LME seeks profitable billet with steel contracts

When the London Metal Exchange launched its aluminium contract in 1978, it faced bitter opposition from producers who considered it an unwelcome financial innovation. It was even rumoured that Krome George, chairman of Alcoa, had threatened to dismiss anyone who suggested using the contract. Fast-forward three decades, and you could be forgiven a sense of déjà-vu. This time the LME is launching a steel futures contract. And once again it is facing opposition from some quarters of the industry, including the world’s largest steelmaker, ArcelorMittal. The aluminium contract did eventually gain acceptance – but it took time. Today, according to Michael Parker, vice-president of Alcoa Material Management, the company uses “the contract to price virtually all its products”. The steel contract – based on billets, a semi-finished steel product primarily used to manufacture reinforcing rods for the construction sector – will start trading next month. And no doubt the LME would be very happy if it emulated the success of aluminium, which last year traded 40m contracts, up 10 per cent from 2006 and almost double the amount of copper traded. “Today aluminium is the most heavily traded commodity on the LME, but full acceptance was only gained almost a decade after its launch,” says Ralph Oppenheimer, executive chairman of Stemcor, the world’s largest independent steel trader. He adds: “For steel, I believe that it will take far less time.” The contract will collide with the shadowy world of steel price negotiations, leaving the industry facing a major shake-up and the threat of a shift of the pricing-power from the large producers to traders and financial investors. In spite of opposition from leading producers, bankers say it is rapidly gaining support among steel physical traders, medium-sized Russian and Asian producers, and Wall Street banks, which are eager to obtain further exposure to a booming sector. “Eventually, even [the producers opposed to the contract] will want to price goods with a margin relative to some LME or other tradable index price,” says Mr Oppenheimer. The launch of the derivatives contract comes as steel prices reach record highs amid robust demand from emerging countries, particularly China and the Middle East, and surging production costs as a result of rising iron ore and coal prices. Martin Abbot, LME chief executive, says the increase in price volatility justifies the new contract. Mr Oppenheimer adds: “Steel prices are increasingly volatile, which makes business planning a complicated and risky exercise for many players in the steel supply chain.” Alex Heath, head of metals at Royal Bank of Canada, says: “There is more interest in the new steel contract than anything launched by the LME in the last 20 years.” Bankers say the contract would allow the industry to improve its access to credit as credit lines could now be secured against forward steel prices. Liz Milan, LME steel business manager, says: “The banks which are financing the steel industry are among the keenest proponents of the contract.” The contract will also help steel consumers involved in long-term projects who have not had the tools to hedge their exposure to price changes. Mr Abbott says that the LME move reflects a fundamental change in the industry prompted by emerging countries’ appetite for steel. He says: “Steel’s international trade has grown thanks to the emergence of China as a large consumer and the development of the former Soviet Union steel producers’ industry.” The stakes are high – after oil, steel is the second largest commodity by value traded in the world. And after disappointing attempts at plastics and metals indices, steel contracts are a key part of the LME’s expansion plans. It aims to double its trading volumes in the period from 2006 to 2011. The development also creates an opportunity for investment banks and commodities brokers, eager to gain further exposure to a booming sector. Sucden, the London-based commodities broker, is among the floor traders at the LME planning to enter the new derivatives contract. Tariq Ahmad, director of corporate strategy at Sucden, says: “We will be offering it from day one.” Financial investors, however, are likely to wait to see if the contract gains enough traction, although some hedge funds have expressed interest in what it is seen as a proxy for construction activity in emerging countries. But the industry’s big guns, including Arcelor-Mittal and Germany’s ThyssenKrupp, oppose the derivative because it will transfer pricing power away from them, analysts say. Lakshmi Mittal, president and chief executive of ArcelorMittal, has argued that steel futures are essentially a mechanism for financial companies, not a solution for curbing price unpredictability. “Some customers have expressed a belief that this would be a useful starting point to help establish a more stable pricing market [but] I do not believe this to be the case,” Mr Mittal has said. In spite of this criticism, ArcelorMittal last year upgraded its membership at the LME, which it uses to protect itself against volatile zinc, nickel and tin prices. However, other steel producers and physical traders have expressed support, reflecting a division between the producers of billets and those of high-quality and more customised flat-steel products used, for example, in the automobile industry. Source: The Financial Times Limited 2008