* Greater volumes seen for exchanges, cleared iron ore swaps
* Big steelmaker participation needed for effective market
By Melanie Burton and Marie-Lousie Gumuchian
LONDON, Dec 3 (Reuters) - Small and medium-sized steel producers are increasingly looking to derivatives trade to lock in profit and cut risk as they contend with meagre margins, shifting economic trends and volatile raw materials prices.
But more participation by major steelmakers is required to make hedging effective, participants at a recent steel conference said.
"Steelmakers ... are more exposed to the impact of international trade than ever before," said Matthew De Morgan, chief executive of Swiss trader and producer Duferco.
"The more successful of these steel companies are now employing ... very similar management tools to the traders. This is frankly essential to manage unique commercial risks and maximise margin," he told a steel conference in London.
Steelmakers have traditionally been reluctant to join the exchange-traded world on worries that exchanges will offer easy entry points to investors, who will in turn drive up and distort prices and the cost of doing business.
But in the wake of the global credit crunch, mills are looking for new tools as their margins have been squeezed by overcapacity as well as sluggish demand from the West, while input costs have risen and fallen.
"Mills have joined the rest of the supply chain in the need to manage price risk of raw materials," said Patrick McCormick, president of WSEM, a unit of information provider World Steel Dynamics.
NEW HORIZONS
At least five exchanges trade steel contracts, and new services for clearing over-the-counter iron ore swaps have sprung up in Europe as well as Asia as the industry moves closer to market-based pricing.
This was partly after miners ditched a 40-year-old annual benchmark system for iron ore, the major material of steel.
The Shanghai Futures Exchange has been the most successful, but volumes are growing elsewhere. Steel billet on the London Metal Exchange has traded in record volumes of over 10 million tonnes this year, up almost five-fold on 2009, which was the first full year of its trade.
Billet is a semi-finished product in the form of long steel, mainly used in construction.
"It is only recently we have been able to manage risk in a few products, either through the LME billet market or iron ore swap market," said Robby Afnaim, chief executive and chief financial officer of Ronly, a UK-based steel trader.
"By hedging our physical deals, we are effectively fixing our profit margin and creating a more sustainable business environment ... We are also giving value to our customer - being able to give a price when he wants it to be priced."
But the participation of traders and some smaller mills does not make a market, and more industry backing is required for contracts such as those on the LME to fully take off.
Also the plethora of products on the market may need to consolidate before critical mass is reached.
"If the industry gets around a few contracts and gives them liquidity, then the hedging will become much more easy and cost-competitive, said John Short, a director at broker New Edge.
"The biggest risk in these markets is not the presence of speculators, it's a lack of (industry) presence," he said.
"It seems bizarre not to use a tool that can help us mitigate risk when it's available," Ronly's Afnaim said. "But currently the liquidity is still not there to make good use of these tools."
(Editing by Jane Baird)