Risk Management - Steel Procurement

Risk Management - Steel procurement

31/16/2007

Executive Summary……………………………………………………………………3

1. Scope…………………………………………………………………………….4

2. Steel – Significance and Market Characteristics………………………....4

3. Risks……………………………………………………………………………...6

4. Risk Management techniques………………………………………………11

5. Conclusion……………………………………………………………………..15

Sources

Executive Summary

Steel prices increased close to 400% from 2002 to 2008. In the same period price differences between the European, American and Asian markets were at times exceeding 30%. All three markets have in turn been the cheapest in that period. In 2008 we have seen prices increase by close to 30% year to date.

The price development is uncontrollable as it is driven by a complex mixture of global circumstances. The demand is driven by massive infrastructure developments in major economies – especially China. Raw material prices have sky rocketed as supply has struggled to keep up with growth rates in excess of 7% year on year for five consecutive years. The price increases on raw materials are successfully being passed on through the steel industry to the end-user.

The pressure from other developing economies (Brazil, Russia, India as well as China) is expected to keep demand high in the foreseeable future.

During this period of heightened demand, the industry has experienced some issues with product quality leading to escalating quality costs.

The volatility of this scenario makes long term commitments with fixed prices risky and therefore generally unavailable. A Futures market is under development at LME and NYMEX. However, none of them currently offer hedging contracts on Hot Rolled steel plate.

Strategically it would be prudent for The Company to develop an alternative to the steel Product with cost drivers different from those increasing the price of steel. Having the flexibility between two different products would give the company a competitive advantage. The Company should deploy risk management mechanisms through a vertical integrated approach by linking price escalators mechanisms in the sales contracts to regional steel price indices determined by project designated production allocation prior to entering into any sales commitment. The Company should also exploit international pricing differentials whenever possible.

Summary of recommended strategy:

1. Develop an alternative product based on cost drivers different from steel

2. Vertically integrated sale of steel Products – the steel purchase and the end product point of delivery must always be determined prior to entering into any sales commitment, and if the PO cannot be released at fixed prices the appropriate market index should be linked to a price regulation mechanism in the sales contract

3. Exploit international sourcing whenever justified by price differentials on the world market; but with increased quality control

4. Scope

Steel is important to The Company. It is by far the most important cost driver for our product.

In the following I will try to analyze the Threats and Opportunities posed by a market where prices have increased by close to 400% since 2002 with some wild fluctuations in between - most notably a 100% increase in 2004 followed by a drop of close to 40% in 2005. It has proven extremely difficult to manage the risks associated with such volatility.

The overall trend in this millennium has been a steep rise fueled by the growth of emerging economies - especially the Chinese - on the backdrop of many years decline in the western steel Industry.

Looking forward it is therefore of the utmost importance that The Company has a clear risk management strategy for maneuvering within the steel market – both upstream and downstream. The most significant steel volume comes with the Product. I will focus on the Product related steel in this analysis.

I will try to outline the possibilities as I see them now and will encourage SCM to keep updating