The search for a CRU solution
A new year often brings renewed optimism, excitement for what’s to come and a fresh start with higher prices for those in the steel industry. Customers are more willing to make stock buys, not worried about inventory overhang at year’s end. But the start of 2013 was different. Over the first few months, the market wasn’t showing signs of the kind of recovery that many had been anticipating. Early attempts to bump up flat rolled spot prices were short-lived or entirely unsuccessful, and prices fell rapidly.
Rumblings that the flat market’s inability to absorb higher prices despite steady demand surfaced in early January, and by late March, service center buyers contended that deals made under the CRU index moved tons out of the spot market, and when combined with lagging demand and low service center shipments and inventories—many service centers had been living off low inventories, only placing orders when immediately necessary—contributed to pushing spot prices lower.
The CRU numbers are an assessment of the market for various products, the most prominent of which being hot rolled sheet. The CRU aims to follow the market and provide price transparency for those buying, selling and trading steel. The CRU tracks spot prices by polling suppliers and the prices at which they sold steel on the spot market and customers, and at what prices they purchased steel on the spot market. Volume submitted to CRU is equally split with 50.6 percent coming from major mills while 49.4 percent comes from mill-direct buyers who are active in the spot market. Further, the CRU index is created by removing any outliers (significantly high or low numbers, as a spot price can vary based on order size, relationship with a mill, etc.) to create a weekly price assessment that is the clearing index used to settle futures on the Chicago Mercantile Exchange (CME). The CRU is responsible for the settlement of over $20 billion dollars of contracts, including steel futures, so its accuracy is essential.
The majority of service center business is under some sort of contract umbrella based on the CRU spot market index. The most popular is a year-long monthly contract, referred to as CRU-minus, whereby a buyer and mill agree to a specific amount of volume every month, priced at a discount to the CRU spot price index for the prior month.
With buyers always looking for the best possible deal, and mills hungry to fill order books, mills allowed their customers to tuck extra spot tons under their existing contract tonnage, known as a bucket deal, to secure a more competitive price, a “CRU-minus something” price. The bucket deals allow service centers to flex their tonnage up or down, based on the direction of prices. Sources told SteelOrbis that a CRU minus 5 percent price was extremely common, and the number of these deals seemed to grow almost exponentially within just the first few months of the year. It appeared that the “CRU-minus” deals essentially replaced the spot market: why pay the higher spot price when CRU-minus deals were so accessible, and significantly less expensive?
It all came to a head in April when mills publicly told customers that they’d had enough of the CRU-minus deals, and, essentially, losing money. But these deals were nothing new to the flat rolled market. Josh Spoores, the Principal Consultant – Steel for the CRU, explained that these types of deals have grown in prevalence the last couple years. As sheet steel capacity domestically (i.e. the ramp up at ThyssenKrupp Alabama, and upgrades at Severstal NA) rose, competition increased, and mills looked to secure monthly tonnage commitments from typical spot market buyers. In order to secure the tonnage, mills began to offer larger and larger discounts.
Securing tonnage at competitive prices is one thing, but selling material at a loss is another, so in late April mills separately, but collectively took a stance against the deals that they themselves had been making. A number of US domestic flat rolled mills informed customers of their intention to no longer sell at price discounts to the CRU. Led by ArcelorMittal USA, Nucor Sheet Mill Group and Severstal NA sent letters to customers indicating that the market deals at prices that were a discount to the published CRU index would be coming to an end due to the detrimental effect on domestic prices over the previous months.
ArcelorMittal USA said specifically: “We believe this pricing mechanism has become more prevalent and is causing an unnatural ceiling price and therefore is undermining our ability to collect a fair market value for our products. For the balance of 2013, we will offer firm price agreements for monthly, quarterly, and six month durations that assume volume and price is sustainable for all parties. We will consider competitive situations on a case by case basis for longer term agreements, but it is not our intention to enter into agreements based on a discounted level to the CRU. If a reference to the CRU index is required, we will use CRU, as a minimum price only.”
The immediate impact of the announcements was negligible—walking away from contracts, particularly annual contracts, is not an easy feat, and would clearly anger customers, so it was evident that there was no swift solution to a problem that had been building for years. Mills kept their annual CRU-minus contracts, but said that they would not enter new ones.
Immediately following these mill letters, media reports abounded about mills’ discontent with the CRU, and many began to question whether the CRU index was as neutral, and accurate as it claimed, asserting that the prices on the index were distorted.
Some spoke out against the accuracy of the CRU index, claiming that CRU-minus deals, which were well below spot market prices at a given time, were reported as a spot price transaction to the index, thereby altering prices on the index. However, Spoores countered that “with typical ‘CRU-minus’ discounts of 5 percent or more, any submission that is $30/nt ($1.50 cwt. or $33/mt) or more below the prior week or prior monthly price is quickly questioned and subject to further verification.”
But while some voiced uncertainty as to whether prices published on the index were distorted, Spoores, and Glenn Cooney, the Head of Indices for the CRU, stressed that this distrust was misguided. First and foremost, Cooney explained that as the index that is used to settle millions of dollars’ worth of futures on the CME, the CRU has checks in place to ensure that prices being reported are indeed only spot numbers, such as running prices provided in a given week to prices provided in the prior month. The CRU is also subject to a third-party audit of the data it is provided, the first commodity price index to do so.
Additionally, Spoores and Cooney contest that much of the media misinterpreted what mills announced, and there is a clear distinction between eliminating CRU discounting and abolishing the use of the CRU index altogether. Somewhere in all the frustration and multitude of letters, reports, rumors, etc., those two things seemed to get confused.
“The issue was not with the index itself, but the way that it was being used,” said Spoores. Mills all support the CRU index, he added, but can’t live with the discounts being made. The CRU provides accurate, third-party data, he said, but how the index is then used is not entirely under the CRU’s control.
The index, and its widespread use, is not likely to disappear anytime in the near future, and the way prices on the index are generated is not going to change, either, according to Spoores and Cooney.
Like individuals everywhere, buyers and sellers of steel constantly search for some sense of stability and assurance. Without it, it’s nearly impossible to plan ahead, and in many cases, remain profitable. Economists and steel analysts have repeatedly emphasized the short market cycles in the US domestic steel market over the last few years. Spot prices in arguably the most volatile of steel products, flat rolled, endure multiple upswing and downswing cycles per year, making it difficult to predict the direction of prices a few weeks out, much less where prices will be six months to a year from now. The CRU index, therefore, provides a level of transparency to the market, and is used a tool for buyers and sellers to plan their next moves.
In order to preserve the integrity of this price mechanism that has been in use for over 30 years now, CRU hired a major international accounting firm to carry out a third party audit. According to a number of service center and trader sources, CRU hired major accounting firm KPMG to work with each data provider as well as conduct an onsite audit of a sample of large data providers, representing both mills and buyers.
But even after the dust settles—by early fall, the number of CRU-minus deals dropped substantially, but the deals did not entirely disappear, either—Spoores and Cooney are unsure as to whether the kind of rampant deal-making that defined the first half of the year will creep back into the market sometime in the near or distant future.
“Nothing is a secret in the steel industry,” according to the head of sales at one Southern service center. “If one guy was able to get a deal, it won’t be long before everyone else is asking their supplier for the same discount.”
So long as there is competition, there will be individuals, and companies, seeking to undercut one another for market share.