The price of steel is always fluctuating, and it is extremely difficult to predict when and what direction those price moves will occur. Market participants, such as steel service centers, steel mills, and manufacturers can mitigate their risk and protect their bottom line by hedging with futures contracts such as COMEX Hot-Rolled Coil, Busheling Steel Scrap, and Domestic Steel Premium futures.
Let’s look at a hedging example. In March, an OEM would like to place an order with a steel service center for 10,000 short tons of processed steel due in November. They would also like to agree to a fixed price on the order that same day.
The steel center agrees to the order including the fixed price of $750 dollars per short ton. Instead of purchasing all the steel for the order in March and incurring extra storage costs, the steel center decides to purchase semi-finished steel as needed for production, beginning in July.
To limit the risk between purchasing semi-finished steel at a variable price and delivering processed steel at a fixed price, the steel service center can hedge this risk by buying HRC futures contracts. Should prices rise, the steel service center will make a positive return on the value of the futures contracts, which will offset the additional expense.
The HRC Steel contract has a contract size of 20 short tons. To hedge the full order of 10,000 short tons, the steel service center must purchase 500 HRC contracts. The steel service center buys 500 November HRC contracts at $700 per contract. The current cost of semi-finished steel is $400 per ton.
As July approaches, the cost of semi-finished steel has increased to $420 per ton. As this is the underlying for the Steel futures contract, the increase of $20 also increases the futures contract to $720. The steel service center buys 2000 tons of semi-finished steel at $420 and simultaneously sells 100 of the HRC futures contract at $720.
As the service center continues to purchase semi-finished steel to process, it reduces the amount needed to hedge and can sell the equivalent amount of HRC futures contracts until the entirety of needed material is purchased and the entire hedge is liquidated.
If the price of semi-finished steel increases so does the price of the futures contract, thus offsetting any increased costs to the service center. If the price of steel decreases, the service center can buy the semi-finished steel cheaper, which will compensate for the loss on the futures contract.
By hedging with HRC futures contracts, the service center can deliver finished steel to the OEM at the agreed upon price, while protecting themselves against unknown price fluctuations.
Risk management tools, such as Hot Rolled Coil, Busheling Steel Scrap, and Steel Premium futures, enable steel companies along the entire supply chain to protect profit margins and minimize risk.