IRON ORE WEEK: Ferrous scrap is 'next big thing' for derivatives in Asia, SGX says

Ferrous scrap will be the “next big thing” for commodity-based derivatives in Asia, according to the Singapore Exchange (SGX).

It is one key commodity that the SGX is looking at to expand its slew of ferrous derivatives under the “virtual steel mill” concept, in addition to the iron ore and coking coal contracts that are already trading well on its platform, the exchange’s head of commodities, William Chin, told Fastmarkets MB ahead of the Singapore Iron Ore Week 2019, which takes place this week.

“The ferrous scrap markets are unfettered by state intervention, and the ‘bottom-up’ participation by the scrap market participants makes ferrous scrap a useful tool for the virtual steel mill. That is why ferrous scrap is of very high priority for us,” he said.

This is especially since the steel world is shifting toward a greener form of steelmaking. China, for one, is implementing a strict capacity replacement program that would ultimately tweak the ratio between electric-arc furnaces (EAFs) and blast furnaces to 1:1.25.

“We are hearing about exciting stuff about the growth of EAFs in steelmaking and how industry developments in China are moving in that direction,” Chin said.

Ferrous scrap is also a “simple and honest indicator” that reflects what steel price changes mean when it comes to industrial demand and production, he said.

“It is unlike conventional economic indicators such as gross domestic product growth, which are often tainted by biases by virtue of their reflexivity with the markets,” Chin said.

While the SGX wants to have China-centric ferrous scrap derivatives in place in the long run, it is not shying away from launching ones that do not revolve around China if there is demand for them in the near future.

“We do want a scrap contract centered on China in the long term, because it will be a big price discovery center for ferrous scrap in the future. However, we are still studying the timeline as to when to come into the market,” Chin said.

The SGX is open to exploring other suitable ferrous scrap contracts as well, of course.

“I don’t see a world where the ferrous scrap markets only trade a China-centric derivative contract. It is not wrong to have other [non-China] contracts because it reflects physical trading activity and that is where demand is coming from at the moment. The bigger question would be how these particular [non-China] contracts fold into our bigger plans in the future,” Chin said.

With interest in ferrous derivatives “definitely growing”, market participants are naturally expected to start shifting their attention to contracts for scrap and finished steel products because of how those for raw materials such as iron ore and coking coal have been working.

“There is no debate about whether ferrous scrap derivatives will work. It is only a matter of time when that happens, and when market participants are ready to come on board,” Chin said.

Downstream challenges
The complex nature of the finished steel industry downstream still poses unique challenges for exchanges such as the SGX, especially when it comes to getting market participants to understand how derivatives work and take them up to hedge against price fluctuations of the underlying commodity.

“The finished steel markets are still very young when it comes to derivatives, and not every company has the right risk-management frameworks, or the right resources or people in place to do so.

“So there is a very natural element of teaching and educating the steel market about hedging and derivatives, and how these add value for market participants, especially since they have traditionally been using fixed prices for production and sales,” Chin said.

That fact that the steel market is a very big industry is both a bane and boon, he noted.

“Steel is a very big and fragmented industry. There are opportunities there for sure, so it’s important that exchanges continue to keep a close eye on it as the finished steel industry evolves, especially with regard to the pain points that market participants have,” Chin said.

Paul Lim

paul.lim@fastmarkets.com

Published

Paul Lim

May 06, 2019

05:55 GMT

Singapore