For the last 4 years, the Steel industry has been facing obscurity. The affects of macro & micro economic factors is what’s making the fluctuating Indian steel market.
Steel market is waiting to be rescued by demand. Factors such as overcapacity, low prices and economic slowdown are adversely affecting it.
India urban population is expected to touch 600 million by 2030 from the current (2013) 400 million. A prosperous India will need new infrastructure. Government promised for economic growth and infrastructure investment. If it stays faithful to the 12th Five Year Plan, this will lead to additional demand of 40 MnT pa of Steel, which is about 60 per cent hike.
The gap between production capacity of 74 MnT and demand of 68 MnT doesn’t seem wide. But companies are made miserable by expensive raw material and competitive imports. The net debt of India’s top six steel producers combined is about INR 1525.6 billion, which is ever expanding with the shrinking rupee.
Since Steel making is cash intensive business, its survival depends on strategic cost cutting. The best decision could be to optimize the operations of factory. It can be done effectively if company can forecast how prices will behave in the coming months.
Steel production costs are spread amongst many variables such as prices for Iron ore, Coking Coal, Limestone, Natural gas and Power. Since these are all separate components, risk managers believe that it couldn’t create an effective hedge.
Futures prices are a forecast tool. Decision making on capital investment can be more objective. Knowing the future revenue in well advance means that producers should be able to better plan capacity. Such planning may also help to control the working capital.
Banks charge higher interest rates for businesses which they view as being more risky. If a producer can show that his future cash flow risks are less with a hedge of futures contracts, a bank is likely to lend cheaper money.
A risk management tool such as futures contracts may help in potentially increasing the available capital, reducing the cost and thus improving profitability. The open exchange price and related transfer pricing makes integrated business less risky. Also, the open exchange price allows the whole industry to share the risk.