Futures Daily: Phased Hedging of Steel Enterprises is at the Time

Updated on: April 5, 2016

Reported by Que Yanmei, Journalist from Futures Daily

Since last December, black variety futures have ended the weak market with a relatively strong rebound. "Iron ore, the upstream raw material of the industrial chain, has fallen more sharply on the way down, and in this rally, the rebound strength of iron ore has been greater than that of the steel. Steel enterprises at this time who do hedging can achieve very good results." Zhang Guichuan, Head of the Industrial Products Division of CHINA FUTURES said.

Data show that the RB1610 contract rebound from the low point of 1618 yuan/ton at the beginning of last December to the recent high of 2240 yuan/ton, up 38%, while I1609 contract rebound from the low of 282.5 yuan/ton at the beginning of last December to the March high of 469.5 yuan/ton, up 66%.

Zhang Guichuan said that the price risk steel companies face now is mainly caused by the mismatch between pricing time and pricing model. There is a certain lag between the raw materials and finished products of the steel mills, leading to the price exposure. In addition, the purchase pricing of raw materials of steel industry chain is different from the sales pricing model. For example, when purchasing raw materials, the steel mill is in strong position in face of the coking enterprise, but in the face of several large mines, steel mills are in a weak position.

"Steel companies need to avoid the risk of raw materials that are more concentrated in iron ore." said Zhang Guichuan. In last December, when international iron ore prices fell to around $40/ton, a steel mill in Tangshan believed that iron ore would rebound as a result of seasonal and replenishing supplies. The futures division of the steel plant saw iron ore futures clearly discounted, especially the contracts of distant months deviating largely from the spot price, and decided to hedge iron ore futures to lock in costs.

According to the introduction, the steel mill bought an iron ore futures contract of 2 million tons (20,000 lots) on the I1605 contract last December, and the average price was 292 yuan/ton. At the moment, they closed out their futures positions while completing the spot purchases. In the meantime, the iron ore spot market rose to the highest $18/ton, or about RMB117 yuan/ton, while the futures price average rose to 168 yuan/ton.

Zhang Guichuan said that currently the bank tightens credit for the whole black industry, especially the iron and steel industry. Under this background, use the way of stocking up to solve price risk of the raw material won't work, must use futures tools periodically.

In fact, in addition to keeping value of the raw material, it is equally important to preserve in the end of finished products. Zhang Guichuan told Futures Daily journalist that some steel companies have achieved very good results in hedging the product end this year.

After the Spring Festival, the steel market experienced a sharp surge in the steel market due to shortage of production and strong demand, and steel mills in Shandong and Hebei province made a big profit. One of the steel mills in Tangshan already has a profit of about 300 yuan per ton. The company has locked up the profit space of around 300 yuan/ton in advance through hedging finished products in the futures market, so as to prevent the profit of the company from declining due to the sharp decline in the late steel price.

The specific operation is the enterprise will sell 500,000 tons, or 50,000 lots at 2191 yuan/ton after two consecutive limit-up of RB1610 contract. The day the price of HRB400 20mm in Shanghai is 2,430 yuan/ton.

"If not selling out to hedge, the company will not have a profit of 300 yuan/ton as the steel price declines later." Zhang Guichuan said. If the company hedges its raw materials and its products at the same time, their profits could be even higher this year.

Zhang Guichuan argues since the financial instruments is complete, the steel mills can earn profits at sight, that is, the steel mills using futures prices of the coke, iron ore, rebar and hot rolled at sight to calculate, if there is profit, consider locking this portion of profits directly on futures quotation on the basis of the actual supply-demand in market.

"Companies involved in hedging should view futures and spot as a whole, and incorporate futures business into the whole operation of the enterprise. A loss in future is not equal to hedging failure. Companies should correct the notion that hedging sometimes doesn't hedge all risks, because basis risk always exists." Zhang Guichuan said finally.