Whilst CEOs and CFO's concern themselves with what has been an historically startling recent story of cost-push inflation, the financial & commodity markets have sought to exploit this period of instability so as to both hopefully gain from corporate executives discomfort and theorectically allow corporations to smooth and better manage their own input prices.
The emergence of 3 exchanges dedicated to the Forward Contracts of finished steel variants demonstrates how the once mundane, low value, metallurgical product has escalated in demand over the last decade as Asia's manufacturing and infrastructure economic and societal expansion acted as a powerful catalyst in driving up steel demand and so prices as supplies, and the mining to finishing value-chain, came under severe pressure.
Steel occupies the 2nd largest commodity market, junior only to (unsurprisingly) oil, with a global value of approximately $500bn. And it comes in 3 main forms:
1. Base Billet (bar form) – used for rods, rails, pylons etc
2. Semi-Finished Billet (bar form) – used for re-enforced and engineered solutions
3. Hot / Cold Rolled Coil (sheet form) – used for automotive bodies and consumer goods.
Given the relatively stable, long continued growth in steel demand , we are surprised at the time taken by traders to develop steel orientated exchanges, but suspect that there must have been much discussion regards which bourses create exchanges for different steel product / finish types to avoid their own in-fighting and trading margin erosions. It had long been thought that each bourse could offer services for each steel product type, but the markets hadn't developed as expected as constant inflationary push, and so rising prices, meant that steelmakers would rather provide at timely and market-sensitive spot-prices rather than at secured longer-term, often lower margin, contract prices.
The opposition is still presently understandably prevalent from leading steelmakers such as ArcelorMittal as Indian, Chinese, Brazilian and other nationalised and private large corporations make record profits and face new consolidation challenges to maintain their own momentum. But, the medium and small sized firms reportedly welcome the initiative as 'opening up their potential'. However, perhaps as the Asian economic slow-down appears over the horizon (intimated by the well placed HSBC) those same leading producers that have 'made hay whilst the sun shone' may start to see the advantages of a well constructed, transparent market that finds supply-demand equilibrium, and so allows for better operational and CapEx planning in what looks to be a slowing and perhaps even contracting steel environment. This is of course very much in constrast to the often opaque pricing that has been an element of the seller's market recent years, but a sharp slow-down and new sluggishness in BRIC regions would bolster the pronciples of such bourses.
Earliest on the scene just under 10 months ago, on the back of its own massive infrastructure development programme was Dubai, its DGCX exchange focused on the contract trading of Semi-Finished Billet that goes into many of its new skyscrapers; as much a national endeavour to best-price steel procurement in rocketing times as that of earning exchange commissions. Next to arrive was the London Metals Exchange (LME) focused on Base Billet and operating in a context of broader applications, but very well positioned to gain from what is primed to be massive infrastructure investment policies throughout Europe and US.
But the major news for the long suffering auto-industry is the arrival in Q408 of the New York Mercantile Exchange's (NYMEX) version, focused on Hot-Rolled Sheet Steel that is the staple of the US auto industry. (Previous studies indicated that this raw material cost accounts for approximately 15% of a medium sized vehicle's production cost). The NYMEX bourse, unlike DGCX or LME with an options base, is dedicated to financially settled contracts, giving automaker buyers far more confidence in their mid-term production budget projections, which in turn allow greater stabilisation of cashflow and strategic options picture building.
Having endured such heavy input cost headwinds US executives will be keen to leverage such newly available assistance to steady their rocky rides. Indeed for all of Detroit's Big 3 and the likes of Toyota, Hyundai, BMW, Mercedes etc with US plants, the news of the NYMEX venture will be welcome indeed.
The very fact that the Hot-Roll Sheet market will be based in the US makes a fundamental difference to global seller and buyer perceptions, giving the US a much needed economic and industrial structural boost since now instead of looking directly to Indian, Russian, Chinese etc sellers, VM's and the Supply Chain will increasingly look to primarily the NYMEX but also LME and DGCX as intermediary market modulators.
The obvious struggle will be between automakers and the steel-producers, relationships will have to be sensitively managed as automakers seek to exploit the willingness of smaller steel producers and the exchanges against the entrenched positions of sector leaders. investment-auto-makers believes that we could possibly witness a fracturing of the steel industry as nationalistic BRIC-based producers are put under pressure by their own governments to focus on domestic price sensitivity to keep their individual economies moving forward as fast as possible in a globally restrictive climate.
That in turn will pressurize said BRIC producers to ramp-up capacity to maintain margin and either sell directly (as today) but on non-spot price agreements or 'go to market' endeavouring to make up the revenue differential. And as an inflow of FDI goes into the states over the next few years o n the back of a devalued Dollar and underpriced industrial asset-base, so the FX $ value will climb against the normative international basket of currencies and so 'market-sold' steel capacity (in $) will assist the balance sheets of those BRIC steel-producers.
In the mid to long-term, automakers should start to see the headwinds deteriorate with slowed inflation and more trading transparent, whilst steel-makers may in turn be put under pressure and seek alternative pricing models via the NYMEX and beyond; perhaps even creating a bourse of their own to claw-back their own power in the decades to come - just as investment banks have sought their own exchange facilities (eg Turqious et al)
But for the moment the signs are that finally the auto-industry, US in particular, could be seeing the much needed change brought about by not regulatory reform, but by Adam Smith's principles of created markets relative to macro and micro pressures.
