Building momentum

Exchange services and brokers who have a stake in ferrous scrap trading contracts can look back on 2018 as a year when activity and interest in using the contracts as a hedging tool grew considerably.

Backers of the Nasdaq Futures Exchange (NFX) and London Metal Exchange (LME) contracts remain optimistic that ferrous scrap processors, brokers and mill buyers are on a path to using hedging as a risk minimization tool the same way buyers and sellers of nonferrous scrap metal use such contracts.

While there are reasons to be optimistic, ferrous scrap trading advocates also tell Recycling Today more positive momentum is needed before hedging is entrenched in the steel and ferrous scrap industries the way it is in the nonferrous sector.

Wading into the surf

The contract offered by New York-based NFX was just launched in the first quarter of 2019. John Conheeney and Mike Frawley of New Jersey-based World Steel Exchange Marketing (WSEM), which seeks to develop and support the NFX Midwest Shredded Scrap Steel Futures Contract, say time is needed for a community of steel futures traders to develop.

“Acceptance of new futures contracts takes time,” Conheeney says. He adds, however, “We have broad interest across the entire ferrous industry developing in these contracts.” In addition to offering its Shredded Scrap contract since January 2018, NFX also launched a hot-rolled coil (HRC) steel contract in December 2018.

Collateralized financing and referencing of LME prices in physical contracts are two key trends that could change the scale of the ferrous scrap derivatives market in 2019.

In 2012, the Chicago and New York Mercantile Exchange organization (COMEX and Nymex) introduced a contract for prompt or busheling scrap tied to Fastmarkets AMM Midwest Index pricing. As of early March, the busheling contract showed zero volume traded the previous day and a limited amount of open interest. A companion heavy melting steel (HMS) contract showed zero volume and zero open interest.

Subtracting the somewhat dormant Nymex contracts, the London-based LME thus has a first-mover advantage with its LME Steel Scrap contract, launched in late 2015. The contract is tied to Platts obsolete scrap pricing for import shipments purchased by Turkish buyers.

Alberto Xodo, vice president of sales with the LME, says 2018 proved to be a breakout year for the contract. “In 2018, we saw traded volumes of LME Steel Scrap reach around 5 million metric tons, roughly double the previous year’s volumes.”

Xodo says he sees positive momentum in the nature of conversations with current and prospective clients in terms of how they view hedging ferrous scrap.

“If we look at the annual accounts of certain large recyclers, four or five years ago they would have mentioned a desire to manage steel price risk that was frustrated due to the lack of a suitable instrument,” he says. “If we look at the most recent accounts of the same companies, the mention of such a tool not being available has been removed. Potentially [it’s] just a simple omission, or perhaps it is a sign indicating they have been dipping their toes and started managing steel price risk on the LME.”

He says recyclers have been “much more inclined to embrace the LME Steel Scrap futures in the earlier phases” compared with mill buyers. However, Xodo adds that “a number of steel mills have begun testing use of the LME Steel Scrap contract and also have expressed the view that once liquid markets to hedge both inputs and outputs become available, risk management will become a real strategic option for their businesses.”

New York-based trader and consultant Nathan Fruchter of Idoru Trading Corp. says prodding processors or mill buyers to try contract trading can require patience.

“I have suggested plenty of times to recyclers to dip their toes in the water; it usually falls on deaf ears,” he says.

On that outputs side, Nymex, the LME and NFX offer finished steel futures contracts, with the LME’s tied to steel rebar and the NFX contract tied to HRC steel.

Plenty of reasons

Advocates of the ferrous scrap contracts point to several reasons why recyclers and mill buyers alike can benefit from the risk management aspects of making trades tied to the contracts. “Price opportunity and volatility are key drives,” Frawley says. He cites price drops in the second half of 2018 as having provided a perfect example.

“In early June 2018, second half of 2018 futures could have been sold at a $395 per ton average price.” That sale figure could have been realized even though “shredded steel scrap prices dropped under $320 per ton in September,” Frawley says.

Regarding such scenarios, he says, “The tipping point for many will come when the pain of not being hedged will outweigh the fear of taking the plunge.”

Inventory levels can offer another reason for scrap processors to consider hedging, Conheeney says.

With scrap and finished steel contracts available, Fruchter says steel producers have two good reasons to begin hedging. “Mills should have greater interest because they can buy and sell using these contracts for their steel as well as their scrap, whereas recyclers can only hedge their scrap.”

Xodo says bankers who like to see more evidence of stability from their metals sector clients can see hedging as a plus. “Two key trends have been slowly emerging, and in 2019 they could change the scale of the ferrous scrap derivatives market by orders of magnitude: collateralized financing and referencing of LME prices in physical contracts,” he says. “We have heard of a number of banks beginning to offer financing to corporations against hedged scrap as collateral,” Xodo continues. “This type of transaction is beneficial for both parties.”

He also points to the commodity pricing volatility risk minimization benefits. “It provides both buyers and sellers the ability to manage their risk exposure flexibly according to varying market conditions and risk appetite,” he says. “It also allows both parties to Xodo on the negotiations around the specific premium or discount and value-add of the transaction rather than having to discuss the market price over and over again.”

Sparking a real change

While acknowledging that firmly establishing new trading contracts is hard work, Frawley, Fruchter and Xodo all say they see momentum building for the ferrous scrap contracts.

Fruchter sees a glimmer of hope based on 2018 LME activity but repeats his assertion that the timeline stretches forward.

"Price opportunity and volatility are key drives.” – Mike Frawley, World Steel Exchange Marketing

Frawley says the NFX contract, tied to Fastmarkets AMM Midwest shredded scrap pricing, “seems like the ideal scrap product to list,” since “obsolete scrap makes up about 80 percent of the U.S. scrap market.”

Xodo says “a few major players” in the recycling sector “have been exploring how to effectively structure long-term physical supply transactions referencing the LME prices for steel scrap.”

The LME is demonstrating confidence in its steel and ferrous scrap products by introducing two additional products March 11, he says. “Until now, steel mills have not had appropriate instruments to hedge their outputs, and this is a gap that the current LME Steel Rebar contract, as well as our new ferrous contracts—LME Steel HRC North America and LME Steel HRC FOB (freight on board) China—aim to fill.”

Frawley is bullish on the future of hedging in the steel and ferrous scrap sectors. “Those who work to develop their expertise in this space will reap significant rewards,” he predicts. “To us, it feels like the tinder is dry, and we are just looking for a spark.”

The author is senior editor with the Recycling Today Media Group and can be contacted at btaylor@gie.net.