Producers worldwide have rejected the idea of steel futures, but several options and barter groups still see mileage in the idea of a steel price risk management tool. "Futures are simply rights to buy a fixed amount of a specified product at a fixed price at a fixed time,'' says Rod G. Beddows, executive director of steel consultancy, Hatch Beddows Associates in London. "It's an insurance policy against forward, or future, price volatility."

Various steel market surveys by commodities exchanges in Europe, the U.S., and Asia have uncovered a growing demand from end-use and service center buyers and traders for new price-risk management tools. (A fledging steel exchange already operates in India.) The driving forces behind steel futures are increasing steel price volatility, high cost of capital and limited effectiveness of existing price hedging practices in financial marketplaces. However, producers tend to dislike published reference prices—which end-use buyers, distributors and traders reckon are quite important.

A futures contract is an agreement between two parties for the deferred delivery of a commodity product at an agreed-upon future price. A big problem is that neither buyers nor suppliers appear able to translate the language of the steel marketplace with the terminology of the hedging arena, says Beddows. Atop that, he adds, "the futures traders are just discovering the surprisingly complicated world of steel." Still, the consultant reckons that "translation mechanisms can be developed so participants can understand each others' businesses enough to move forward" with steel futures trading.

At present, the concepts and mechanics of hedging price risk using future options for steel sheet are being developed or initiated:

• The LME (www.lmesteel.com) plans to launch steel futures trading in mid-2004 with the options of either delivering or taking metal, as well as settling out cash differences between buy and sell contracts.
• Koch Supply & Trading, a global trader of such commodities as crude oil, refined petroleum products and nonferrous metals, added over-the-counter (OTC) steel swaps to its trading and financial risk management capabilities. Koch Steel Trading went online at www.kochsteel.com in June.
• Rockwood Risk Management and Fortis Bank in June started offering over-the-counter (OTC) steel swaps to the financial market in the old fashioned way—that is, by telephone and client visits with no electronic-commerce platform.
• Steel finance and purchasing veteran Jonathan Putman is launching the Birmingham Futures Exchange (www.bfex.net) to trade futures off an index of spot prices for steel.

Trading in futures and options allows buyers and suppliers to hedge; that is, to use traded futures and options contracts to protect against uncertainty caused by metals price volatility. The LME is the world's premier commodity exchange for nonferrous metals, handling $2 trillion annually in trades and physical metals sales. Neil Banks, operations director, says, "The LME believes that exchange-traded risk management tools can be designed for the steel industry and that it is best positioned [out] of all the commodity exchanges to provide those tools."

The steel industry produces a variety of products in various sizes and grades; so, most insiders have rejected the view that price volatility can be controlled through LME futures contracts on a single item, hot-rolled sheet in coil form.

"We see no value in it to our customers or the steel industry," says Daniel R. DiMicco, chief executive officer of Charlotte, N.C.-based Nucor. He contends "there's nothing in futures trading proposals that would enhance our profitability or our relationships with our customers."

However, producers and consumers of steel products whose prices move closely with the prices of flat-rolled products can also use futures and options products to mitigate their price risks. That's why Mike Hutchinson, chief executive of Sempra Metals Group Ltd. in London, thinks steelmakers should participate in discussions "to ensure that the LME steel futures contract is tailored to meet the needs of the whole sector."

"The steel industry already has credit, interest rate and foreign exchange management tools," he says. "So, why not a steel contract that hedges against price risk?" Note: Sempra Metals Group Ltd. absorbed the Enron Metals operations in 2002 and expanded its nonferrous trading. However, it didn't continue Enron's steel program.

The once high-flying Houston-based Enron Steel trading firm purchased steel from mills at a floating price and then sold it into the market at a fixed price, making money off the spread between the two prices. Enron sold the hot-rolled, cold-rolled and galvanized sheet steel through its EnronOnline.com Web site and by telephone and facsimile machine. Steel unraveled when the seventh-largest U.S. firm was forced into bankruptcy because of $67 billion in debt from various trading fiascos.

Still, while the mills and consultants continue their debate over the wisdom of an LME steel futures exchange, new firms are attempting to rekindle the Enron Steel hedging activities of swaps, cap and floor options, and collars. Koch Supply & Trading and Rockwood Risk Management both began offering over-the-counter (OTC) steel futures contracts—independent of one another—in early June.

Swaps give hedging companies the ability to effectively switch from one price structure to another—from an index price to a fixed price or vice versa. They are used most often to fix, or lock in prices received or paid for a commodity. Caps and floors are options that provide the right, but not the obligation, to enter into a short- or long-term position at a specified price. Collars provide steel producers and consumers with price protection by keeping their prices within a certain predefined range. In these options, a price index—such as Purchasing magazine's transaction prices (www.purchasingdata.com)—is an accepted proxy that closely tracks actual but moving market prices.

Rockwood Risk Management in Humble, Texas, has been founded by Glenn Wright, president, and Kevin O'Donnell, executive vice president, both of whom worked for the old former Enron. "We are offering such financial instruments as swaps and options to lock in price levels, thereby reducing price volatility and stabilizing cash flows," says O'Donnell. "The fixed price will be compared each month to the index price to determine cash flows." The Global Commodities Group of London's Fortis Bank is underwriting the financial contracts on the swaps.

Jeff Kabel, vice president of steel trading in London, says that Koch Supply & Trading's participation "will primarily involve developing and offering financial price risk management services for flat-rolled products to producers, service centers, converters, end-users and vested financial institutions."

Meanwhile, after 25 years at Hanna Steel as chief financial officer and executive vice president for steel purchasing, Jon Putman has reopened the supply chain management firm Jonathan Putman & Associates. He is using this as a base to launch Birmingham Futures Exchange, a "pure hedging" futures exchange revolving around a steel index. The members will be vested, he says, so they will be mills and large buyers, either end-user or service center purchasing groups, "but not speculators." The exchange will be keyed to counter party credit arrangements so letters of credit from two banks will be required.

"The idea is to provide a hedging vehicle for, say, mills who want an assured spread between hot-rolled and cold-rolled sheet prices for an extended period of time, or a buyer who wants to guarantee a three-year price," says Putman. "These will be financial transactions only," he says, "since no physical metal will be delivered." That's why the exchange will have both exposure and return capped to a fixed maximum dollar value for the life of the hedge.