Back in the day, there was a car rental company that played
up its status as the second-largest operator in the business
with the mantra, Were No. 2. We try
It is essentially the theme of commodity trading and risk
management (CTRM) in the global metal markets. The smaller and
more concentrated marketscopper, aluminum, specialty
metals and alloyshave never had the scale to
counterbalance potential swings in the market, so they were
quicker to adopt software tools and management practices that
helped mitigate volatility and other market risks.
In contrast, participants in iron and steelfrom mines
and mills to fabricators and service centershave had
advantages of scale that in many cases became natural hedges.
That is especially true of integrated companies. Recently,
however, with the rapid proliferation of short-term contracts
and growing international competition, some steel operators
have been looking into CTRMs possibilities for their
sector as wellfacilitated by a burst of activity in
commodity exchanges for physical metal futures contracts as
well as cash-settled, index-based instruments.
We have seen an increase in exchange-traded
contractsfutures, options, swaps and so forthfor
iron and steel, said Robert McCutcheon, head of U.S.
metals and industrial products for PricewaterhouseCoopers LLP.
Aluminum, for example, has been better able to construct
models for their sales practices, and to link them back to the
market indices used for trading.
While steel has been a worldwide industry almost from its
earliest days, it was not actually a global market as it is
known today until privatization and consolidation began in the
1980s, he said. Until then, it was a patchwork of regional and
national markets, somebut not allwith interactions.
In contrast, aluminum was truly global early on, while
steel was often regarded as a national resource.
There is a great deal of activity in the CTRM market today,
McCutcheon said, and it is rising with the tides of in-house
risk-management expertise at metal companies and the tools
available on various exchanges. Trading has been focused
on higher volumes and lower prices, which means that the margin
is tight. The software today allows for daily management of a
hedging portfolio, which is a long way from the spreadsheets of
just a few years ago. However, that kind of access means the
operatormill or traderneeds secure control,
segregation of duties and good governance.
The industry is a mix of commercially available software,
custom-made applications, home-grown solutions
andstillsome souped-up spreadsheets, he said.
There are still lots of home-grown systems, but more and
more companies are quick-
ly thinking about commercial ones. Regardless of which
direction management chooses to go, this is a very good time to
address these issues and have these discussions within the
company and with suppliers and customers.
Indeed, McCutcheon said that the bulk of CTRM adoption is
driven by the C-suite. Typically, this kind of thing is
top-down. CTRM and enterprise resource planning (ERP) are very
much on the minds and agendas of CEOs, COOs and CFOs. These are
operational, commercial, cost and risk-management issues, but
the risk-management groups cant really solve all these
issues on their own. Organizations need to generate as much
open discussion as they can.
Many various exchanges started off with the same ideas
in iron and steel, said Harry Knott, product manager for
London-based software company Brady Plc. There are
considerable volumes in the global market, and everyone wants a
piece of that.
Knott said the current state of the steel market is
like the very early days of aluminum. People are offering
different products and solutions, but there is very limited
liquidity and uptake. The cultural adoption is not high.
Aluminum took years and years to get up and running to be
usable in any real way as a hedging tool.
That difference exists today due to the long history of
steel as a high-volume, low-margin, strategic commodity, Knott
said. The reason CTRM adoption has been faster and more
extensive in aluminum, copper and other metals is due to simple
Given the volumes of raw materials that steel mills had to
buyand given the volumes that they have sold over the
many decades before the earliest CTRM solutions became
availablethey simply made do, and they now have practices
in place. The soft reason why uptake has been slower in
steel than in nonferrous metals is cultural, Knott said.
It is a deeply conservative industry, inclined to stick with
what is working even if it is working only fairly well.
Knott acknowledged that point is somewhat at odds with
another common explanation: Steel is only a commodity as an
aggregate industry. For any given relationship between mill and
customer, there are so many grades that steel has more in
common with performance products. Thus, it is too diffuse a
market for the tight algorithms of CTRM to be of much help. But
that explanation may be a bit too finespun. I am willing
to accept that argument to a point. It is legitimately a
more-complex material and market than is aluminum. But that can
also be used just as an excuse. Historically, steel has been
priced on long-term contracts based on some benchmark. So while
there is an element of truth in the specialty premise, there is
also an element of truth in the commodity premise.
Others find the differentiator not in the metal itself but
in its end-use markets. Aluminum and copper have become
essential components of the high-tech industry in Japan and
South Korea, said Doug Gyani, director of sales for Asia
and the Pacific at software company OpenLink. For casings
and wiring, we have seen a higher concentration in the market,
which has meant a more frequently traded market, and that has
pushed liquidity. In contrast, iron and steel are
still materials more for mass manufacturing. Although there is
more paper trading recently than in years past, here in
Singapore they trade a lot of iron-ore paper. The exchange is
happy with any level of interest.
