HRC ’21 deals settling fast, favorably for mills
Nov 18, 2020 | 03:49 PM
Mills are concluding hot-rolled coil contract talks more quickly than anticipated and on more favorable terms thanks to an unprecedented spot market supply squeeze, market participants said.
Just how bad is it out there for a steel buyer in urgent need of an extra coil or three?
“At the beginning of the pandemic, it was toilet paper, let’s hope coming out of it, it’s metals,” one Great Lakes service center source said. “Every signal we are getting is that we are in a heck of a supply shortage that will last all the way until March.”
The most notable changes, according to market participants, are as follows:
Your minus: a percentage instead of a dollar amount
- Contract talks are wrapping up more quickly so that buyers can secure 2021 tons given that spot lead order books are into February at some mills.
- Contract discounts are calculated in terms of a percentage rather than a fixed dollar amount.
- Buyers are allotted a narrower “min-max” bandwidth when it comes to their monthly contract volumes
Contract terms are typically based on a discount to published spot prices.
That might be, for example, $20-60 per ton ($1-3 per hundredweight) - depending on the customer and the volume purchased - below a spot index such as Fastmarkets’ daily steel-hot rolled coil index, fob mill US.
Fixed amounts might be advantageous to mills when times are good. Take last week, when US HRC prices averaged $713 per ton, according to Fastmarkets' calculations. Even a $60-per-ton discount to that figure would have left most mills making a solid profit of $653 per ton.
But when steel markets deteriorate, as they did after the Covid-19 outbreak this spring and again in July and August, these mechanisms can send contract tons into loss territory for mills.
Take, for example, the week ended July 31, when Fastmarkets’ daily HRC index averaged $447.20 per ton. A contract discount of $60 per ton would have dropped that number to $387.20 per ton - break even or worse for all but the most efficient producers.
Contracts in 2021 will still be based on a discount to spot prices. But in many cases, the discount will be expressed as a percentage instead of a dollar amount. For example, 5-8% below the spot price, with the discount amount depending on the volume and the customer.
“We went to a percentage this year vs a fixed number to help us on the downside. … and we have settled with everyone except for a couple of guys,” one mill source said. “We basically said, ‘This is the way it’s going to be, take it or leave it.’ It didn’t win us any friends. … But if we don’t do it now, when are we?”
A 5-8% discount to last week’s average HRC price of $713 per ton would result in contract prices that were $35.65-57.04 per ton below spot prices, or on par with the amount specified under current dollar-based discounts.
In a weak market, however, a percentage-based discount would offer more protection for mills. The resulting discount for the late-July weekly average ($447.20 per ton) would have been $22.36-35.78 per ton, meaning fewer contract tons would have been priced at loss-generating figures below $400 per ton.
It might also contain a “scrap plus” floor
Mills aren’t only protecting themselves from a potential market correction by changing to percentage-based discounts.
Some mills are keeping the dollar-based discount, but are also instituting a “scrap plus”-based floor, which the contract will not allow prices to fall below, sources said.
This format takes a scrap price, such as one of Fastmarkets busheling prices, and adds a certain amount, perhaps $150-200 per ton, to cover conversion costs, they said.
Such a mechanism could prove useful should finished steel prices and scrap prices trend in different directions. That happened this spring when automotive plants, which consume finished steel and produce busheling, stopped output for approximately 10 weeks in response to the Covid-19 pandemic.
The result: HRC prices plummeted while busheling prices soared - squeezing margins at electric-arc furnace (EAF) producers, which make sheet from prime grades such as busheling.
Case in point: Fastmarkets' steel scrap No1 busheling, consumer buying price, delivered mill Chicago settled at $276.79 per short ton on May 6, up 14.8% from $241.07 per ton on April 13.
The problem was US hot-rolled coil prices fell to a more than four-year low of $437.80 per ton on April 30. Assuming a conversion cost of $175 per ton, HRC prices would have been in loss-making territory when scrap adjusted upward in May at $451.79 per ton - or $13.99 per ton above the spot price in April.
