China steel firms shield profits from volatile market

China’s steel mills and traders are embracing more sophisticated ways to sell metal and buy raw materials to protect their bumper profits amid rising price volatility.

Steel mills typically sell their finished products at market prices to traders that later sell them on to end-users such as construction companies, also at market prices.

However, some mills and traders are adopting new arrangements to lock in their profits on expectation that prices may decline as demand could drop as activity in the construction industry, a major steel consumer, slows during the cold, winter months.

Steel prices in the world’s top producer surged to their highest in 4½ years this summer and mills are making more than 1,000 yuan for every tonne of metal they produce, the highest in more than seven years, based on data from brokerage CLSA.

Prices climbed on supply worries as China has shuttered steel mills for not complying with environmental rules. However, prices in September posted their biggest monthly drop in a year because of demand concerns from the expected winter slowdown and as the environmental crackdown will also close steel-consuming industries.

Amid this price uncertainty, mills are now buying raw materials such as iron ore and coking coal and selling their future products to one trader at an agreed price, officials from two Chinese steelmakers said.

By fixing those prices, the mills can secure their profit margins. “Whatever is good for the mill to reduce the risk and protect the profit then they consider it,” said one of the officials, from a mill in China’s southern Fujian province.

In turn, some traders are signing long-term contracts with customers, like construction companies, who have agreed to take the same tonnage at a fixed price each month, said Alexis He, director of sales for derivatives at CEFC Shanghai Resources Co Ltd.

By hedging those sales on the futures market “they can price in a reasonable safety net and provide a fixed-price contract to downstream construction companies ahead of time,” said He.

It is mostly smaller mills that have partaken in these “more creative ways of doing business”, said He. “But now, we’re seeing bigger mills getting interested because they’re hearing about it in the market.”

Source: Reuters