As other metal markets expand their use of CTRM and as
vendors, consultants and service providers continue to hone
their skills, Knott said, adoption in steel will accelerate,
albeit slowly. The change in steel will be an
evolutionary, discovery process.
Moving from philosophy to practice, Knott said that
competition among exchanges and indices is adding to the
complication. All the indices want to be the basis of any
new steel futures contract or hedging tool, he said.
No one wants to be left out at this formative stage of
the business. If you look ahead, you see where copper is with
its wire basis on the LME or Comex, and those markets are
obvious and standardized.
Interest is developing on both sides of the industry, Gyani
said. We have seen markets changing. There is certainly
more interest in the physical space for steel, while the
financial interest has focused more on precious and
non-precious nonferrous metals. We are finding people taking
multiple positions in multiple markets across the
Like any new tool, the more broadly CTRM is used the more
integral it becomes. Taking multiple positions in physical and
paper markets worldwide is not something that can be done on
lined paper under a green eyeshadeor even, for that
matter, on a spreadsheet, Gyani said. There are issues of
inventory management, taxation and relative valuation. The
financial side of CTRM in metals is quite similar to that of
agricultural commodities or energy, but the
materials-management side is very different.
The challenge for risk managers in the steel sector, then,
is akin to that of the Federal Drug Administration: determine
the safest, most effective solutions. Just as with clinical
tests, making that determination is an iterative process, Knott
said. On the supply side, upstream of the mill the basis
seems to be working. That end of the business seems to be what
is getting picked up.
Exchange-traded futures seem to be struggling for adoption,
while cleared swaps are getting more traction, Knott said.
That is because, as compared to futures contracts, swaps
seem to be the more obvious hedge. So at this point in the
development of the market, that route seems the more likely.
And, honestly, I dont see a big difference in the
validity of a swap or an exchange-traded future based on an
index in utility as a hedging tool.
As Knott explains the situation, it seems as if mills are
like sports fans trying to watch several games at the same
time: The exchanges and indices are vying to bring new
contracts to the market; physical exchanges are starting to
offer cash-settlement instruments; and financial exchanges are
starting to offer hard-metal contracts, all using different
CTRM vendors and consultants are vying to stay current on
the newest hedging tools while simultaneously tweaking their
offerings to improve speed, accuracy and comprehensiveness. The
term virtual steel mill is used with increasing
frequency for the concept of tracking expenses in raw
materials, production, sales and delivery all in the same
At heart, CTRM is an aggregating tool, Gyani
said. For those people with their fingers in a lot of
different pies, there is often a lack of clarity of their
overall position. They have so many exposures. Some of those
risks exist in certain commodities or certain markets, some are
unique to metals, some are common across ag(riculture) and
energy as well. Whether a specific user is in a specialty
market, or is value-driven or supply chain-driven, not having a
complete picture limits opportunities for growth.
The principle applies even in cases in which companies are
more vertically integrated rather than horizontally dispersed
among several sectors, Gyani said. The end game is the
same. You need efficiency of the supply chain. CTRM is a
decision-support tool. It never replaces a full ERP platform,
but there is more and more overlap between CTRM solutions and
ERP systems. That has happened, he said, due to the
increasing development of vendors, but it also reflects the
volatility that has come into the non-traded markets.
From a mills point of view, all these different
prices for different grades are just added difficulties to the
business, Knott said. In grain or oil, the spreads
can be more easily tracked and the arbitrage opportunities can
be more apparent. But that can also be done in steel. From a
systems point of view, the fiddly bits can be done.
But there are a large number of fiddly bits.
The lack of fungibility among products is a
challenge, Knott said. Again, it compares to the energy
sector: All over the country, producers of natural gas put
their liftings into common-carrier pipelines. Drivers use many
different brands of gasoline, all on top of each other.
Substitutions for finished products are rarely seamless in
Refiners know their cracking and blending costs, of
course, but also their transportation costs, Knott said.
Steel mills know how much they pay for ore and scrap and
coal, and somewhere, someone knows how much they pay for
transportation, but do all the people who need to know that
actually know it?
Knott gives a lot of credit to the early adopters in any
metals sector, but especially in steel. Right now, they
are quite brave because they are facing a lack of liquidity in
many of the markets. Conversely, the last ones to get on board
will be facing market risks that their competitors are already
likely to be managing better than they are, he said.
