Before we analyze whether lag pricing could be a tailwind for steel companies in 4Q16, let’s familiarize ourselves with a few terms. Steel companies such as U.S. Steel (X), Nucor (NUE), and ArcelorMittal (MT) sell their products in the spot market or under contract sales. AK Steel (AKS) has one of the highest percentages of contract sales in its sales mix.
The pricing of contract sales is determined by several variables, which we’ll explore in detail in the next article. In this article, we’ll see how the lag impact could help steel companies’ 4Q16 spot sales.
Note that there are lead times before steel mills take spot orders and the steel is delivered to the buyers. Looking at the current market dynamics, lead times for cold-rolled coil (or CRC) prices are higher than they are for hot-rolled coil (or HRC). Higher lead times in CRC have seen CRC prices diverge from HRC prices. As a result, the HRC-CRC spread has risen to record highs this year, as can be seen in the graph above.
Some of the metal that steel companies will ship in the spot market in 4Q16 was booked in August and September 2016. It would be safe to assume that these orders were placed at higher prices compared to the current spot prices. This would support steel companies’ 4Q16 average steel selling prices.
Having said that, the lag impact from spot sales seems to have been factored in by the markets (DIA). Analysts’ earnings estimates also seem to be factoring in some of the tailwinds from lag pricing.
Along with the lag pricing, contract sales could also benefit companies in 4Q16. We’ll discuss this more in the next article.