Stellar steel mill financials obscure opportunity cost of not indexing

Author Oscar Tarneberg, VP Business Development, Metals | Colin Richardson, Editor

Spot steel prices in Europe, as elsewhere, are rocketing. Ostensibly, the sun is shining, and steel mills are making hay. Yet they could be making more hay.

Pricing mechanisms utilised in the European coils sector mean mills’ financial results nearly always lag implied spot market margins. And often fall short of where they could be.

In its quarterly results published on 6 May, ArcelorMittal reported an average increase in its average flat steel selling prices of 17.4pc quarter on quarter in January-March. Most mills — and their investors — will be over the moon with an increase of that magnitude. But not if they compared it with the 34pc gain in spot prices over the same period. Argus’ benchmark northwest Europe hot-rolled coil (HRC) index rose from an average of €549.92/t in October-December to €739/t in the first quarter.

Arcelor’s realised first-quarter steel price of $813/t also fell below the Argus HRC average of $890/t (€739/t), for the first time in over a year. At face value, this suggests index-beating pricing over 2020 (see chart). But the reported average price does not just include commodity HRC, but also cold-rolled, galvanised and other products that should command a large premium.

ArcelorMittal reported sales prices versus index

Second-quarter average sales prices will no doubt be even better for Europe’s steel producers. But will they be as good as they could be? ArcelorMittal recently hiked its HRC prices to €1,000/t. But this is already lagging the market uptrend. The Argus HRC index passed this level on 5 May. The mill has since hiked its prices by another €50/t, bringing it close to the index.

This constant lag has a huge impact on profitability. Current spreads between the Argus European coil price and raw materials are hovering at around $800/t. Granted, this does not capture labour, energy or many other key costs. But it captures the big ones — coking coal and iron ore. It is significantly higher than the per-tonne steel EBITDA of €131 reported by ArcelorMittal for the first quarter.

Profitability steel EBITDA vs implied index margin

Times are not always this good for steelmakers. When conditions are this fortuitous, mills need to be capitalising on them. So how can this value be fully captured?

Why indexes don’t mean the end of long-term contracts

Linking the sales price to an index average is the obvious way to close the widening gap between realised and market prices. Of course, most buyers do not want to buy based on an index average. Europe is a long-term contract-focused marketplace, and original equipment manufacturers want long-term fixed-price contracts that provide visibility over their costs as well as security of supply. Consequently, spot sales account for as little as 20pc of overall sales books for some leading northwest European mills.

This has worked well for buyers in a period of rising prices, enabling them to lock in bargain rates, but less so for mills, which have had to try, often unsuccessfully, to renegotiate deals, citing rising spot prices. It is not much better for mills when prices fall. Some of those same buyers are quick to walk away from volume commitments at a fixed price in a falling market.

It is not only buyers who back out of commitments due to the disparity between the contract and spot market price. Current supply tightness has seen poor delivery performance by producers, some of whom have also reportedly cut allocations. This would be less likely if they were achieving market prices.

Tensions in the contract business are not new, but they are reaching breaking point owing to the widening schism between contract prices and market reality. Contract prices do not have to be as divorced from reality as they are now. A supply agreement that references an index can still contain long-term tonnage commitments, preserving security of supply. They are just priced according to market-average prices, represented by the index, or the average of an index over a given period. Where forward visibility on costs is required, futures can be used. Where product grades differ from the index, premiums or discounts can be applied.

Why only a daily index works

The right index must be used. Some mills, particularly in southern Europe, have a smattering of index-linked contracts. In recent months, they have reneged on these index-linked deals, as the index lagged the rapid uptrend in spot prices. But this was not the fault of the indexing approach in general, rather the indexes being used. In a market moving this fast, an index must be published sufficiently regularly to capture all the gyrations of the market.

In the first two publication days of May alone, Argus’ northwest Europe HRC index increased by more than €34/t. Such a double-digit daily jump makes it is impossible for a monthly index print to keep pace with market undulations. Even a weekly index struggles, with one such number lagging the Argus daily print by nearly €60/t in early May.

Averaging fast-moving daily index prints over a period smooths out the volatility in spot prices. This makes it a perfect way to conduct both contract and short-term spot business. A deal can be tied to the index average of the delivery or transaction month.

Why steel mills, and investors, should care

This recent bull market, like every other before it, will not last forever. In reality, the lost opportunity for mills during the uptrend is likely to be compensated on the way down if new deals are signed at the peak of the market. But this overlooks the lag between market prices and those being achieved in practice. It also ignores the stress on relationships and the potential impact on volumes if buyers walk away.

The current pricing mechanism is unable to handle price moves of the magnitude or frequency seen of late. A shift to an index-based pricing system, coupled with a liquid futures market that facilitates the forward hedging of prices, is the best possible solution. This will not only serve steelmakers, but also buyers, which often face long lead times and huge uncertainty on forward costs.

But the index must be fit for purpose, and that means a daily price capturing spot value. The Argus northwest European index is published daily and covers Europe’s key steelmaking region. It is also the settlement basis for the CME’s HRC futures contract, as well as an upcoming contract on the LME, which means seamless hedging for those looking to protect themselves against market moves. It’s time to use it.

Argus provides daily price assessments for NW Europe Hot Rolled Coil against which the CME Group futures contract is settled. Later this year, the LME will launch a futures contract which also settles against these assessments.

Argus provides our price assessments, along with wider pricing and market coverage for steel and raw materials markets in all regions, in our Argus Ferrous Markets service. Argus Ferrous Markets supports market participants across the value chain with their price risk management, contract settlement and indexation.

If you would like to speak to the Argus team about our price assessments and our Argus Ferrous Markets service, please email

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