Posted on 07 Jul 2021
The London Metal Exchange (LME) on 19 July will launch its new futures contract for Taiwanese containerised ferrous scrap, which will be settled on a basis of the Argus daily HMS 1/2 80:20 containerised cfr Taiwan index.
Ahead of the launch, Argus spoke to veteran ferrous scrap trader and industry consultant Nathan Fruchter of New York-based Idoru Trading to discuss the value of a contract specifically aimed at the seaborne containerised scrap market, and why this market is particularly well-suited to driving futures engagement in the scrap industry.
How do you see a dedicated cfr Taiwan scrap futures contract benefiting US exporters and Taiwanese buyers?
US exporters and Taiwan buyers are two groups that fit well into the same sentence, because ever since ferrous scrap has started to ship in container (circa 1999-2000) Taiwan has been buying most of its containerised scrap from the US.
The obvious answer that comes to mind here is that if you take a physical position on a cargo, then you can hedge your tonnage and take some of your risk out of this transaction. Depending if prices moved up or down by the time you sell or buy that physical cargo, your hedge will protect you against price movements.
One can argue that if you buy and sell that physical cargo simultaneously, or as we traders would say ‘back to back', then you don't need to hedge this cargo. That may be so in a perfect world, but the ferrous scrap container business is not as reliable as Swiss train schedules. We have seen plenty go wrong here. More often than not, the seller finds himself with a contract which the buyer refuses to take, or the buyer finds himself with a contract the seller fails or refuses to deliver.
Can you give a few examples of what sort of things can go wrong here?
Here's a few classic examples. You sell 1,000t on 31 May for latest shipment on 30 June, you get a booking that is scheduled to sail on 26 June, you load and deliver all your containers on time to the port two days before the latest cut-off, and then a few days later the shipping line tells you that the vessel scheduled to sail on the 26th has been taken out of rotation or is undergoing repairs, and then you hear that sentence you dread hearing…. "but don't worry, we already have you covered, your booking has been rolled to the next sailing, one week later on 3 July".
Another classic example — a trader buys a cargo, prices are gradually moving up so he hopes to sell it at an even higher price while it is already sailing across the Pacific Ocean. Suddenly there's a crisis and prices drop, or buyers are holding back and not buying for whatever reason. What now? You are forced to sell that cargo elsewhere at additional freight costs and at a reduced price. A hedge would have come in handy here and help minimise some of those losses.
Or you buy a cargo, prices go up and your supplier has a much better bid from another trader and decides to sell your cargo to him, ship that first, then when prices weaken he will ship your cargo. Now you are late shipping again.
What other regions are primed to benefit from the new Taiwan contract?
Several Asian markets often — but not always and it's not a given — move in tandem. When the cfr Laem Chabang, Jakarta, Penang or Haiphong prices move in tandem, then you can hedge the Taiwan contract on the back of a sale to Thailand or Indonesia and you accomplish the intended mission. The cfr Laem Chabang or Jakarta price does not have to be the exact same price. It may require some finessing and trial and error at first, but if you are smart about it and follow it carefully, then other regions can benefit from it.
What makes a Taiwan container contract a potentially more liquid product than the existing Turkey bulk option?
It's like comparing apples and oranges. A typical Turkish bulk contract is 30,000-35,000t and we often see larger sizes. A typical container contract is 500-3,000t. At 10t a lot, you need many lots. I expect this will be more easily manageable for container businesses than on these big bulk cargoes. You can hedge a container contract in one day, perhaps even hedge several container contracts in one day. But recently a respected derivatives trader pointed out to me that in order to cover a 30,000t cargo you will need to hedge this tonnage spread out over a few days at the rate of a few thousand tonnes every day. That may work well for the exporter who ships one bulk cargo a month. But how's that going to work for an exporter who ships several cargoes a month?
It's been six years since the Turkish contract was launched. I find it has some shortcomings that prevent it from being used the way it was really intended to. I am not even talking about selling scrap on a derivatives-linked basis. Just the hedging parts need serious review and changes. Until such obstacles are overcome, I cannot see Turkish scrap being sold on a derivatives-linked basis.
Have market developments since the start of the Covid-19 pandemic heightened the need for a containerised futures contract — particularly with relation to how container freight volatility has disrupted Asian container scrap import price relativities to Turkish bulk?
The example I mentioned above about a container ship being delayed is just one classic example and one that already existed since the start of the container business, long before Covid-19. Today, however, the container freight market is in a shambles, it's like the system is broken and nobody holds the shipping lines accountable. Nobody takes them to task, while they do with the customers and their bookings whatever they want. In this wild west-style freight environment, it would make a lot of sense for a seller to hedge his goods.
The Turkish bulk is a different animal, you don't really have these kinds of cancellations. It can happen but it is more the rare exception. Unfortunately, the same cannot be said about the containers.
Who do you see as the main early users of the Taiwan index?
The usual suspects, I would say, are the export recyclers, the export traders and the Taiwanese steel mills. I can also see some of the Latin American sellers wanting to get in on the game.
Do you see demand for additional ferrous scrap futures contracts going forward, or do Taiwan, Turkey and the new Indian shred contract cover sufficient bases for now?
I would not smother the industry with more ferrous futures contracts until we see how well the existing contracts are performing, what the traded volumes are and what percentage of industry players actually participate. I always felt the need for a Taiwan contract simply because it is the main market indicator for most Asian buyers, and as I pointed out earlier, the players of the container business are generally far more exposed to risk and things going wrong than the bulk players.
I have heard rumblings in the past two years about a possible Vietnam and Bangladesh contract. These are two markets that have seriously ramped up their scrap imports in recent years, so logically they deserve a good look, but I think it is wiser to see first how the Taiwan contract is performing, work out the kinks if there are any, and then look at a possible next product launch.
Talking of a possible next product, just like I felt a strong need for a Taiwan contract, it would not be a crazy thought to consider a Mexican contract via rail or truck. But I think that would be something more for the US exchanges to offer as only US suppliers are in this suite and many of them also sell their scrap to US domestic mills. So I think here may lie the next futures contract group of participants, i.e. US exporters to Mexico, sellers to US domestic mills and Mexican steel mills.
Source:Argus
