China steel firms shield profits from volatile market
18 October 2017
China’s steel mills and traders are embracing more sophisticated ways to sell metal and buy raw materials to protect their bumper profits amid rising price volatility.
Steel mills typically sell their finished products at market prices to traders that later sell them on to end-users such as construction companies, also at market prices.
However, some mills and traders are adopting new arrangements to lock in their profits on expectation that prices may decline as demand could drop as activity in the construction industry, a major steel consumer, slows during the cold, winter months.
Steel prices in the world’s top producer surged to their highest in 4-1/2 years this summer and mills are making more than 1,000 yuan ($151) for every ton of metal they produce, the highest in more than seven years, based on data from brokerage CLSA.
Prices climbed on supply worries as China has shuttered steel mills for not complying with environmental rules. However, prices in September posted their biggest monthly drop in a year because of demand concerns from the expected winter slowdown and as the environmental crackdown will also close steel-consuming industries.
Amid this price uncertainty, mills are now buying raw materials such as iron ore and coking coal and selling their future products to one trader at an agreed price, officials from two Chinese steelmakers said. By fixing those prices, the mills can secure their profit margins.
“Whatever is good for the mill to reduce the risk and protect the profit then they consider it,” said one of the officials, from a mill in China’s southern Fujian province.
In turn, some traders are signing long-term contracts with customers, like construction companies, who have agreed to take the same tonnage at a fixed price each month, said Alexis He, director of sales for derivatives at CEFC Shanghai Resources Co Ltd.
By hedging those sales on the futures market “they can price in a reasonable safety net and provide a fixed-price contract to downstream construction companies ahead of time,” said He.
It is mostly smaller mills that have partaken in these “more creative ways of doing business”, said He. “But now, we’re seeing bigger mills getting interested because they’re hearing about it in the market.”
‘WE CAN MAKE MONEY’
While some companies are looking to clinch their profits in fear of collapsing prices, others are looking to expand their exposure to the market to benefit from an expected price rise.
These companies are cutting back their hedges on China’s futures markets because they predict prices would rise on falling steel supply as Chinese cities close down mills and production lines to meet winter air pollution targets.
The production curbs will last for four months starting on Nov. 15, the typical start of the heating season in China, but cities in the top steelmaking province of Hebei, including Tangshan and Handan, have ordered output cuts as early as this month.
Nearly 46 million tonnes of steel output could be lost if all 28 Chinese cities covered by the restrictions halve production, or nearly 6 percent of China’s 2016 output, SDIC Essence Futures analyst Cao Ying has estimated.
The decline in the open interest, or the number of outstanding contracts held by market participants, in the rebar steel contract on the Shanghai Futures Exchange (ShFE) illustrates the hedging slump.
The open interest for the ShFE rebar contract has dropped to 4.1 million contracts on Oct. 17 from 5.9 million on July 13, data from the bourse shows.
“It is not necessary to do futures which is highly risky when physical prices are good and we can make money,” said a futures market trader for a midsize steelmaker in Hebei.
“Bosses at other mills are also thinking like us.”