8/2/2012 — The evolution of steel futures as a financial risk management tool is somewhat akin to an aspiring actor who dutifully rehearses his lines, only to be relegated to the role of understudy. Patiently, he bides his time until his big break comes.

Like that actor, steel futures have been around for a while. On a limited basis, the concept was tried in China in the 1990s, although the contracts eventually closed because of a lack of business. According to Platts, a McGraw-Hill subsidiary and provider of metals and energy information, current interest in steel futures dates largely to 2008 when the London Metal Exchange launched contracts in April of that year and the New York Mercantile Exchange, a CME Group subsidiary, began trading hot rolled coil futures six months later.

Timing is everything, and steel futures have taken off since, serving as a valuable counterweight to rising volatility as the Chinese economy entered a period of rapid expansion, and now, a slower rate of growth.

Whirlpool Corp. provides an example of how end users are increasing their reliance on futures. The company buys steel futures over the counter through financial institutions, and purchased its first steel contract in July 2009 because it wanted to ride what it envisioned as the next wave of innovation. “We were involved in certain industry associations and we were aware the market was starting to take off for futures,” says David Brooks, director of global commodity risk management for the Benton Harbor, Michigan-based company. Whirlpool is no stranger to futures, having traded in them on the base metals side for years, starting in 2005. “We get involved in programs to reduce volatility and increase price value,” Brooks adds.

When China began demanding more raw materials for infrastructure, the supply base could not react fast enough, and the price of commodities increased rapidly, which was a major shift for the steel industry, according to Jeremy Flack, founder and president of Flack Steel, a Cleveland-based provider of custom steel products.

“If you look at pricing with hot rolled coil or band from 1980 through 2003, the price never went much higher than $400 a ton and never went lower than $225 a ton … you had a $150 spread there,” says Flack. “So it was a pretty quiet thing. The dollar was pretty strong in the 1990s. That put downward pressure on the commodities market.”

A steel service industry company formed in 2010, Flack Steel began trading in steel futures in the summer of 2011 and has been very successful with it, says Flack, an ardent supporter of his industry’s plunge into the trading practice. “The futures have helped hedge our inventory many times,” he says, adding that the practice has steadied earnings for the company.

For Worthington Industries of Columbus, Ohio, the impact of steel futures contracts was “very minimal” through 2010 and parts of 2011, recalls Marc Gase, its director of price risk management. “About three percent of our purchases were based off hedge in 2011, but as you go forward we’ll be pushing 10 percent of our purchases in Q3 2012.”

(via Open Markets)