Another formula involves linking the discount to finished steel prices, expressed as a dollar amount, to the spread between hot-rolled coil and scrap prices. When the spread between hot-rolled coil and busheling increases – implying increased profit for an EAF producer - the dollar amount of the contract discount to spot steel prices increases.
And, whatever the contract formula, some mills continue to offer annual rebates, sources said.
Volume: fixed - or a lot closer to fixed - than it used to be
Another standard feature of US flat-rolled steel contracts is a mechanism that allows customers to buy a specified minimum or maximum of tonnage every month.
The problem with the “min-max” mechanism is that it can increase volatility, especially given the notorious herd mentality in the steel industry, sources said.
Case in point: Buyers tend to load up on the “max” end of their “min-max” contracts when prices are rising, but buy the minimum amount when prices are falling, sources said.
The result: Mills tend to miss the highest points of the spot market because buyers have placed as much tonnage as they can on the “max” end of their min-max contracts. And mills tend to see volumes dry up when price are falling - and when the volume is needed most - because customers order only the minimum of their “min-max” tonnage, they said.
Customers, for example, used to be allowed to place a minimum tonnage of 2,500 tons or a maximum tonnage of 3,500 tons in any given month - a spread of 1,000 tons. That might not seem like much, but spread across 25 customers, that’s 25,000 tons.
To put that in perspective, NLMK USA’s hot-strip mill in Portage, Indiana, has annual capacity of 1 million tons per year, according to the Association for Iron and Steel Technology 2020 Directory of Iron and Steel Plants.
That breaks down to approximately 83,333 tons per month, so a 25,000-ton swing could impact as much as 30% of available capacity, according to Fastmarkets' calculations.
Mills have therefore attempted to narrow the spread to 500 tons (2,750-3,250 ton in the example above) or 200 tons (2,900-3,100 tons), or have fixed the volumes at 3,000 tons, sources said.
The same applies to min-max contracts that had been based on percentages. Mills might have been offering 10% or even 20% plus or minus a specified base amount. Or, in the case of the 3,000-ton example, a 2,400-ton minimum and a 3,600-ton maximum.
That percentage has been reduced to closer to 5% - a 2,850-ton minimum and a 3,150-ton maximum. Or that variance has been eliminated altogether, sources said.
While customers might not like the reduced flexibility, mills sources stressed that it will make it easier for them to plan and coordinate production schedules, something that should result in more on-time deliveries and greater predictability across the steel supply chain.
“If everyone goes to min or max, then you are talking some serious tons - and it’s hard to manage your order book,” a second mill source said. “If you want your steel on time, you order consistently every month.”
Reduced min-max spreads or fixed monthly contract volumes might also result in more tons being priced in the spot market. And that could be advantageous to everyone in the supply chain because when the spot market dries up - like when most buyers order at the “max” end of their contracts - it leaves only the smallest, least-informed buyers as a gauge of the spot market, sources said.
The spot number can come crashing back down again when larger, better informed buyers return to the spot market - often at the same time and often at far lower prices, they said.
The timeline: baked in time for Thanksgiving
Several producers have wrapped up or nearly wrapped up 2021 contract talks, according to market participants.
That stands in stark contrast to past years when talks dragged into the second half of December or even into the beginning of the following year, they said.
That timeline is not what was expected when contract talks kicked off in the fall. At that time, many market participants doubted that the recent rise in prices would prove sustainable, and the sharply divergent outlooks were expected to result in a protracted contract-negotiation season, sources said.
But US HRC prices have been steadily rising since late July and some market participants are more concerned about securing the tons necessary to maintain their operations than about the price, they said.
The result: talks have concluded ahead of Thanksgiving, which is unusual, or remain outstanding for only key large accounts or smaller accounts that cannot be settled until the big players are squared away, some sources said.
“We are typically concluding contracts much later than this,” the first mill sources said. “This is the first year we got it done as early as we did.”
While a few contracts are in the “final throes” of being negotiated, there is little indication that talks will drag on much longer, the second mill source said. “It’s not if we’ll get it signed, it’s just the fine points,” he said. “In years past, we have been well into December or even into January.”