Steel hubs and spokes for Turkey
Posted by meb at April 10th, 2008
The London Metal Exchange, the world’s number one non-ferrous market, is officially launching its futures trading in steel April 28 and Martin Abbott, the man in charge, has good news for Turkish producers, traders and investors alike.
Turkey is going to be one of the four major hubs for the LME, he told the Turkish Daily News in Istanbul, a city he and his colleagues have become increasingly acquainted with in the last few months. The LME, founded in 1877, has been offering futures contracts for aluminum, copper, nickel, tin, zinc, lead and even plastics up to now. The move in steel comes amid a worldwide commodities boom and reinforces London’s position as the world’s leading business center. Futures contracts are financial risk management tools that enable companies to hedge their price risk exposure by agreeing to buy or sell a particular volume of product for delivery on a fixed future date at a price agreed today.
Profound changes in industry:
“We were looking into [trading in steel] for the last few years,” Abbott told the TDN Monday. “And the reason is the changes in international steel industry, over the last decade in particular.” Industrialization of China and other emerging economies, including some Gulf nations and North Africa is one reason. Another one is the “re-energizing” of some of the “old Eastern Bloc nations,” particularly Ukraine. “Consequently, there is an increase in amount of international trade in steel,” he said. “Particularly in steel billet, which is the raw material for construction and the material which we base our trading on.” Currently, the market in steel billet is about 500 billion tons a year. Summarizing the international picture as one of increased price volatility, a more complex trading environment exists at the moment, Abbott pointed out, “there is more investment due to a worldwide building and infrastructure boom. Thus, there is a need for greater predictability in pricing, a need for stability.” The price of steel last year was around $600 a ton, while today it hovers around $900. Such volatility is comparable to that of aluminum and copper. The launch of trading in steel futures “will not take the volatility out of the marketplace,” he noted. “But by futures contracts, we give people a chance to manage their volatility.”
Turkey’s pivotal position:
The place of Turkey in the picture comes mainly in the form of warehouses. “LME approves warehouses around the world for delivery,” Abbott explained. “We will deal with steel warehouses in Turkey, Dubai, South Korea and Malaysia. Turkey occupies a pivotal position in steel billet. It is an exporter, importer, a producer and a processor into rebar. Also, it is geographically located between Ukraine, North Africa and the Middle East.” While dealing with warehousing companies, the LME has to make sure “there is no tax or duty, as the LME warrants – receipts given when one delivers the approved steel billet into the warehouse – change hands many times,” he continued. “Thus, it has to be the equivalent of a free trade zone. Once we get the legal concessions from governments, we list the area. And we have chosen the Marmara region in Turkey.” Warrants change hands many times, because “less than 1 percent of all LME trade actually results in delivery,” Abbott added. “If you sell and leave the contract open, you can settle it by delivering into a LME warehouse. But people will deliver only if they have nowhere else to deliver to, as it is much better to directly deliver to the customer.” So, how does it work for Turkish warehousing companies? “They apply to us and prove they can handle LME business,” Abbott said. “They will have to be able to handle steel here and produce the paperwork in London.” Thus, there are two benefits for Turkish businessmen. The first is a universal one, as they will be able to use risk management tools that the LME offers. The second is the economic benefit to warehousing companies in the form of rental and logistics payments.
Indicating the market:
Warehouses also act as indicators of the market. “If warehouse stocks are rising, there is a surplus somewhere in the world,” the 48-year-old executive said. “If they fall, there is a shortage. That keeps the price fully correlated with the underlying market.” Citing an example from Turkey, he reminds that during the winter there was an inventory buildup as construction slowed down. “With LME warehousing, you can put the approved material into the warehouse, receive the LME warrant and then get financing from the bank with more convenient rates. Because the bank, then, in the event of default, can put the material into the market from the warehouse.” Abbott, who was appointed as the LME’s chief executive in October 2006, said the steel industry “needs the tool we offer,” and points out that the LME is well-connected with international banks which provide financing to the steel industry. “They are already members of the LME and they feel the volatility,” he said. “They also would like a way to take control of the risks involved in the business.”
Good level of expertise:
Turkish business has a “good level of expertise” in futures trading, he said, confirming the notion that amid an appreciating national currency, Turkish exporters have become more accustomed to hedging currency risks through financial instruments such as futures and options. “Turkish aluminum companies have been trading on the LME for a long time. Also, energy companies have an understanding of hedging. When we explain what we do, they say they have been doing that all the time.” Praising the authorities’ constructive approach, Abbott also said major players in the Turkish steel industry, such as Çolakoğlu, are regarding the LME move into steel futures as “a friendly action.” The LME is currently working with a local law firm and customs agent, who coordinates the plan with relevant ministries. “We are very pleased with the progress,” he said.
International consolidation:
Does the LME move into steel have a link with consolidation in the international steel industry, as giants such as ArcelorMittal strengthen their position? Abbott disagrees. “The steel industry is remarkably fragmented actually,” he said. “In the billet sector, the industry is made up of many different participants. In the flat sector, even Mittal only accounts for 10 percent of global production.” “China has thousands of steel mills,” added Lotta Ulfsdotter, the LME’s Steel Market executive. “Any consolidation in the West has little significance compared to China’s position.” The launch on April 28 will be “relatively low key,” Abbott said. “We will have a small event in London, and will, of course, invite people from all over the world, including Turkey. But the launch of a futures contract takes time, so I do not expect big fireworks.” Such composure is not unfounded, as trade in plastics futures has not attracted the attention that was hoped. Aluminum, the biggest deal at the LME, was launched in 1978 and took 10 years to build volumes. But still, maybe in a couple of years, they will be “celebrating the successful launch of steel contracts on the Bosporus,” Abbott said.
THE FUTURE IN STEEL
- Steel futures trading has been tested at the LME since Feb. 25. It officially starts on April 28.
- Each contract is for a specified parcel of 65 tons of steel billet. The contracts are priced in U.S. dollars. So, at a price of $900 a ton, each contract is worth about $58,500.
- Steel billet is mainly sourced from scrap and is used mainly as reinforcing bars in construction. Turkey is considered an important base for scrap steel. - Billet prices have more than tripled since 2003.
- The New York Mercantile Exchange (NYMEX) is also planning to launch steel futures contract this year. The Shanghai Futures Exchange is also planning one in the near future.
- In certain industries the introduction of a futures contract has increased the opportunity for sector/specialist consolidation
- There is a risk that if too few steel companies use a futures market, some traders could “corner” the market with speculation. The LME says this is true “in theory,” but “if the contract is appropriately structured, and the exchange is well regulated this is unlikely.”
Source. Turkish Daily News
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