Harriet Hunnable on CME U.S. scrap metal futures

Sarah Rudolph

Sarah Rudolph

Managing Editor

The CME Group recently announced that they will launch a new U.S. Scrap Metal futures contract in August. Harriet Hunnable, managing director of the CME Group’s metals products, sat down with JLN Metals editor Sarah Rudolph to talk about the new product and how it fits in with the CME’s current metals product suite.

Q:  You recently spoke at the AMM Steel conference about the launch of a CME U.S. Steel Scrap contract.  What is the reason for the launch?

A:  We are working to launch a scrap contract specifically for the U.S. market, because a lot of steel production uses scrap here in the U.S.  For electric arc furnace steel mills, scrap can make up between 45 to 85 percent of the steel cost in scrap.  There is a lot of volatility in the price of scrap, and this product can help people to manage their price risk.

While we’ve been developing meaningful products in Asia in iron ore, and in Europe in scrap and HRC [Hot-Rolled Coil], we continue to bring out products that are relevant both internationally and to the U.S. market.  The U.S. is currently the largest scrap exporter in the world. Turkey, China, Korea and Taiwan are four of the biggest importers of U.S. scrap. So the U.S. scrap price is very sensitive to not only domestic market conditions but also global demand. As a result, at present, the U.S. scrap price tends to be the world benchmark price. So we expect that a U.S. scrap futures contract will not only be a useful risk management tool for domestic U.S. market participants but also for international market participants who import steel scrap from the U.S.

Q:  There is a lot of interest in China, which is a big consumer of metals products. Do you see ways of coordinating the two markets, the U.S. and China?

A: The great thing about metals markets is they are very global. Scrap produced in the U.S. will either be used domestically or it could travel halfway across the world to China or Turkey.  It is absolutely relevant to the U.S. marketplace where small, medium-sized, and larger businesses are trading in scrap and producing steel, but they are also exporting products abroad.  Some are exporting scrap abroad.  So it’s a domestic product but with international opportunities for us and for people who want to manage their export businesses.

The scrap product also fits in very neatly with our iron ore product, which happens to be Platts and TSI iron ore for the China market and the billet contract we have in Europe.

Q: There was a recent Reuters story that talked about giving scrap recyclers, mini mills and construction companies the ability to hedge.  Have they had any ability to hedge before this?  Or just not as much?

A: In this industry people have used owning physical material as a way to hedge price movements. There’s a lot of speculative activity in the U.S. in this market already, but people have only been able to use that by buying and holding and storing, up until now.  Then there is also activity in managing price risk, some of it by entering into other arrangements, but it wasn’t very flexible.  Under the current arrangement you need to have a lot of cash, and you’ve got to have a big risk appetite, and find the right counterparties all the time. You need to get a lot of things right in order to manage your price risk, whereas with futures you can manage the same risk with less outlay, more counterparties, and the assurance of executing and clearing the product.

Because historically companies wanting to fix the price of a metal had no other choice than to buy the physical material, this meant a high exposure to risk during volatile markets.  If you introduce flexibility, people’s reactions could be less extreme. At the moment it is a highly volatile market, and people have very few tools to manage that exposure.

Q:  What is the AMM index, what is its importance?

A:  When designing this contract, we wanted an index provider that had two things: the most robust data collection and the most coverage by commercials.  We found that AMM was most widely used as a pricing reference by commercials, and that AMM were doing the right work on this new index. This is a new index with a very robust pricing record.

Q: Can you say anything about the decline in interest in the LME’s steel billet contract, which could potentially benefit the CME?

A: We’ve already seen good take-up of our cleared billet contract in Europe and an understanding that a financially settled product and one with the backing of CME Group is more valuable to that sector of the iron and steel industry.  We are looking to grow that business. The iron and steel industry really wants to have credible players provide products and clearing and liquidity. We’ve put tremendous resources into the various products we’ve launched around iron and steel. Billet is an important component of that.

Q:  What is the CME’s “Virtual Steel Mill”?

A:  The Virtual Steel Mill is a suite of products — the raw materials that go in and some of the products that come out. Anyone in the steel market can tell you there are hundreds of different products. We’re working hard to select the ones that can gain traction today, rather than bring 400 products out at once.  We have iron ore, swaps, coking coal, and now U.S. scrap. We also have scrap in the European market.  We were the first to bring options in and the first to bring coking coal in.

The first contract we launched for the Virtual Steel Mill was the U.S. HRC contract. That contract had very good adoption here in the U.S. and its open interest is growing. The key with products is not that they have a high turnover, although you want that, but that they have open interest. The HRC contract was launched in 2008, so it was an early market. Shortly after that, LME launched their billet contract. They went for a different model, with physical settlement, whereas we have index-based financially-settled contracts.

We also have the Turkey scrap billet contract, European HRC steel, and the Black Sea Billet.  We’re working on other products as well, but we’re being selective, focusing on growing liquidity in these products.

With the virtual steel mill, you can virtually hedge almost all of your price risk if you wish, or you could hedge or put on a position to reflect your view on a component of the virtual steel mill.  This enables people to make better decisions on what risks they want in their business, and enables markets to really reflect what’s happening. The forward curve in the iron ore market does have some relationship with the scrap curve. If people see the price in one go down, they may decide to use another product for a period of time. So you can put on a view that reflects market dynamics. Just as you can in the oil market, you can do a dark spread in natural gas as well. We’re bringing that type of trading opportunity to the iron and steel sector.

Q: Have the Virtual Steel Mill products already launched?

A: Yes, except for the US scrap contract, which will also be part of the Virtual Steel Mill.

Q:  So, overall, futures products in that sector are relatively new?

A: Yes, this is an early stage market. We’ve been looking at this market since well before 1985. In 2008 the assessment was made that it was the right time to bring out HRC. This market is still growing and evolving. People who like to be involved in early-stage markets have opportunities here they don’t have in other markets.

Q: Why do you think CME has been more successful with cash settled products?

A:  I’d say that some of the commercials are still thinking through the fact that it is financially settled. We made the assessment that given the amount of trade done internationally and the flexibility that people want to take their physical anywhere, combining a futures product with a physical delivery of the product into a warehouse at this stage was not appropriate. The market was more suited to index-based financial products.  We continue to review that. The history of billet has clearly shown that financially settled contracts work more effectively at this stage.

Q:  The Reuters article I read also mentioned that many steelmakers are opposed to having futures contracts. Why is that?

A:  I’m not surprised that there’s some resistance.  In our engagement with the industry, we see that that is changing, and that we have really strong sponsors for what we’re doing. Futures are not for everyone, and we accept that. We don’t need everyone to use them, we just need to launch products that are relevant, that are usable, and that are accessible.

Q: Why would people be resistant?  Isn’t there the potential for steelmakers to use these products for hedging?

A: I don’t see hedging as a religion that everyone has to adhere to. Shareholders take the view that they can live with high volatility and securing price risk by buying outright assets. That’s just a decision they make. For us, as long as we can see enough sponsorship and liquidity potential, we can go ahead, even when there is some resistance. But we’ve got to get it right in terms of the contract specs fitting the purpose.

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