The Chicago Mercantile Exchange trading
Several weeks after the launch of a new ferrous scrap futures
contract by CME Group Inc., the outlook for the new risk
management tool is still mixed.
Everyone, from the developers at
CME to traders, buyers and sellers, readily agree that these
are still very early days. Supporters note that there has been
a flurry of early trading--modest volumes, to be sure, but a
positive note on which to start. There are no detractors,
per se, but there are more than a few in the industry
who doubt the utility of such a contract for both technical and
Even the competitive picture is
mixed. Cleartrade Exchange Pte Ltd., Singapore, just started
trading a scrap contract that settles against the Turkish Scrap
Index, and Indias National Commodity and Derivatives
Exchange said it plans to launch a ferrous scrap futures
contract by year-end, but a representative of the London Metal
Exchange, which has no current ferrous scrap contract, declined
to comment on whether it was contemplating developing something
The new CME scrap contract is
settled against AMMs Midwest Ferrous Scrap Index
for No. 1 busheling. That is relevant because both the CME and
the LME launched steel futures contracts competitively in 2008.
At the time, global steelmakers expressed concern that such a
contract would stoke speculation in a market that traditionally
has been the domain of just buyers and sellers. The CME
primarily handles contracts in agriculture and energy, precious
metals and currencies, as well as equity indices and interest
rates. In contrast, more than three quarters of the LMEs
business is in industrial metals futures, including steel,
aluminum, copper and nickel.
The world economy fell into a
major recession at the end of 2008, led by the financial
sector. Banks, brokerages and trading houses, the institutions
that might have been willing to speculate in the steel market,
were instead fighting for their lives. Still, the same specter
of speculation shadows the new CME scrap contract.
The big exchange is
sticking to its guns. Since the Sept. 10 launch, the
reaction so far has been positive, CME director of metals
research and product development Yong-jin Chang said. For
any brand-new contract, there is a very steep learning curve
and a long education process.
That said, Chang is cheered by
some good news for the scrap contract. We saw some early
adopters, as well as regular clients who are users of our
hot-rolled coil contract, take some interest in the scrap
contract. There was 420 gross tons of open interest in the
first few weeks, which we are taking as a very positive sign.
Those early adopters are taking one contract at a time, one
position at a time, concentrating on the shorter months,
November through January mostly, she said.
According to the exchange, daily
volume traded in the CMEs domestic hot-rolled coil
futures index peaked at 536 contracts in August. In contrast,
there were 90,793 copper contracts traded on the CMEs
Comex subsidiary in New York.
There are two primary drivers
behind the new scrap contract, which is traded on CMEs
Globex electronic platform. First is the sheer size of the
market and the reality that it is just about the only major
industrial commodity without some hedging tool. The second is
that the CME has been promoting its integrated risk management
suite, called the virtual steel mill, for some
time. Chang said that a scrap contract is an essential
component in the full steel life cycle.
In 2011, about 65 percent of the
steel produced in the United States was based on scrap,
according to the CME. About 73 million tons of scrap were
produced last year, for a total domestic and export market of
Looking out across the broader
base of the steel sector, on the yard side and on the
producer side we are getting a lot of calls with inquiries.
People are really trying to understand the new contract, and it
seems clear to us that the industry is starting to see the
value of this contract, Chang said. At the most basic
level, then, the CME believes that a worldwide business of the
size and scale of scrap steel needs a futures contract as a
hedging tool for the same fundamental risk management reasons
as other global commodities.
Based on those figures and that
premise, everything the CME has said indicates high hopes for a
large and robust trade in the new contract. But reading between
the lines, there also seems to be the business proposition that
even if the scrap contract by itself doesnt become a big
standalone winner, it is still an element in the virtual steel
mill and will be retained as a role player in that capacity.
The virtual steel mill goes to the big picture in the
industry, Chang said.
In either case, building
liquidity takes time, she added. That liquidity is
what people want to see in these contracts. And building that
liquidity gets back to education and awareness. The education
process is a very big portion of our development plan. We are
holding hedging workshops and conferences around the
At the same time that the CME is
working hard to enlighten the market and drum up interest in
both the scrap contract and the wider virtual steel mill
concept, the exchange is playing down any near-term
expectations for the scrap offering. At this point, we
would not want to speculate on future volumes for the scrap
contract, Chang said. We are very encouraged by the
fact that it was traded on its very first day and that volume
is already building so soon after the launch.
Both developments are very rare
in a new contract, she said. There is definitely capacity
in the physical market against which this contract can grow.
