Price escalation clauses for steel construction

Steel – a volatile raw material

Any company that processes steel in large quantities is the Development of the steel price delivered. This primarily affects the construction industry, but also many industrial companies and their suppliers. A long-term forecast of the steel price is not possible, because the steel producers are also from volatile raw materials dependent and do not enter into long delivery obligations. The rising steel prices in the wake of the corona pandemic posed major problems for many steel processing companies in 2021. There have been similar price peaks in the past, around 2008.

However, companies can protect themselves from having to bear the risk of an increase in steel prices in various ways. For example with one Hedging through price escalation clauses or through appropriate Financial instruments.

Depending on the industry, there are differences that speak in favor of one or the other option.

Examples and templates for price escalation clauses

Detailed explanations and Examples of the application of a price escalation clause based on the Federal Procurement and Contract Manual can be found in Chapters 2 and 3 this article by Dr. Hammacher.

Very good Samples for the formulation of price escalation clauses, which you can easily use in practice can also be found at the Austrian Chamber of Commerce this link (pdf).

Suitable indices for price escalation clauses

As in the above comment from Dr. According to Hammacher, the main thing to be clarified when applying price escalation clauses is which index this refers to. Here one Selection of steel price indices and raw material exchanges.

Alternative hedging – hedging the price of steel using financial instruments

Even outside the construction industry, raw materials, especially steel, are regularly purchased and processed. This particularly applies to large-volume series production. Here it is not possible to assign the purchase price exactly to the product sold. Long-term delivery contracts also require one Price stability, which cannot be realized when purchasing raw materials. You therefore need one general insurance against rising steel prices.

A means of doing this is derivative financial instruments. The aim is to protect your own steel requirements against price changes. This is only possible in a certain amount at a certain time.

Because steel comes in different forms, it was only discovered relatively late as the basis for a derivative. Today you can conclude contracts for different types of steel such as reinforcing steel, wire rod or hot strip on various international exchanges.

How does steel hedging work?

The prerequisite for hedging using a derivative is that you know your own steel requirements in the future. Only then can this amount of steel be secured. Of course, it is also possible to cover only part of the demand and at least partially ensure cost security. We'll look at this using a small example:

Stahlbau GRÜN buys 1000 tons of steel every month and processes it further. Long-term delivery contracts with fixed prices exist with customers. The company wants to protect itself against the risk of an unfavorable development in steel prices over the next 12 months. To do this, you purchase a financial instrument that gives you the right to purchase 1000 tons of steel in one year at a fixed price today.

After the 12 months have expired, Stahlbau GRÜN purchases 1000 tons of steel through its supplier at the current market price. At the same time, the financial instrument is settled. There are two options here.

1. 1. The current market price is higher than the fixed price in the derivative, then Stahlbau GRÜN receives a payment equal to the difference. You paid a higher price for the physical steel, but you get it in return Compensation the cost one Payment from the derivative.
   2. Should the Steel price lower on the reporting date If it fails as agreed, steel construction must be GREEN Difference amount to the issuer of the financial instrument. However, these costs were largely saved when purchasing the physical steel.

This is how you can protect against rising costs and the development of the steel price is included in the calculation you have absolutely no risk, more. However, a fee is due to the issuer of the financial instrument for this. The longer the lead time until the deadline, the longer it will be.

Unfortunately, this form of insurance is only for companies with one large demand for steel and corresponding Expertise in trading financial instruments.

Risks of hedging steel

The prerequisite for hedging is that the material in question is listed on a raw materials exchange. From the previous chapter it can be seen that only a few types of steel are traded. This aspect poses a great risk for SMEs because they process it Sheet metal, profiles and shaped tubes in different material qualities are not listed on the stock exchange. Although raw material prices correlate, they are only part of the market price. Local shortages, such as production bottlenecks or delivery difficulties, are not taken into account. To put it simply, if a steelworker has to produce a structure from seamless tubes and these are currently in short supply and therefore expensive, this does not mean that hedging to one of the above values ​​will compensate for the price increase. This type of protection would therefore be speculative for the listener everywhere and thus being a additional risk. (See. Procurement current)

Conclusion: Hedging against rising steel prices remains a complex issue

Depending on which industry you are active in and what position your company has in relation to your customers, you can pass on any price increases to your customers using a price escalation clause.

However, this will not be possible for many companies and the use of financial instruments also involves risks. This is also missing for many applications, especially in mechanical and plant engineering appropriate comparison value, which means that a supposed hedging of steel price developments quickly comes to an end speculative business is.

Here, companies have to act on sight and be careful not to make commitments that are too long.