London: JP Morgan is looking to expand its physical steel trading activity to help manage its positions in the ferrous derivatives market, which is bound to grow noticeably, the bank told Reuters in an interview on Monday.

Photo: Bloomberg.

“It would help us to manage our financial positions and to hopefully offer greater liquidity to both our clients and the market in general."

A number of banks have entered the steel and iron ore derivatives market in the last few months, attracted by the large size of the market in terms of volumes and by its growing liquidity.

Some banks are also venturing into physical iron ore and steel trading to better manage their financial positions and to help forge financing deals for mining companies, steelmakers, automakers and construction companies.

Iron ore derivatives volumes grew to over 9 million tonnes in October from 4 million tonnes in July, helped by more volatile prices and a push towards shorter contract pricing.

Steel derivatives are also growing but at a slower pace, because the market is divided into a number of disparate contracts that reflect a variety of products and different regional markets, which tends to dilute liquidity.

“Iron ore will probably grow quicker than steel because more people are looking at it," Kabel said.

“It is a global contract, it’s clearer to understand, there is more liquidity and there are more financial players, yet it is still only one price risk element in the ferrous chain."

Slowly But Surely

JP Morgan said the most liquid steel derivatives contracts are the US Midwest domestic hot-rolled coil (HRC) futures offered by the CME and the billet futures offered by the London Metal Exchange.

Trading volumes for the CME US HRC contract grew from 244,831 metric tonnes in 2009 to 392,140 tonnes in 2010, and in October 2011 a record 91,099 metric tonnes traded.

“We look at US hot-rolled coil as being a good indicator of what will happen in other parts of the world as well," Kabel said.

As for billet futures, “That’s a good global indicator ... You can sell it as a global contract for construction projects whether in Asia, Europe, Middle East or South America. It’s not quite the same in the US, because the US has still got its own distinct construction pricing environment, for now."

Higher Volatility

In the past 18 months, a shift from annual to quarterly pricing methods for iron ore and coking coal has boosted volatility and attracted more financial and physical players to the derivatives market.

A steep fall in iron ore prices pushed some iron ore buyers, especially in top consumer China, to ask for delays or renegotiation of terms for contracted material in the last few weeks.

This has put contract pricing under scrutiny once again and may lead to even shorter and more volatile pricing mechanisms, which could prove to be a boon for ferrous derivatives.

“As the physical market has changed the way steel, iron ore and coking coal is contracted, it naturally follows that there is also more trading of these commodities financially," Kabel said.

“This increased trading most likely has little to do with what financial institutions want to offer or what big producers want to push. It’s more about the margin exposure and risk management."

Steel pricing has also moved from annual to shorter methods, and this put more pressure on steel buyers to hedge their purchases to manage cost risks. More and more steelmakers and end-users, in the automotive and construction sectors in particular, are looking at using derivatives, JP Morgan said.

“If you look at most big buyers of steel, many hedge their aluminium and copper, and they also hedge their energy inputs to some extent," Kabel said.

“But in most cases, steel is their biggest commodity input cost, biggest by far, and it’s just as volatile as their other cost inputs, so they look to these markets to hedge out some of that risk."

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