Bullish But Cautious

(Reuters) - Trading in steel derivatives has soared in 2010 and is likely to keep on increasing, despite opposition from the big steelmakers as the futures market eats into their control over pricing.

Iron ore and coking coal contracts last year switched from annual to quarterly periods, which triggered an increase in steel price volatility and led market players to use steel futures and iron ore swaps to help manage risk.

Most of the largest steel mills, however, continue to oppose the use of steel derivatives, saying they will encourage the entrance of financial investors and speculative activity in the market and lead to more price volatility.

"We are neither favoring them nor using them (steel derivatives)," said Markus Heidler, senior investor relations manager at German steelmaker Salzgitter. "The simple reason is that we don't want to open a new casino."

The development of steel futures also means the largest mills would lose their current control over prices. But traders say steel derivatives will take off with or without the support of the top steel mills.

"The more the mills resist, the more it is going to happen. None of the mills is powerful enough to go against the market's forces," said Jean-Luc Fiorenzoni, director of risk management at steel trading company Stemcor.

"They are just delaying the inevitable," he added.

Carmakers and other end users in construction will exert pressure on steelmakers for fixed prices, and these can be provided only by using steel derivatives now that raw material prices are quarterly, Fiorenzoni said.

"Some large mills are closer than one thinks to supporting the (steel) contracts, though not in an overtly public sense," said Jeffrey Kabel, executive director of ferrous products at JP Morgan.

"The support should come from the smaller mills - actions which are not dissimilar to past developments of other new financial contracts."

Trading in iron ore swaps has grown to over 20 million tonnes from zero in the past two years as a way to cope with increasing volatility of raw materials costs.

In the past year, the steel market has also been swept up in a move to derivatives. Trading volumes of steel contracts have jumped on the London Metal Exchange (LME), the Chicago Mercantile Exchange (CME) and the Shanghai Futures Exchange, where they surpassed global steel production volume.

PIECE BY PIECE

"There is a big need in the market for the development of steel derivatives, and the need comes from a massive increase in steel price volatility," said Sebastian Castelli, director of commodity derivatives sales at Deutsche Bank.

"We are very supportive of all these initiatives. The steel market is massive and everyone is attacking a different piece of it."