Industry upbeat on prospects for LME steel contracts

15 October 2015

A range of industry players in both physical and financial markets are backing the London Metal Exchange's new steel derivatives contracts, boding well for the exchange's bid to make inroads into the new market.

With U.S. bank Goldman Sachs, top global steel trader Stemcor and top global metals recycler Sims Group on board, the LME will launch the cash-settled contracts next month, hoping to make money in the fast evolving ferrous derivatives market.

Volumes on cash-settled iron ore contracts have soared as speculators use them as a way to bet on China's growth while physical market participants look to them as a hedge against price volatility.

"Having steelmakers on board at first, though helpful, is not necessarily a critical success factor," said James Rilett of MVS, a commodities analytics business.

"The contract needs people with a variety of physical trading priorities, as well as speculators to take both sides of a trade. It also needs banks and other counterparties. It sounds like the LME could have this," he added.

Since its purchase by Hong Kong Exchanges and Clearing (HKEx) in 2012 for $2.2 billion, the exchange has sought to boost revenues with new contracts, though its history in ferrous derivatives is not a happy one.

It launched a physically deliverable steel billet contract in 2008 that failed, largely due to problems storing and withdrawing the metal from backlogged LME warehouses. Top steelmakers, averse to ferrrous derivatives, avoided the contracts and their price eventually lost synchronicity with the physical market.

The LME's new contracts, by contrast, will be cash settled against a physical Turkish scrap and rebar price index, to stay in touch with the real market. Crucially, the products will have several market makers guaranteeing liquidity.

The LME steel committee, which advises the exchange on contract launches, has the International Steel Trade Association, which represents steel merchants globally, on board.

Also present is the Turkish Steel Exporters Association, a powerful industry lobby.

"This has obviously been well thought out. Turkey is so well located for supply in so many markets, not just Europe. I think having Turkish based contracts is a useful mechanism for the market," said an industry expert.

Turkey is the world's biggest rebar exporter and steel scrap importer. Its buys a lot of its scrap from the Unite States, and experts say the addition of U.S.-based steelmaker AK Steel to the LME steel committee is another positive.

In Europe, steelmakers are more wary, although their attitude towards ferrous derivatives is more open than it was when the LME billet contact was launched.

Voestalpine, SSAB and Salzgitter told Reuters they will not be using the contracts, as did several mid-tier German steelmakers, but Germany's ThyssenKrupp and another mid-tier German steelmaker, said they will take a wait-and-see approach.

ArcelorMittal and Tata Steel declined to comment, but industry sources say they use iron ore derivatives, and so have traders in place should the steel contracts take off.