous scrap contracts for Midwest busheling and shredded. Suppliers who only or mostly sell their scrap to the U.S. domestic steel works are in a far better position to take advantage of the CME futures contracts than the average export recycler who, if anything, would look at the LME Turkish HMS contract.

Many people don’t realize that just because the U.S. domestic market moves up $20 to $30 on any given month, does not mean that the Turkish CFR price moves up that much. The subsupplier who has a choice to sell his scrap to the steel mill or to an exporter does not pay attention to what the LME is quoting on their Turkish CFR contracts. For him, it’s a choice between what he can get from the steel mill or from the exporter. And for some, it is never a choice: It’s always either one or the other, depending on their distance and transportation cost to a steel mill versus an export dock.

RT: What is your current involvement in supporting increased ferrous scrap hedging? How much increased activity would you consider a sign of progress when looking ahead to 2025?

NF: I dare not put a target number on increased activity for any period of time, but I see certain advantages to these ferrous futures contracts, and I would be willing to lend my knowledge to try and help crack this. I have some ideas how and where changes should be made.

I am actually looking forward to the LME launching its Taiwan container contract and am hopeful it will have an easier liftoff, as I feel it will be far more conducive to hedging ferrous scrap. It will also appeal to a larger group of ferrous scrap recyclers, traders and steel mills than the current Turkish contract for bulk cargoes. There are many more players dealing in containers compared with bulk shipping, and the physical contract sizes are smaller, so hedging does not require as many lots.

RT: Any closing thoughts?

NF: It’s been five-plus years since people have tried to trade ferrous scrap futures in an environment that was established for nonferrous metals. Why does it have to be the same as nonferrous? Why not review the rules of this game and the entire ferrous scrap platform process and adapt it in such a way that it serves the industry users well? I think for this to really work the way it was intended to, there’s a lot of bridge-crossing and listening to the other side required. But it is not impossible.

Nathan Fruchter is the owner of New York-based Idoru Trading Corp. and can be contacted at nfruchter@me.com.