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COMMENT: Those damn discounts
April 26, 2013 - 16:34 GMT
hot rolled coil
A widely known but little-examined practice broke into the light earlier this month, when ArcelorMittal USA, followed by Severstal North America and Nucor, said they intended to stop selling hot rolled coil (HRC) at a discounted rate to CRU’s HRC index for the US midwest.
The mechanism of offering term business at a discount to
published and benchmark prices is not confined to flat steel in
the US midwest, of course. Such mechanisms are also widely
signed into contracts in the global cobalt market, for example.
Quarterly ferro-chrome benchmark pricing in Europe is defined
as much by the scale of the discounts as it is by the headline
It is easy to understand how such agreements come about.
Having settled on a market reference that both sides have
reason to believe will be representative, they then contract
maximum and minimum tonnages to be delivered over a specified
period, with the price settled with regard to a published
assessment or index.
The reports that some US steel mills are looking to move away
from the CRU-minus-a-discount pricing terms that
have become prevalent is a vindication of the index's success
to this point.
The discounts have helped to seal deals...
Producers' marketing teams introduce the discounts in
competition with their peers in both rising and falling
In the former case, securing as much business as possible when
prices are rising can make the discounts seem immaterial and,
in the latter, the producers' need to fix tonnage gives buyers
a strong hand in negotiations.
(A sceptical observer might question whether the move against
the discounted rates has anything to do with the mechanism at
all as opposed to the low level of steel prices.)
If company X is offering a 1% discount to the average low price
for the second quarter of 2013, company Y's marketing team
reasons, we will offer a 1.5% discount, or match the discount
but offer a better option on tonnage.
...but are now eating away at spot prices
Of course, like the introduction of an alien species
the discounts tend to take over.
Just as Japanese knotweed strangles other species, so the
discounts impede spot business in the first place.
Why would a customer enter the spot market at all, if instead
they could push up volumes on contract and take the discount?
A strong and widely used reference combined with the habitual
use of discounts in contracts inevitably means that risk-averse
and cautious sellers and buyers will frame their spot
discussions around both the index - and the discounts to it.
This is not helpful since it can add artificial downward
pressure to the spot market.
So: damn the discounts at the best of times, and particularly
at the worst of times, as they threaten to erode sales margins
beyond a sustainable level.
And praise the producers that brought them into being, if they
now have the creativity to come up with an alternative - and
the stomach and staying power to wean their customers away from
this pernicious form of pricing…
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