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European steel buyers eye shorter-term contracts without index-linked clauses

By Colin Richardson, Hector Forster, and Emanuele Norsa in London

June 25, 2013 - European steel producers could be caught in the grip of shorter-term raw material contracts and end-users demanding the “contracts of old”, sources told Platts.

Some customers -- particularly in the automotive sector -- are hoping to move away from shorter-term deals with index-linked raw material components that they felt were imposed upon them after 2008, as steelmakers tried to pass on more regular fluctuations in the cost of iron ore and coking coal.

Once raw materials were priced on quarterly and monthly agreements, new steel contracts developed in Europe, whereby hot rolled coil and other products would have a base price and raw materials “adjustment.”

The adjustment, which accounts for iron ore, coking coal, scrap and ferroalloys, tends to move depending on the length of the steelmakers contract with its raw material suppliers.

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Hot rolled coil (Euro/mt): 1 April – 25 June 2013

If the mill has a quarterly price for its iron ore and coking coal, for example, the surcharge contained in its steel contract will move quarterly too, a banking source in London said.

Once the surcharge does shift, it can trigger a renegotiation in the raw materials surcharge, or an automatic adjustment.

Many customers were unhappy with this formulaic approach, which they thought diluted their pricing power.

However, buyers felt they needed to be protected from steelmakers’ perceived upper hand with such a formula, one southern European service centre source told Platts.

Buyers feel they have power to challenge the system

Given the weakness throughout the European steel supply chain, buyers now feel they have the power to challenge the system, the service centre source added.

Rather than contracts with a base price and raw material adjustment, they want “old style” negotiations between buyers and sellers.

“People are very much pushing against this [contracts with index-linked raw material clauses], as nobody trusts these indexes anymore, because they do not reflect their reality,” a source with a large European trading company said. (See related chart: CFR China iron ore 62% Fe ($/mt): 1 April - 25 June 2013)

Customers want to revert to the old system, with no index-linked clauses, he added.

Another service centre servicing the automotive industry said they have a “number of annual agreements” in place, and are looking to get even more.

A source at the company said mills are more flexible than in the past.

A source with one large European mill admitted his company is losing some of their pricing power to OEMs, and could be forced to compromise on commercial terms to maintain market share.

He said customers were taking advantage of weak demand to press for fixed steel prices for a year and threatening to move business to other mills that will agree to their terms.

“The market is so weak that unless we meet their demands they will just take their business to another producer,” said a mill source.

A procurement executive with a leading global automotive producer said his company tries to refrain from signing contracts with index-linked clauses.

“We try to avoid index-linked raw material clauses wherever possible as we think they are leading to unreasonable inflation,” the executive said.

“We do have some index-linked contracts with small tier-one suppliers for specific raw materials,” he added. In these instances the index-linked clause is related to finished product prices, rather than raw materials.

Index-linked clauses provide more visibility

An executive with a large white goods producer, however, said index-linked clauses provide more visibility over how steel prices will move going forward, given that raw material prices have been so volatile of late.

“If we are back to more stable raw material prices then it will not be a big issue for steel producers to go back to 12 month contracts,” he added.

His company in turn has formulas in contracts with its buyers – which can range from 12 months to three years – based on its primary raw materials.

The executive said they are not so much index-linked, but raw material prices are monitored for their percentage change over a period of time.

It is in the interests of mills, to an extent, to have raw material clauses in contracts allowing them to pass on upstream cost volatility to their customers.

However, a Benelux-based agent with one large European mill said index-linked contracts “only work for a short period of time as they create problems whenever prices change sharply.” The agent did say, however, that his mill was sticking to quarterly and 6 month-long contracts. They ended their relationship with one large customer that was not accepting shorter-contracts, he added.

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