Lakshmi Mittal, CEO of Mittal Steel, (MT) - Get Arcelor Mittal NY Registry Shares NEW Report says the way out of the steel industry's boom-and-bust cycle is through consolidation, not financial markets derivatives.
"We are not working for the banks," Mittal said Tuesday at a steel industry conference in Manhattan co-sponsored by American Metal Market and World Steel Dynamics. "We are working for the shareholders."
Such comments from the CEO of the world's largest steel producer won't be welcomed by the London Metal Exchange (LME), which is currently in the process of developing steel market futures contracts. But they can't be a surprise to the LME. The steel industry has long resisted attempts at anything approaching price transparency.
In his speech, Mittal elaborated that in the past, steel companies had produced "volume for volume's sake," meaning that producers had simply continued their output of steel products when there was no market demand. As a result, price levels had periodically crashed, leading to the dramatic feast and famine style swings in industry fortunes. Now, however, he noted that industry participants were acting more rationally by reducing production levels, but remaining firm on prices during weaker economic times.
When Mittal indicated that he didn't see a need for an LME futures contract, he was rather predictably greeted with warm cheers by half the 1,200-strong audience at the conference at the Sheraton New York Hotel. The concept of risk management has never been a big hit with steel producers, which have steadfastly resisted using open market mechanisms to facilitate price discovery, as in other metal markets such as copper and aluminum.
Mittal's remarks are a reflection of his actions. Mittal Steel is actively engaged in the process of consolidating market share. Earlier this year, Mittal Steel made a $29 billion offer to acquire the world's No. 2 steel company,
. Arcelor, which itself wants to merge with Russian steel company
, announced Tuesday it was hoping for an improved offer.
Affinity for Financial Products
Mittal's words stand in stark contrast to those of Peter Marcus, managing partner of New Jersey-based World Steel Dynamics (WSD), also a speaker at the conference, who foresaw transactions totaling 20 billion metric tons of steel per year as financial derivatives take off. That stands against WSD's own estimates of global steel production, which it says will reach only 2 billion tons a year in 2015, up 500 million from this year's projected output. It is not uncommon, however, for futures market transactions to dwarf those in the physical market.
Marcus says the Chinese have a huge affinity for using financial products such as those proposed by the LME. "The interest in steel financial transactions matches up well with the gambling mentality that is inherent in the Chinese psyche," states a report published Tuesday by WSD.
The report goes on to state that the Chinese Futures Exchange wants to begin trading in rebar and wire rod, another staple of the steel industry.
Whether or not any of the contracts proves appealing enough to attract sufficient volume for a viable contract is unclear. But commodities futures contracts can be notoriously difficult to introduce. For instance, although the LME aluminum contract is extremely liquid in volume terms, a similar contract listed on the New York Mercantile Exchange appears to exist only in name, with insufficient activity to make it a useful hedging instrument. On Friday, 14 contracts of about 20 tons each were traded.
The LME's own plastics products themselves haven't attracted much volume compared with those of its metal futures. So far this month, the exchange's two plastics contracts each had volumes of fewer than 1,000 contracts vs. almost 3 million for aluminum, which had the highest volume.
And the contracts proposed by the LME face another hurdle, for while most commodity futures can be settled through the delivery of the underlying commodity, the ones proposed will need to be completed by a transfer of cash from the buyer to the seller at the traded price.
The option for physical delivery used in most commodity exchange transactions ensures that the value of the futures contract doesn't stray too far from the value of the physical commodity. When a big-enough difference does occur between the traded price of the future and that of the physical metal, arbitragers seek to profit from price differences between the two.
The Nymex is currently considering introducing a steel contract, but it is still in the research stage at this time. However, based on past practices, it seems likely that it at least will allow the contract to be settled using metal.
Despite steel producer resistance to the futures contract -- Mittal's attitude is widely supported as the cheers to his remarks demonstrated -- the contracts may not just be useful for consumers, but also for producers. "Since the early 1970s, with the founding of
Chicago Board Options Exchange, we have discovered how important markets are in marking markets more efficient," says Robert Bruner, dean of the University of Virginia's Darden School of Business. "We know that suppliers and customers are much better off in the presence of these contracts than without."
The reason is that the risk of changes in prices can be shifted to those who are more able to bear it through the use of such financial market derivatives, he says.
In the fall, it's highly likely that some steel sellers will wish there were a steel futures contract. That's because, although they don't necessarily disagree with Mittal's outlook, analysts say that prices are likely to soften. Ioannis Kallinikos, metals analyst at Metal Bulletin Research, says that current steel market prices are unsustainable.
Like Mittal, however, he says it won't be a crash because producers will moderate their production volumes, but that there still will be a slight weakening as inventory levels in the U.S. look set to climb.
Scott Burns, equity analyst at Morningstar, believs that softness -- added to a general level of market skepticism towards companies in the sector -- will keep shares of producers such as Mittal,
lower than perhaps is justified by changing market fundamentals.