Just look at the growth in the (hot-rolled coil) contract. And
look at the record volumes in iron ore contracts. We take all
of that as very positive for the scrap contract. When the
market becomes aware of these tools and understands how to use
them, the adoption accelerates. The scrap contract is a nice
addition to those.
Cleartrade chief executive
officer Richard Baker said his exchange received regulatory
approval for the Turkish scrap export contract in late August.
We already trade north Europe (hot-rolled coil) and south
Europe (hot-rolled coil), and we have looked at Midwest
(hot-rolled coil), but we have not looked at North American
scrap. The market is just too immature at this point. The
players are not really ready for a scrap contract.
That said, Baker has every
confidence in the long-term growth of the markets and their
eventual need for more sophisticated risk management tools.
We are seeing paper contracts in steel, he said.
It took two-and-a-half years to get the iron ore contract
to work, and we are only now just seeing volume increase. I
tend to be practical about these new contracts. In the next 12
to 18 months, I expect to see broader contracts in steel as
that market becomes more mature. There will be more acceptance
of the paper contracts.
Baker offers a global
perspective on the scrap market, beyond the shredders of Middle
America. He sees the scrapping of ocean vessels as an important
driver in the global scrap business. In the boom before the big
recession, new shipyards were created across China, elsewhere
in Asia and in many other regions. Since the recession,
hundreds of ships have been idled. In the last few years,
all those new shipyards have turned to disassembly, he
said. The typical lifespan of an ocean vessel over the
past several decades has been about 20 to 25 years. Just within
the last 18 months, the average lifespan of the world fleet has
gone down to 15 years because the owners of older or underused
vessels are getting good prices for the scrap. This is a
Far from competition
or complication for North American scrap markets, we see
strong organic growth in scrap. But we dont yet see
significant need for risk management in those markets.
Certainly it would be nice to have, but the ecosystem is not
ready yet, he said.
What gives Baker confidence in
the ultimate growth of scrap contracts is straight economics
and basic risk management, arising out of the needs of buyers
and sellers rather than fueled by speculation. End-users
and mills will wake up to the fact that they have a floating
price behind their raw materials, and that has a profound
effect on their profitability, he said.
Bakers model is the iron
ore market. Until recently, iron ore was settled
100-percent bilaterally. Today, about 90 percent of the market
is done in spot index contracts. Beyond that, the worldwide ore
market was 43 million tons last year and there were about 165
million to 170 million tons of derivatives used. From ore to
scrap is the full product cycle; scrap as a raw material brings
the supply chain around 360 degrees, he said.
And that is where the market is
headed, Baker believes. Today, however, scrap merchants
are getting reasonable prices in bilateral trade so there is no
need yet for more sophisticated risk management
We have been watching
steel and scrap and all the other futures for five years,
Steel Manufacturers Association (SMA) president Thomas Danjczek
said. The worth of any of those things is the real value
added to mills or yards. So far, the exchanges and the traders
have failed to sell the market as a whole on the value. That is
why the volumes have not taken off.
Danjczek suggested several
tactical reasons why industrial users, at least, havent
rushed to embrace the new futures instruments. Lead time
in our business is down to something like two weeks, he
said, suggesting that the real-time physical market moves too
fast for a paper market. Also, the size of scrap lots bought
and sold doesnt fit well with standard volume contracts.
Scrap goes in truckloads or railcars or shiploads. A
shipment is usually the sum of lots of small orders. It is
tough to handle that in a futures contract with all those
different lots and sizes, he said.
Beyond the structural and
logistical questions, there are some practical financial ones
as well, Danjczek said. These days, with interest rates
so low, you can just buy a pile of scrap and keep it for as
long as you need. Who needs a futures contract to manage
In essence, scrap isnt a
high-value or perishable commodity like gold or grain, he said.
I dont know if we need to pay someone to manage our
risk for us. I go back to my first question: what is the real
value to the mill or the yard? What is the real cost
Then, of course, there is the
shadow of speculation. Some SMA members simply see these
derivatives as speculative, Danjczek said. Look at
aluminum. The volume traded on the LME is seven times the
volume of physical metal produced in a year. Look at copper,
look at grain. They all have impacts in their markets that do
not pertain to steel and scrap. What affects our business are
location and logistics, freight costs and demand. You
cant change any of those things with a futures
For all his reservations,
Danjczek is willing to concede that there may be a time
and a place for a scrap futures contract. However,
this is not it yet.