Maybe they will get lucky, but the late adopters
certainly run the risk of having their margins wiped out for a
Mines are always long by definition, Knott said.
Integrated copper producers, with both mining and
smelting in the same house, have a built-in hedgeraw
materials against finished product. But for non-integrated
companies in any commodity, not just steel, they call
themselves producers but they really dont produce; they
are fabricators. They turn one thing into another. In steel,
the term fabricator means a segment other than the
mills, but the mills are actually that. And as fabricators,
they face an inherent transactional risk.
The mills also have another element in common with
fabricators, distributors and suppliers: Their business is in
physical metal, and they need financial instruments as
risk-management tools. In the market trading houses, they are
essentially financial operators who need physical metal
activity as a risk-management tool.
Traditionally, the derivatives analysts, the trading
and finance houses, have been better at risk management than
the physical commodity operators, Knott said. Each
developed without the tools of the other: Trading houses and
banks rarely had access to contract terms or pricing schedules,
and mills and fabricators rarely had access to derivatives. Yet
every business manager is groping for the same insight.
Whether you have the thorny, fiddly contract issues or
whether you have the power and flexibility and insight of a
trading platform, you still need to know at bottom what is your
current exposure on any given position and in aggregate,
Knott said. Even the biggest guys need to know this.
Maybe a steel manager knows his position for the next 10 days,
or maybe at the end-of-the-month settlement. But does he have
the ability to bring details of his companys disparate
These days, every company has some sort of risk-management
policy. The goal usually is to eliminateor at least
minimizeprice risk on the commodities a company needs to
operate. It is not trivial to translate all of those
details and the risk-management policy into an overall system
with the entire metal position, physical and financial,
Knott said. If the senior executives dont know the
true exposures, they dont know how the actions of their
traders and sales staff and buyers and plant operators are
affecting that position. They dont know if policy is
being followed and executed.
The analogy Knott offers is having a map for a journey but
not being able to see the road or signs due to fog, rain or
darkness. CTRM software is not going to tell you whether
or not to hedge. It can tell you that if you want to be in a
certain position at a certain time, this is the way to get
there, he said.
Gyani said that when he and his colleagues walk into the
offices of a big metals trading house, a banks
commodities floor or even some multinational mill
operators headquarters, they often find former Enron
Corp. and Bear Stearns Co. Inc. tradersthe ones who had
nothing to do with the troubles of their previous companies but
who cut their teeth in the first blooms of the trading heyday.
Those guys are now bringing that level of skill and
sophisticated trading ideas to the industry, he said.
Now, to be fair, there are people who dont want
these traders coming into a market that is functioning well, a
non-traded market, and mess it up. But everyone
acknowledges that some metal markets, especially steel, could
use additional liquidity and transparency.
We read AMM and we see the volatility in
China and other major markets, said Robert Hamilton,
global sales director for metals at Aspect Enterprise Solutions
Ltd., based in London. Now the LME will tell you that it
all can be controlled, but we see customers using LME plus
quite complex formulae in their pricing models. Copper could be
in backwardation in one place and contango in
Theoretically, that reality would even open arbitrage
opportunities, which could really draw speculators into the
metals markets, but Hamilton said he has not seen a great deal
of that. People are not moving metal around, but they are
making more use of swaps. Steel guys in particular are
resistant to hedging because they believe it will end up with
the market driven by speculators, he said. However,
some speculation is necessary to supply liquidity.
The latest segment of the market to see a surge in CTRM
adoption is the scrap business, Hamilton said. We are
doing quite a bit of business in Turkey. Globally, scrap is
green, so there is a lot of support for that trade.
We are seeing huge interest in us tweaking the standard edition
of our software to provide price de-escalators for all
non-refined inputsscrap, coal, ore and concentrate.
Those are really discounters, he said. You buy the
material based on a certain quality or grade, but if in
monitoring your output you realize that there is a variance in
the quality, you can plug that back into your operating model
and cost functions.
Aspects business comes 95 percent from its standard,
cloud-based solution and just 5 percent from
enterprise deliveries in which there are low-level
adjustments to a code for a specific client. In those cases,
Hamilton said, Aspect tries to enhance the standard edition by
whatever non-proprietary elements can be incorporated from the
bespoke versions. In turn, every enhancement to CTRM gives
mills more optionsand sometimes new challenges.
How do you assay scrap? Hamilton asked
rhetorically. In practice, you have to monitor the
quality of output, which is not exact, but there is an evolving
view that scrap from North America is of a higher quality than
scrap coming out of other regions. But whether you are talking
about scrap or other inputs, CTRM is still in its very early
days. It is an enabling tool with a long way to go, but at
least we are all having this discussion.