As automation reshapes financial markets around the world, there’s still one place where handshake deals are the norm and using technology means bcc-ing bids and offers over email.
The complex and antiquated world of steel -- among the oldest industries in America -- is one of the last lines of defense against the bots. Instead of a computerized market where orders ping-pong back and forth in milliseconds, a large bulk of the industry’s transactions are done in annual contract deals, with agreed-upon prices and volumes. Unlike most commodities, there’s hardly a futures market and when steel does trade, it’s by phone or email.
The situation in the $900 billion steel market has almost no parallels. On the plus side, there’s more price stability, which saves producers like U.S. Steel Corp., ArcelorMittal and Nucor Corp. from having to spend billions hedging future output. Customers with cozy relationships can get sweetheart deals. But to critics, the status quo is inefficient and lacks transparency, which means buyers can end up paying too much. That could lead to higher costs for consumers on everything from cars to refrigerators, at a time they’re shouldering part of the burden of President Donald Trump’s steel tariffs.
“The reality is something needs to change,” said Todd Leebow, chief executive officer of Majestic Steel USA, which buys steel from mills and processes it for sale to end users. Steel is “not really an efficient marketplace.”
There are plenty of explanations for why “financialization” has yet to gain a foothold in the steel industry. Myriad products -- reinforcing bar, hot-rolled coil, stainless steel, etc. -- have made it hard for standardized contracts to gain much traction. Steel mills also have a history of prioritizing relationships over economics. But you could also argue a key reason the industry has been so slow, and maybe even hostile, to updating how it trades is that big producers have long had a stranglehold on setting prices.
Modern steel production in the U.S. can be traced back to the Bessemer Process from the mid-1800s, which converted heated iron into molten metal and was key to the industrial revolution. These days, the steel industry is one of the largest in the world of commodities, with production of over 1.8 billion tons a year. Output for copper and aluminum is just a tiny fraction of that.
Yet there’s nothing modern about how the market trades.
Once a year, or sometimes every month or quarter, the largest U.S. steel mills determine how much they’re willing to sell various products at what price. The majority of these bilateral deals are based off the Midwest hot-rolled contract, using an index from research firm CRU Group. These types of deals accounted for roughly 60% of sales at the five biggest U.S. producers last year, data compiled by Bloomberg show.
What’s bought the rest of the year is usually done on an as-needed basis, often between service centers, which warehouse and process steel purchased from mills, and users. Price depends on volume, delivery point and relationships.
Attempts to drag steel into the 21st century have largely flopped. In 2008, the London Metal Exchange, the largest market for industrial metals derivatives, launched its futures contract for steel billet. (Billets are essentially long bars.) Hopes were high, but demand never materialized. Martin Abbott, the CEO at the time, says the industry often just absorbed price changes rather than hedging its risk. Trading in the physically settled contract was suspended in 2017.
When LME started a program to attract algorithmic trading firms -- which use computers to take quick advantage of small changes in price and volume -- to steel and other lesser known metals, it “caused a lot of consternation from our more traditional traders who don’t have the same speed advantage,” current CEO Matthew Chamberlain said. A big concern was that algos were “jumping in front” of certain orders and artificially driving prices higher or lower. The exchange ultimately wound down that program, too.
Last month, open interest in hot-rolled coil futures was just 19,031 contracts in New York, versus roughly 273,000 contracts for copper and 2.1 million for oil. Even fewer futures contracts actually traded, where volume remains minuscule.
“It’s one of the biggest commodities but it’s got the smallest percentage relative to its futures market,” said Massar Capital Management’s Marwan Younes. His $235 million global macro fund trades metals like aluminum, zinc, copper and nickel, but stays away from steel.
Another issue is that there’s no central hub for delivering steel, like Cushing, Oklahoma, for crude oil. Deliveries are fragmented regionally so producers exert greater control over supply, which lessens the need for them to protect themselves against price fluctuations.
The U.S. steel industry has, in any case, often turned elsewhere to hedge its risks: Washington D.C.
In March 2018, Trump issued a broad tariff on steel imports that threaten U.S. producers and endanger national security. It was the latest chapter in the long history of protectionist policies involving American steel and comes as the industry ramped up lobbying last year to a more than two-decade high.
All of which means Big Steel has little incentive to change. In aluminum, pricing power wielded by Alcoa and other large producers kept widespread adoption of futures at bay for over a decade after the contract was introduced in 1978. It wasn’t until the early ’90s -- when the breakup of the Soviet Union caused a glut of supply to hit global markets and prices plunged -- that the industry embraced derivatives.
“The inertia from people in the trade is that they don’t want to see their product as a commodity,” said Shan Islam, head of ferrous trading at Amalgamated Metal Trading, a London-based market maker. Not only do they lack an understanding of how hedging works, “they’re pushing back against that because they want to command a premium.”
The problem is a lack of transparency. Bilateral deals are negotiated privately and discounts can vary by buyer. That gives mills a degree of pricing power over contracts as well as in the spot market. Moreover, higher costs often get passed along down the supply chain, inflating the cost paid by consumers.
In recent years, the LME has even tried to boost trading in steel futures by paying firms to make markets on its electronic platform. Rebates, which are commonplace in equities, aren’t offered for any other contract. The model has been hotly contested, though it has helped steel volume slowly pick up. Even so, the numbers remain a far cry from what’s typical in other commodities.
“Until you get a mechanism that’s trade-able, hedge-able and transparent, plenty of folks will say this is a business or market that’s more risky than we want to get involved with,” said Tai Wong, the head of metals derivatives trading at BMO Capital Markets.