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A shred contract to kick-start ferrous scrap futures

Jan 30, 2018 | 07:00 PM | Michael Cowden, Grace Lavigne

In the next turn of the screw for the ferrous futures market, Nasdaq Futures(NFX) haslaunchedaMidwest US shredded steel scrap financial futures contract based on American Metal Market’s Midwest shredded scrap prices to give market participants an opportunity to directly hedgetheir exposure to the physical market.

The 10-gross-ton-lot contract is cash settled and will trade 15 months forward under the ticker symbol USSQ. The small lot size was chosen to allow market participants to dip their toes in the water on futures in an industry that is evolving to increasingly consider risk
management tools. The recent successes of the London Metal Exchange’s ferrous scrap futures contract has galvanized the industry
to take another hard look at this avenue to hedge risk and protect revenue.

“Metal Bulletin Group is pleased to provide the pricing for this contract at a very exciting time in the ferrous futures market,” said chief
executive officer Raju Daswani. “It highlights the robustness of our indices and the trust of both the futures and physical industry in what we do.”

The group, of which American Metal Market is a part, has “invested significant resources to ensure the accountability and auditability of our prices, including in state-of-the-art pricing software,” Daswani said.

The contract
The contract is the result of a partnership between NFX and World Steel Exchange Marketing (WSEM) that aims to introduce and
market steel and iron ore markets to global hedgers and institutional investors. “We believe the steel and steel scrap industry is ready for this product and for other ferrous products,” said World Steel Exchange Marketing founder Peter Marcus in a statement.

Trading hours are Sunday to Friday 7 am to 5 pm Eastern Prevailing Time. The contract is being cleared by Options Clearing Corp.

“Liquid futures curves will become an important financial tool for steel mills and foundries, steel scrap processors, middlemen companies, car makers and those in construction and demolition,” added Marcus, who is also principal of World Steel Dynamics, Englewood Cliffs, New Jersey.

Daily settlement prices will be determined by NFX using price data from a number of sources, including the spot, forward and derivative markets for both physical and financial products.

American Metal Market’s shredded scrap contract on Nasdaq currently trades on a monthly basis, with settlement on the 10th of each
month. However, the frequency of the index assessment could be increased in coming months, pending an industry consultation
that is now underway (see box below for specifications).

The monthly index is currently published at the end of the working day on the 10th of each month and reflects the latest spot transactions captured by American Metal Market.

Most deals in the US ferrous scrap market take place early in the month, and American Metal Market publishes the monthly settlement
prices for individual grades and regions then. However, a small number of trades take place throughout the month, and American Metal Market aims to capture these transactions by eventually increasing the frequency of the index, following an ongoing market consultation.

Increasing the frequency of the index assessment would add transparency to the market if spot trades are recorded and demonstrate
stability in the absence of trade. It would also incorporate intra-month transactions that might provide insight into the direction of the
market prior to the monthly settlement.

Broker support
Brokers like Ferrometrics are supporting the launch of the domestic shredded contract. The company traded the first contract on
January 12. “Ferrometrics is very pleased to have been involved in the first shredded scrap futures transaction and to support the
development of this contract,” chief executive officer Phillip Price told American Metal Market on the day of the trade. “The domestic industry now has a tool at its disposal that will enable hedging with minimal basis risk. We are already working with key US industry players to leverage the opportunities offered by this contract.” Shredded scrap, generated largely from obsolete auto bodies being run
through large industrial machines simply called shredders, is one of the most ubiquitous scrap grades in the world. It is used largely by electricarc-furnace steelmakers to make long steel products, although it is also used in flat steel production.

US obsolete scrap consumption, including shredded, is estimated at around 50 million tons annually, and shredded scrap is exported from the US, mainly to Turkey, in large quantities. Turkish steelmakers use the material to produce finished steel, some of it then gets shipped back to the US. In 2017, scrap exports of shredded scrap totaled 3.26 million tonnes through November, according
to the latest US Customs data.

Related indices
Metal Bulletin Group’s prices underpin a number of metals futures contracts worldwide – including the Chicago Mercantile Exchange’s copper cif Shanghai futures contract and the exchange’s duty-unpaid aluminium premium contract. American Metal Market’s Midwest No. 1 busheling index also supports the CME’s US Midwest busheling ferrous scrap futures contract. Busheling, launched in 2012, has traded sparsely recently although one Mid-Atlantic scrap dealer said he “uses the contract whenever I can.” The contract closed 2017 with 615 lots of open interest and 75 lots of the 20 gross tons instrument were traded on December 20.

Further potential
Big River Steel is one domestic steel producer that has committed itself to trading futures. Chief executive officer Dave Stickler’s embrace of futures stands in contrast to the position of other steelmakers, some of whom have spoken out against them.

He used the example of the aluminium industry as one that has managed to minimize price volatility through widespread adoption of
futures, talking at American Metal Market’s fifth DRI & Mini-mills Conference in November 2017.

“Big River Steel by itself is not large enough to do that... but if some of our friends in the steel industry also get on this [futures] bandwagon... I think we stand a fair chance of seeing some increased liquidity that will benefit all participants,” Stickler said.

Ferrous futures in the US have a checkered past, with some steel industry executives having taken a dim view of derivatives. But stances have softened more recently, especially as global pricing volatility has risen. And China has led the way in steel futures use.

“We are witnessing a seismic shift in the way that the steel recycling sector, and the wider steelmaking sector, views derivatives with more and more supply chain participants beginning to use ferrous derivatives every day,” Ferrometrics Phillip Price told Metal Market Magazine.

“China is already having a large influence on the international scrap market, and therefore the LME contracts, due to its rapidly shifting
balance of trade for this product.”

Rebar futures in China for example are trading at a significant multiple to the physical business. The LME’s ferrous scrap contract, while lagging behind these kinds of numbers, has grown in liquidity.

“With significantly reduced exposure to extreme price movements, scrap industry players can stabilize their physical trade flow
and revenues, enabling them to focus on enhancing their margins, improving their services and expanding their range of trading
counterparties,” Price said.

Futures participants now range from major recycling companies through trading companies and other intermediaries to steelmakers
and end users, according to Price.

And there is lingering financial interest too. “Coinciding with some of the major shifts now occurring in the global commodities markets...we are seeing a great deal of interest from players outside the steel sector looking to participate in the value the
industry creates, now that they are able to utilize products like the LME contracts to shield them from extreme price volatility,” Price said.

“This includes leading players in the private equity world, major multi-commodity trading companies and a whole range of financial
institutions – excellent news for a sector that has been starved of meaningful investment and working capital since the global financial crisis.”

The next frontier in ferrous scrap futures could be the containerized markets in Southeast Asia. “Following on from the LME’s
success in providing a tool to the deep sea bulk market, we see huge potential for a financial instrument enabling participants in the
containerized ferrous scrap market to manage their exposure to price risk in a similar fashion,” Price said.

“We are aware of a number of exchanges that are already looking at plans in this area, rightly focusing on containerized trade into the key markets of Taiwan and India/ Pakistan and Ferrometrics has already begun working with physical operators who are interested to
utilize these products, once they are launched.”

After a few fits and starts, ferrous futures finally look to be here to stay and are expected to become a much-used part of the supply chain. New contracts will also allow the use of further arbitrage opportunities between different grades and regions of the world.

Michael Cowden, Chicago, and Grace Lavigne, New York, contributed to this report. If you have any questions on any of Metal Bulletin’s futures contracts please contact us at: