oEPA
             United States
             Environmental Protection
             Agency
             Municipal Environmental Research
             Laboratory
             Cincinnati OH 45268
EPA-600/9-80-002
March 1980
             Research and Development
A Handbook on
Scrap Futures
Markets and Futures
Trading

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                RESEARCH REPORTING SERIES

Research reports of the Office of Research and Development, U.S. Environmental
Protection Agency, have been grouped into nine series. These nine broad cate-
gories were established to facilitate further development and application of en-
vironmental technology.  Elimination of traditional grouping  was consciously
planned to foster technology transfer and a maximum interface in related fields.
The nine series are:
      1.  Environmental  Health Effects Research
      2.  Environmental  Protection Technology
      3.  Ecological Research
      4.  Environmental  Monitoring
      5.  Socioeconomic Environmental Studies
      6.  Scientific and Technical Assessment Reports (STAR)
      7.  Interagency Energy-Environment Research and Development
      8.  "Special" Reports
      9.  Miscellaneous Reports
This document is available to the public through the National Technical Informa-
tion Service, Springfield, Virginia  22161.

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                                     EPA-600/9-80-002
                                     March 1980
        A HANDBOOK ON SCRAP FUTURES
        MARKETS AND FUTURES TRADING
                    by

   Roger C. Dower and Robert C. Anderson
         Environmental Law Institute
            Washington, DC 20036
           Grant No. R804309-01
              Project Officer

              Oscar Albrecht
Solid and Hazardous Waste Research Division
Municipal Environmental Research Laboratory
          Cincinnati, OH 45268
MUNICIPAL ENVIRONMENTAL RESEARCH LABORATORY
    OFFICE OF RESEARCH AND DEVELOPMENT
   U.S. ENVIRONMENTAL PROTECTION AGENCY
          CINCINNATI, OH 45268

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                          DISCLAIMER
     This report has been reviewed by the Municipal Environ-
mental Research Laboratory, U.S. Environmental Protection
Agency, and approved for publication.  Approvel does not
signify that the contents necessarily reflect the views and
policies of the U.S. Environmental Protection Agency, nor
does mention of trade names or commercial products constitute
endorsement or recommendation for use.

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                                  FOREWORD
     The Environmental Protection Agency was created because of increasing
public and government concern about the dangers of pollution to the health
and welfare of the American people.  Noxious air, foul water, and spoiled
land are tragic testimony to the deterioration of our natural environment.
The complexity of that environment and the interplay between its components
require a concentrated and integrated attack on the problem.

     Research and development is that necessary first step in problem solu-
tion and it involves defining the problem, measuring its impact, and search-
ing for solutions.  The Municipal Environmental Research Laboratory develops
new and improved technology and systems for the prevention, treatment, and
management of wastewater and solid and hazardous waste pollutant discharges
from municipal and community sources, for the preservation and treatment of
public drinking water supplies, and to minimize the adverse economic, social,
health, and aesthetic effects of pollution.  This publication is one of the
products of that research; a most vital communications link between the re-
searcher and the user community.

     This handbook resulted from an earlier EPA research effort directed at
examining the feasibility and desirability of establishing scrap futures mar-
kets to increase resource recovery from solid waste.  The handbook was used
at a symposium on scrap futures trading held at New Orleans, Louisiana on
May 14-15, 1979.  A summary of the comments made and conclusions reached at
that symposium are included in this report.  It will be useful information to
persons engaged in buying and selling secondary materials, and to policy
makers concerned with managing solid waste and conserving national resources.
                                       Francis T. Mayo, Director
                                       Municipal Environmental Research
                                       Laboratory
                                     111

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                           ABSTRACT


     The feasibility and desirability of futures trading in
wastepaper and ferrous scrap was the subject of a symposium held
on May 14th and 15th, 1979.  The Scrap Futures Symposium was in-
tended to provide a forum for industry and commodity exchange
interaction on the potential merits of futures trading in scrap
materials.  This report incorporates a summary of the discussions
at that Symposium with an elementary introduction to the mechan-
ics of futures markets and futures trading.

     The risk management and financial functions of futures mar-
kets are argued to be of benefit to the commerical users of those
markets; the consumers and suppliers of wastepaper and ferrous
scrap.  Before futures trading can be initiated, the standard
marketing practices and procedures in those industries must be
duplicated in the futures markets.  In addition, a standard grade
of scrap must be chosen for delivery on the futures contract.
Most of the industry participants at the Symposium felt that
these requirements could be met and that a futures market could
be an important addition to their normal market transactions.

     As a result, in part of the Symposium and earlier reports,
a New York commodity exchange is designing a model ferrous scrap
contract for industry review.  Further presentations on the
mechanics of futures trading must be provided to members of the
wastepaper industry before more specific discussions can take
place.

     This report was submitted in fulfillment of Grant No.
R804309-01 by the Environmental Law Institute under sponsorship
of the U.S. Environmental Protection Agency.  This report covers
the period September 15, 1978 to June 15, 1979.  The work was
completed as of June 15, 1979.
                               IV

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                        CONTENTS
Foreword	iii
Abstract	iv
Figures	,	vi

     1. Introduction  	  1
     2. Summary and Conclusions 	  3
     3. What are Futures Markets?	5
     4. Why Futures Markets?  	  7
     5. How Futures Markets Work	10
     6. The Benefits of Futures
           Trading	19
     7. Designing a Scrap Futures
           Contract	22
Appendix
        Scrap Futures Symposium
           Participants 	 29
                            v

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                            FIGURES






Number                                                    Page



  1  Copper prices: futures, wirebar, and #2 scrap ...    8






                            TABLES






Number                                                    Page



  1  Example of a selling hedge	   16



  2  Example of a buying hedge	   17
                              VI

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                           SECTION 1

                         INTRODUCTION
     The idea of futures trading in scrap materials is neither
novel or untried.  In 1955 futures trading in ferrous scrap was
initiated on a Chicago commodity exchange, only to be withdrawn
after one year.  The concept was reviewed in recent years by the
Department of Commerce in a series of presentations to ferrous
scrap buyers and sellers on the mechanics of futures trading.
Last year, a New York commodity exchange organized a ferrous
scrap futures advisory committee, with the task of investigating
the potential for renewed futures trading in ferrous scrap.  More
recently, after attending a symposium on the subject, the same
exchange decided to develop a model ferrous scrap futures con-
tract and propose it for trading.

     The recurring interest in scrap futures trading has re-
sulted from several conflicting motivations.  The 1955 scrap
futures contract was introduced at a time when the exchange was
trying to generate trading interest.  The Commerce Department
presentations followed in the wake of the commodity shortages of
1973-74, in an apparent attempt to initiate a futures market in
ferrous scrap as a forecasting tool.  The current work of the
Environmental Law Institute in scrap futures originated in an
interest in futures markets as a device for stabilizing secon-
dary materials markets and thus, perhaps, stimulating resource
recovery.

     Until recently, the scrap processing and consuming indus-
try's interest in futures trading has been minimal.  Past dis-
cussions have rarely focused directly on the needs and concerns
of scrap dealers or consumers.  Many industry members view
futures markets as outside their normal business transactions,
offering few benefits to anyone but the speculators who take
advantage of other market traders.  Given this lack of under-
standing of futures markets, it is little wonder that broad
industry support for the concept is just beginning to materi-
alize.

     The purpose of this report is to provide a foundation for
informed discussion and debate on the merits of and potential
for organized futures markets in wastepaper and ferrous scrap.
To this end, it is our intention that the report serve as a

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primer on the structure of futures markets and the mechanics
of futures trading, with emphasis on the economic benefits to
industrial traders in the markets.  Particular attention is paid
to those characteristics of futures markets that may have a
bearing on whether wastepaper and ferrous scrap can be success-
fully traded on a futures market.

     In addition, incorporated into this discussion are relevant
conclusions and comments made at a recent symposium on scrap
futures trading.  The desirability and feasibility of organized
futures markets in ferrous scrap and wastepaper was the topic of
a symposium sponsored by the U.S. Environmental Protection Agency
and the Environmental Law Institute on May 14th and 15th 1979.*
The symposium provided a forum for preliminary industry discus-
sion on the potential merits and barriers to futures trading in
wastepaper and ferrous scrap.  Commodity exchange officials and
industry representatives spoke to audience of wastepaper and
ferrous scrap consumers and dealer/processors on a number of
different topics including the role of the commodity exchange in
futures markets and the uses of futures markets for buyers and
sellers.**

     The design and implementation of a futures contract in
wastepaper or ferrous scrap is a process requiring close inter-
action and cooperation among a commodity exchange and members of
those industries.  The purpose of the EPA grant under which this
work was performed was to provide the initial step in this pro-
cess.  In a sense then by this report, presenting a mix of
theoretical and practical issues that draw upon a larger research
report prepared for EPA by the Environmental Law Institute and
remarks made during the Scrap Futures Symposium, summarizes the
progress which has been achieved.***
*From this point on the Scrap Futures Symposium will be refered
to as the "Symposium".

** The Symposium speakers and the participants are listed in the
Appendix.

***Anderson, R.C. and R.C. Dower, An Analysis of Scrap Futures
Markets for Stimulating Resource Recovery, prepared for the
Solid and Hazardous Waste Research Division of the U.S. E.P.A.,
EPA-600/8-78-018.

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                           SECTION 2

                    SUMMARY AND CONCLUSIONS
     The purpose of this report was to identify some of the im-
portant features and uses of futures markets and to outline some
of the practical considerations that must be evaluated before
such markets can be established in wastepaper or ferrous scrap.
The risk management and financial functions of futures markets
can provide large benefits to commerical users of the markets
with little or no costs imposed on the industry itself.  This
point was well taken by those attending the Symposium, some of
the discussions from which are summarized in this report.  Al-
though there were varying degrees of sophistication concerning
futures markets among those participating in the Symposium, all
but a few regarded futures trading in wastepaper or ferrous
scrap as a potentially useful adjunct to their normal business
transactions.

     This is not to say that futures trading in ferrous scrap or
wastepaper will become a reality in the near future.  Several
barriers, such as industry education and delineation of a stan-
dard contract for trading must be overcome before futures trad-
ing in these materials can be initiated.  The Scrap Futures
Symposium and this report are only the beginnings of this
process.  For wastepaper, a greater effort to demonstrate the
usefulness of futures trading and the mechanics of futures trading
to industry members must be made before a model contract can be
devised or before a commodity exchange will take a strong in-
terest.  All of the wastepaper consumers and suppliers repre-
sented at the Symposium remarked that before more specific
discussions" on a wastepaper futures contract could take place,
they would need further presentations on how futures markets
work.  With the support of an industry trade association and
several of the Symposium participants, plans for such presen-
tations are under way.

     In the case of ferrous scrap, the deliberations are much
further along.  Based, in part, on the comments generated during
the Symposium, and earlier reports on futures trading in ferrous
scrap, Comex in New York has decided to develop a model ferrous
scrap futures contract.  The model will be presented to the
Board of Comex and interested industry parties.  If the reactions

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are favorable, the model contract, or a modified version of the
contract depending on the industry comments, may be introduced
for trading.

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                           SECTION  3

                   WHAT ARE FUTURES MARKETS?
     Much of the mystery and distrust surrounding futures mar-
kets stems from attempts to distinguish futures trading from
other sorts of market transactions.  Strictly speaking, futures
markets are organized market places for trading in future com-
mitments, or futures contracts, for a commodity.  While similar
in concept to forward contracting, a common practice that en-
ables both sides of a market to plan ahead of the current market
period and to make good use of the resources under their control
by smoothing out irregularities in demand and supply, futures
markets are unique in several respects.

     First, futures trading takes place on an organized exchange.
Futures contracts in a commodity are bought and sold in one well-
defined trading area or "pit" of a commodity exchange trading
floor.  In fact, trading outside this area is prohibited by law.
Second, the futures contracts are standardized with respect to
the quantity, quality, delivery terms, and so forth.  The speci-
fications of a futures contract are extremely detailed, covering
the purity of the commodity to be delivered, the method of ship-
ment, and the terms of payment, and the month during which de-
livery is to be made.  The only aspect left unspecified is the
day of the month in which delivery is to take place.  In other
forward contracts, the terms differ depending upon the specific
needs of the buyer.

     Futures contracts are usually traded up to a year in ad-
vance, with contracts designated for delivery in specific months
throughout the year.  For example, a copper futures contract
traded on the Commodity Exchange, Inc.(Comex) in New York calls
for delivery of 25,000 pounds of 99-9 percent pure copper cath-
odes.  The delivery months are January, March, May, June, July,
September, and December.  Delivery can be made from any of the
six Comex warehouses located across the country.  Choice of the
warehouse from which shipment will be made and the actual date
of shipment within the delivery month are decided by the seller
of the contract.  While these last two points would seem to work
to the disadvantage of the buyer, the market compensates for the
uncertainty over delivery.

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     It is important to emphasize that futures markets are rarely
used to make or take delivery of the physical commodity.  Con-
fusion over this point was expressed by many attending the Sym-
posium, particularly members of the wastepaper industry.  Of the
hundreds of thousands of futures contracts traded on U.S. ex-
changes every year, only one or two percent is satisfied by the
seller making delivery and the buyer accepting delivery.  More
often, a market trader who sells a futures contract will buy a
similar offsetting futures contract before the contract reaches
maturity  (before the delivery month) and thus cancel his position
in the market.  For example, should a trader sell a May copper
futures contract in January, he has two choices to follow with
the contract.  He can hold it until May, when he is legally
bound to deliver 25,000 pounds of copper, or he can, at any time
prior to May, buy a May contract.  In the latter case, he has
both bought and sold a May copper contract and has effectively
cancelled any obligation to deliver or purchase copper.  Although
a futures contract is a legally binding contract to deliver or
purchase a commodity at some future date, it does not transfer
title to a commodity.  This aspect of futures trading must be
completely understood.  The strict terms of futures contracts do
not, generally, represent the most profitable transaction terms
for a commercial buyer or seller of the commodity in the cash
market.*  It is this point as well as the other unique features
of futures markets, such as the fact that actual buyers and
sellers of futures contracts are unknown to each other, that
allow futures trading to supplement, and in some instances, tem-
porarily substitute for the forward trading that occurs in most
markets.  The commercial trader is usually better off negotiating
his own contract in the cash market and using the futures market
for other purposes.  To view futures markets as delivery markets
overlooks these more important functions which are outlined in
the next section.
*Throughout this report, the term "cash market" will refer to
transactions that take place in the normal commercial channels
and market place.  These transactions may involve futurity, such
as forward contracts, but are not organized in the sense of
futures contracts.

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                           SECTION  4

                     WHY FUTURES MARKETS?
     This section addresses two questions raised in the last
chapter: If futures markets are not for delivery what do they do
and why would anyone want one?  While there are several uses for
futures markets, this report focuses on the two most important
to commerical traders: risk shifting or risk management, and the
financial aspects of futures trading.

PRICE RISK SHIFTING

     Futures markets enable commerical buyers and sellers of a
commodity to shift the risk of doing business in an uncertain
market environment by hedging against unfavorable movements in
the price of inputs and outputs.  Basically, risk shifting or
the hedging function of futures markets involves taking an
opposite position in the futures markets from one held in the
cash market.  A buyer in the cash market who wants to hedge
against a price decline would sell in the futures market.  If the
price of the commodity does decline, he takes a loss in the cash
market, but by buying back the futures contract at a lower price
than he sold it for, his gains on the futures market transaction
offset his losses in the cash market, and he is able to stablize
his profit margin and his income.

     For a hedge to be successful, the price of the commodity in
the cash market must be closely related to the futures price of
the commodity for the nearest month of delivery.  While this
would almost certainly be true for market transactions involving
the same commodity as described by the futures contract, it may
also be the case for two less clearly related commodities.  Buy-
ers and sellers of copper scrap are able to hedge their purchase,
sale, or inventory decisions against any of the copper futures
contracts traded.  As demonstrated in Figure 1, this is because
the price of copper scrap moves closely with the price of pri-
mary copper which, in turn, is closely related to the futures
price of copper.

     During the Symposium several references were made to futures
markets being price insurance markets.  In other words, that by
hedging on futures markets a buyer or seller could insure against

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00
           Q
           Z
           i
                82
                76
                70
                64
58
                52
                40
                .34
                   WEEKLY HIGH.

                   FRIDAY CLOSE!  COMEX
                   WEEKLY LOW'
                                                            SPOT PRICE
                                                   (SECOND SESSION)
                           Figure 1. Copper  prices:  futures,  wirebar, and #2  scrap

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price changes and therefore, income or profit margin changes.
This analogy was described by a commodity exchange official as
not being entirely accurate.  Hedging on a futures market does
not eliminate risk like an insurance market, but rather reduces
risk and provides a mechanism for coping or managing risk.
Futures prices and cash prices are only rarely perfectly corre-
lated.  To the extent that they diverge, a hedger on a futures
market is still exposed to some risk.

     In futures trading, price risks are shifted.  Commerical
buyers and sellers shift the risk of unfavorable movements in
the cash price for a commodity to other traders in the futures
market, particularly speculators, who are willing to accept this
risk in hope of financial gain.  In Section 4, the extremely
important role played by speculators in making a successful
futures'markets is described in some detail.  At this point,
suffice it to say that many of the benefits of futures trading
to commercial users result from speculators' willingness to
accept the price risks  shifted to them by hedgers.

FINANCIAL BENEFITS

     Futures markets can be thought of as financial institutions
and futures contracts as financial instruments.  As Professor
Hieronymus states in his well regarded book, The Economics of
Futures Trading, "It is not a financial institution in the sense
of a bank in which money is received from one group of people
and loaned to another.  Rather, it is a means by which loans
made by banks or operating money otherwise secured by businesses
are guaranteed against loss."  Holding inventories of any com-
modity, and particularly of scrap commodites, is expensive; if
the value of these inventories can be protected from adverse
price movements, financing will be more readily available.
Futures markets allow commercial traders the opportunity to trade
commodity obligations for equity or money obligations.  Thus,
loans for expansion and other purposes can be acquired at much
more favorable terms, if the lending institution knows that its
investment is protected from a major price-induced loss.

     A simple example of one type of financial benefit from
futures trading involves the use of equity capital for financial
inventories.  Imagine a firm with $1,000 of equity capital to be
used to acquire inventory holdings of a commodity.  If the firm
promises to hedge that inventory, it might be able to obtain a
loan rate of 90 percent from a lending institution.  This would
allow the firm to have $10,000 worth of commodity in inventory.
Without hedging, the loan rate might be only 60 percent, which
would control only $2,500 of the inventory given the initial
$1,000 equity capital.

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                           SECTION 5

                   HOW FUTURES MARKETS WORK
     In order to have even a cursory understanding of the mech-
anics of futures trading, one must understand the players and the
rules of the market.  In this section, we introduce the partici-
pants in futures markets and describe the structure in which
futures trading takes place.
THE PLAYERS

     For the purposes of this report, the participants in futures
trading are divided into three groups: hedgers; speculators; and
the commodity exchange.  It should be kept in mind that only for
the third group is the definition clear enough to be consistently
true.

Hedgers

     Hedgers are the commercial participants in futures trading.
These traders have, or plan to have, a commodity commitment in
the cash market.  They are the buyers, sellers, wholesalers and
brokers of a commodity.  The chances are that they are not
trading in futures markets to accept or make delivery of a com-
modity, but to shift the risk of uncertain future price move-
ments.

     Without hedgers, or more properly, without the commerical
demand for the hedging services of a futures market, the market
is doomed to a short life, if it gets started at all.  Evidence
indicates that only a handful of futures contracts exist without
strong hedging demand.  This point was alluded to by a commodity
exchange speaker at the Symposium, who identified the extent of
industry participation in a futures market as one of the major
determinants of a successful contract.

     While the importance of hedging demand may seem obvious, it
is extremely relevant to consideration of futures trading in
ferrous scrap or wastepaper.  The 1955 ferrous scrap contract,
as mentioned earlier, failed due to a lack of trading interest.
While the reasons for this are obscured by the passage of some
25 years, the failure of the market appears closely related to a
                               10

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lack of hedging interest.  The exchange neglected to design a
contract that appealed to scrap buyers and sellers or to bring
scrap traders into the decision process.  Feeling that the fu-
tures contract did not conform to their standard industry prac-
tices, and that it would not serve a useful purpose, commercial
traders shunned the market.

     Commerical or industrial participation in futures trading
actually has a two pronged impact on trading volume.  One, it
determines hedging volume and at the same time determines specu-
lative trading interest.  As mentioned by one speaker at the
Symposium, if adequate hedging demand is established in a futures
market, speculative participation usually follows.  This aspect
of futures trading and the role of the speculator is discussed
more fully below-

Speculators

     Along with hedging demand, speculative trading provides the
other necessary ingredient of a successful futures market.  Spec-
ulators are traders with no stake in the commerical market for a
particular^ commodity.  Ostensibly, they trade solely for the pur-
pose of profiting from favorable movements in the prices of fu-
tures contract.  If they think prices for a commodity will rise
over a particular period of time, speculators will buy futures
contracts in hopes of selling them later at a higher price.  The
role of speculators in futures markets is actually more subtle
and far-reaching than this.  The misconceptions concerning spec-
ulators in futures markets, several questions on which were
raised by industry participants in the Symposium, justify an ex-
planation of their part in insuring a well-functioning futures
market.

     Trading activity on the major commodity exchanges suggests
that speculators tend to enter markets in which there is heavy
hedging activity.  It is in this type of market that speculators
find the best opportunity for profits.  This also works to the
advantage of the hedgers by enabling them to get in and out of
the market quickly.  Without the trading activity of the specu-
lators, it would be difficult for hedgers to buy and sell when
they want to.  Speculators willingly accept the price risk the
hedgers want to avoid.  It was stated earlier that futures mar-
kets allow commerical traders to exchange commodity obligations
for monetary ones.  It is the speculator who provides the mone-
tary obligation.  In a sense, the speculator is the financier.

     All too often, speculative trading on futures markets is
assumed to have a destabilizing effect on prices arid= to downgrade
the integrity ofcthe marketplace.  In fact, economic- evidence
suggests the opposite.  By buying when they think prices will
rise and selling then they think prices will fall, speculators


                               11

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help stablize prices.  This point of view was defended by several
representatives from commodity exchanges at the Symposium.  Of
course, it cannot be said that speculators, or hedgers for that
matter, never try to corner a market or take advantage of a thin
(low trading volume) market.  However, the incidence of market
abuse in futures trading is amazingly low, for trading rules en-
forced by the exchange allow little opportunity for such be-
havior.

The Commodity Exchange

     In the United States, commodity exchanges are nonprofit or-
ganizations formed to serve the needs of their members.  Exchan-
ges provide a location for futures trading as well as the rules
for that trading.  Besides setting the rules of trade and enfor-
cing those rules, exchanges actively engage in research and pub-
lication.  Membership is open to all individuals of good charac-
ter and financial soundness.  Although, on most large U.S. ex-
changes, the number of members is limited.

     Adjunct to the exchange is the Clearing House, which in most
cases is actually a separate corporation.  Clearing House members
must be members of the exchange, but not all exchange members be-
long to the Clearing House.  The Clearing House is the watch dog
of trading activity on the exchange floor, and more importantly,
an active participant in the trading process.  All trades are
made through the Clearing House and one of its members.   The
Clearing House guarantees all trades and assures openness and
honesty of the market.  If a seller, for example, were to default
on a contract, the Clearing House would be responsible for seeing
that the buyer of that contract was satisfied and that the de-
faulting seller was properly chastized.  At the Symposium, ex-
change officials pointed out that no buyer or seller of a futures
contracts in the U.S. has ever suffered monetary loss due to a
default.

     Admittedly, this is a brief overview of the complex workings
of a commodity exchange.  We have only highlighted some of the
more important functions.  One other extremely important function
or role of a commodity exchange is presented in Section 6.  This
involves the choice of commodities made by the exchange for
futures trading.  This is a decision made solely by the exchange
and will have a direct bearing on the feasibility of futures
trading in wastepaper and ferrous scrap.
                    \
     With the participants in futures markets now identified, a
few general points are in order.  First, the characteristics of
the players have been oversimplified.  The actual distinction
between hedgers and speculators is blurred.  Whereas the earlier
definition suggests that the primary interest of hedgers is risk
shifting rather than speculative gain, very often hedgers have


                               12

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the same motivation as speculators.  Second, for every buyer of
a futures contract there is a seller, and for every winner a
loser - even though the actual buyers and sellers may not be
known to each other.  There is no need to; the Clearing House
guarantees that a delivery takes place, the terms of the contract
will be met.  Finally, all the players have significant roles in
assuring that the futures markets operate properly and efficient-
ly, and that the markets provide the services for which it is
intended.
THE RULES OF THE GAME

     Trading in futures markets is a procedure formalized by the
commodity exhcange and by law.  Futures trading takes place in a
specified area of the exchange floor during specific hours of
the day.  Only members of the exchange may be present on the
floor and engage in trading.  These members may trade for their
own accounts, for the accounts of a brokerage house, or the
latter's customers.  To insure that all trades are public and
competitive, offers to buy and sell must be made by "open out-
cry", which  , because of the loud din on the exchange floor, is
normally interpreted to include hand signals as well as shouts.
Price moves  for a particular contract on any given day are
usually limited by the exchange; for example, copper futures are
limited to price changes of 3 cents per pound.  If the price
change in any given day reaches the limit set by the exchange,
trading is suspended for the day.  Generally, price changes dur-
ing trade in the current delivery month are not limited.  In
response to  a question at the Symposium on this subject, an ex-
change representative stated that the price limits are set in
response to  guidelines from the Commodity Futures Trading Commis-
sion  (CFTC) , the regulatory agency charged with oversight" of the
futures trading industry, and that the limits were for specu-
lators who would not be aware of large changes in the price of
a contract.

Buying and Selling in a Futures Market

     To understand futures trading, it is useful to follow, in
a simplified fashion, the procedures by which futures contracts
are bought and sold.   Suppose,  for illustrative purposes,  that a
commodity exchange offers a ferrous scrap futures contract for
trading.  Assume further that a ferrous scrap dealer or proces-
sor has accumulated in inventory a quantity of ferrous scrap
similar in quality to the grade of scrap described by the fu-
tures contract.  He wants to hedge that inventory against the
risk of a decrease in the price of scrap.  To do this, he could
sell a futures contract.  After checking the current futures
price quotes, contained in most major newspapers, and evaluating
all the available market information, he would call his commodi-


                              13

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ty broker or commission merchant and instruct him to sell one
ferrous scrap futures contract in the delivery month that is
nearest to the month in which he thinks he will sell his inven-
tory.   (He would actually want to sell enough futures contracts
to insure that the quantity called for in the futures contracts
matched his inventory holdings as closely as possible.

     For the broker to execute the trade, the hedge must have a
large enough account with the brokerage house to cover the margin
requirement for the contract.  The margin requirement represents
"good faith" or performance money, for which a minimum level is
set by the exchange.  The brokerage house can set any margin re-
quirement above the minimum.   (Generally, it ranges from 5-10
percent of the contract's value.)  An interesting distinction
was made during the course of the Symposium between the margin
requirement on futures contracts and the margins on securities
or stocks.  Payment of a stock margin gives the buyer title to
the stock and, therefore, actual ownership or equity in the .en-
tity represented by the stock.  Payment of a futures contract
margin provides no title of ownership to the particular commodi-
ty.  This would not happen until the buyer of the futures con-
tract decides to take delivery on the contract and pays the full
contract amount.  Payment of the margin does give the right to
accept delivery or make delivery.

     With the financial issues settled, the broker would call
his floor representative with instructions to sell one ferrous
scrap contract for the delivery month named by the hedger.  The
floor representative will make his desire to sell a contract
known to the other traders in the pit by hand signals or by call-
ing out the order.  If another floor trader wants to buy at that
price, he responds in kind, and the trade is made.  The floor
traders have the responsibility to see that the floor observers,
exchange employees keeping account of the trading activity, are
aware of the price, quantity, and other aspects of the trade.
These observers feed the information into a computer system that
sends out the results of the trade across the world.  The floor
traders also fill out time-stamped forms giving the particulars
of the trade.  These forms are used by the Clearing House to
settle the accounts at the end of the day.  Finally, the broker-
age house is notified of the trade and in turn informs the scrap
dealer.  The total time elapsed between the floor broker making
the trade and the scrap dealer learning the results is only a
matter of minutes.

     The scrap dealer is now short -has sold- one futures con-
tract.  Had he purchased a contract, he would be considered long
one contract.  At the end of the trading day, the Clearing House
reconciles all trades and computes the gains or losses accrued
to each trading position.  If the futures contract sold by the
scrap dealer has risen in price, the dealer will have lost in


                               14

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that day's trading.  To keep his equity at the required level,
he may have to increase his account with the brokerage house.
Should the price of the contract drop by the end of the day, he
will have gained on the transaction, and the difference between
the selling price and the closing price will be credited to his
account.

     The process of taking in and paying out based on changes in
the daily price of the futures contract continues until the
position is closed out.  This is done in one of two ways.  During
the delivery month, the scrap dealer could decide to deliver un-
der the terms of the contract or, more realistically, he could
take an offsetting position in the market by buying a ferrous
scrap contract at any time prior to the delivery month.  He would
take the latter course if he decided to sell his inventory po-
sition.  A simple call to his broker is all he needs to close out
his position with the Clearing House.

     The scrap dealer's net gain or loss in holding the inventory
of scrap and hedging in the futures market depends on how closely
the futures price and the market price followed each other.  Any
gain or loss, however, will be greater if he does not hedge his
cash market transaction.  If the market price rises in the peri-
od during which he holds the futures contract, he will lose on
the futures market but gain on his inventory position.  Again,
he could have greater revenues had he not hedged, but, on the
other hand, he could have taken a loss if the market price fell.

     Table 1 provides a numerical example of how a scrap dealer
could enter into a selling hedge and protect his inventory hold-
ings.  In April, a scrap dealer buys in the cash market a certain
quantity of ferrous scrap at $75.00 a ton to be processed and
placed into inventory until the Fall.  At the same time, he sells
a September futures contract for $72.50 a ton.   (The difference
in the two prices results, in part, from the costs of holding
scrap from April to September.)  Throughout the summer the price
of scrap falls, and in August the dealer decides to sell his in-
ventory.  He sells his stocks of processed scrap for the current
market price of $73.00, taking a loss of $2.00 per ton in the
cash market.  Yet he buys back the futures, which has also
dropped in price to $70.50, and thereby makes a profit of $2.00
per ton on the futures market.  The net loss or gain on the deal
is zero.  Although a simplistic demonstration - for example,
commissions and processing costs are ignored - it does show how
one can hedge against unfavorable price movements in the cash
market.
                                15

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               TABLE 1. EXAMPLE OF A SELLING HEDGE
    Activity	Cash Market	Futures Market

  April:
     Buy                 $75.00
     Sell                 —              September $72.50

  August:
     Buy                  —              September $70.50*
     Sell                $73.00*
* Loss, $2.00; gain, $2.00; net loss, 0.               N


     Throughout the Symposium several other methods of hedging
on futures markets were suggested by speakers and participants.
One, of interest to consumers of scrap materials, is broadly
called a buying hedge and  is a means of protecting against rising
raw material costs.  Suppose that in April an electric furnace
operator enters into a contract with a scrap dealer/processor for
a certain quantity and quality of ferrous scrap to be delivered
to the mill in August at the market price prevailing at that
time.  In April the market price for the scrap is $75.00 per ton
but because the consumer is uncertain what the price will be in
August he wants to protect himself from a rise in the price of
scrap that would make it unprofitable to use the scrap in his
furnance.  He could hedge  his forward contract in the cash mar-
ket by buying a futures contract.

     Using the hypothetical ferrous scrap futures contract intro-
duced before, the mechanics of the buying hedge are outlined in
Table 2.  In April the electric furnace operator enters into the
cash market contract for delivery in August and buys one Septem-"
ber futures contract at $72.50 per ton.  (This assumes, of
course, that the consumer's cash market contract is covered by
one futures contract and that the nearest delivery month to
August is September.)  The current market price for one ton of
ferrous scrap is $75.00.   Suppose now that by August the price of
ferrous scrap has risen by $2.00 to $77.00 per ton.  He is forced
to buy the scrap at a loss, relative to the April price, of
$2.00.  At the same time,  the futures price has also risen by
$2.00 and he sells his contract for $74.50 and makes $2.00.  As
in the case of the selling hedge, the furnace operator's net loss
on both transactions was zero.
                                16

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              TABLE  2, EXAMPLE  OF  A BUYING HEDGE
    Activity	Cash Market	Futures Market

  April:

     Buy                   —           September $72.50
     Sell
     Market Price       $75.00

  August:

     Buy                $77.00
     Sell                  —           September $74.50*
* Loss, $2.00; gain, $2.00; net loss, 0.


     The procedures for making or taking delivery on a futures
market have not been discussed because delivery does not often
occur.  Suppose, however, that the hypothetical scrap dealer
does decide to deliver his scrap inventory to satisfy the fut-
ures contract.  This question was raised several times at the
Symposium and will be addressed below.  First, though, it is
necessary to introduce a few concepts.

Delivery on a Futures Contract

     A futures contract spells out the procedures for delivery:
delivery location; shipping mode; payment; etc.  The instrument
transferring title to the commodity is called a warehouse re-
ceipt or shipping certificate, depending on whether the commod-
ity is delivered from inventory or current production, respec-
tively.  In the former case, the exchange will either own or
have approved the warehouse or location of the inventory from
which delivery can take place.  Traders wishing to deliver on
the futures market must own the commodity at the warehouse.  In
the latter case, where delivery takes place from current pro-
duction, only those sellers classed as "regular" for delivery
by the exchange can deliver on the market.  To insure a stand-
ard of quality, the exchange requires a seller to demonstrate
financial and moral integrity.  The exchange guarantees that the
commodity delivered on the market meets the strict requirements
of the contract, and in some cases it also conducts inspections
to this end.  If the contract calls for the use of a shipping
                              17

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certificate, it will state whether the commodity is to be ship-
ped by rail or truck.  In general, the terms of delivery speci-
fied in a futures contract will follow the normal delivery and
pricing procedures used in the cash market.

     To return to the scrap dealer who wants to deliver on his
ferrous scrap futures contract: on the first day of the delivery
month, the Clearing House notifies him that he must submit the
appropriate delivery instrument or take an offsetting position
in the market.  At any time during that month, the scrap dealer
must present a delivery notice to the Clearing House, which in
turn passes it on to the contract buyer.  Since the original
contract sold by the scrap dealer may have changed hands any
number of times, the Clearing House simply gives the delivery
notice to the contract buyer who has held a buying, or long,
position for the longest period.  In essence, the delivery no-
tice says to the buyer that the quantity and quality of ferrous
scrap called for in the contract is ready and waiting for him.
The buyer can, if trading in the contract has not ceased, close
his position in the market by selling a ferrous scrap contract
for the same delivery month.  Or, he can accept delivery by pay-
ing the amount specified in his contract to the Clearing House,
which then sends the payment to the seller.  In most commodity
markets for futures trading there is an active secondary market
for delivery instruments; the buyer of a futures contract can
pay for the delivery instrument and sell it later in the secon-
dary market.  Hardly ever does a buyer of a futures contract
take delivery on a commodity for which he has no need.

     A ferrous scrap contract has been used as an example here.
A wastepaper contract could be used by industry members in ex-
actly the same manner.  The rules of futures trading vary,  in
small ways, from exchange to exchange and the uses of these mar-
kets differ from commodity to commodity.  Nevertheless, the ma-
jor points presented remain common to all future markets.
                               18

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                           SECTION 6

                THE BENEFITS OF FUTURES TRADING


     Having presented the basic concepts of futures trading in
ferrous scrap or wastepaper, the report turns to the last two
general areas of concern: if a futures market in either of these
commodities was established, how would the futures trading affect
the current market for secondary materials; and, what practical
considerations are relevant to assessing the possibility of fu-
tures trading in wastepaper or ferrous scrap?  The last two sec-
tions of this report treat these questions in turn.

     The effects of futures trading on cash markets for those
commodities with no present futures trading are, to some extent,
conjectural.  The nature and extent of such impacts will be a
function of the type of commodity, the structure and performance
of the industry, the success of the futures market, the number
of commerical traders, and a host of other factors.  Neverthe-
less, several probable impacts were discussed at the Symposium
and will be presented here.  It is important to restate that
futures markets or futures trading does not change market opera-
tions or industry practices, rather they supplement these prac-
tices.

     The provision of a mechanism for risk management or risk
shifting is the most obvious and most important result of futures
trading.  As was stressed by a number of the speakers at the
Symposium, this role of futures trading is particularly impor-
tant for the wastepaper and ferrous scrap markets, which his-
torically have been characterized by volatile prices.  The use-
fulness of a risk-shifting market would be limited if other mar-
ket mechanisms, such as forward contracting and vertical inte-
gration back to sources of raw material suppliers, were exten-
sively used.  Indeed, one commodity exchange speaker stated that
a criteria for successful futures trading was a forward contract-
ing system that was not operating properly.  The consensus of the
industry participants at the Symposium was that the current sys-
tem for forward contracting in the wastepaper and ferrous scrap
industries was not strong enough to stablize the market and that
a futures market would help buttress this mechanism.

     A risk management market would have several indirect impacts
on the cash markets for ferrous scrap and wastepaper.  One, it
                                19

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would tend to stabilize producer and consumer revenue by  allow-
ing commerical users to assure themselves of fairly constant
profit margins.  A number of participants at the Symposium ques-
tioned this point, saying that they made their money off  the
highs and lows in the market.  They were reminded by an exchange
official that you would hedge only when you wanted the protec-
tion and stability.  Two, because buyers and sellers of scrap
could protect their investments that depend in some way on the
price of scrap, financing for these investments would be  more
readily available and probably at more favorable terms.   It
should be added, that capital tied up in inventories could also
be freed for use in other investments.

     During the course of the Symposium other potential benefits
of futures trading were identified, some of which were a  result
of risk shifting and others a result of the structure of  futures
markets.  Generally, futures markets would aid in the dissemi-
nation of prices and other types of market information and pro-
vide for open and competitive price formation.  An additional
point, mentioned by an exchange representative, was that  futures
markets can reduce the possibility of contracts going soft.
This was explained by the fact that when a forward cash market
contract is hedged, there is less incentive or need for one side
of the contract to attempt to modify that contract if the market
moves in an unfavorable way.

     Benefits more specific to the wastepaper and ferrous scrap
industries were mentioned by some of the industry speakers.  A
ferrous scrap dealer/processor argued that a ferrous scrap fu-
tures contract could result in steel mills having more consistent
participation in the cash market for scrap, steel mills being
better able to cope with the world market for scrap, and  steel
mills having less need for government intervention in export
market for scrap.  A point on which there was some division of
opinion concerned whether a futures market would aid in guaran-
teeing a constant supply of wastepaper or ferrous scrap to con-
suming mills  (i.e., that a futures market could be used to cope
with supply risk as well as price risk).  Generally, the mill
representatives saw this as a possibility while the dealer/pro-
cessors did not.  It should be remembered that futures markets
are not delivery markets, and only occasionally would a consum-
ing mill be in a position to take delivery or want to take de-
livery.

     A strong argument, supported by statistical evidence, can
be made that futures trading stabilizes the cash market prices
for a commodity.  With dissemination of more detailed infor-
mation on future market conditions, consumption, production, and
inventory planning decisions can be made in more organized fash-
ion,  thus leading to more stable prices.  Whether this would be
the case if futures trading were initiated in ferrous scrap or


                               20

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wastepaper was not answered at the Symposium.  However,  it  should
be noted that as long as the demand  for wastepaper  and ferrous
scrap is highly dependent upon swings  in the business cycle -
which remain relatively difficult to predict - prices for these
materials will always fluctuate.  Futures trading should, non-
theless, remove some of the uncertainty.

     As stated earlier, the extent to  which the benefits enumer-
ated here would be realized if futures trading in ferrous scrap
or wastepaper were initiated is, perforce, somewhat difficult to
say.  Furthermore, the impact of a scrap futures market  on  re-
cycling rates is even more uncertain.  Although not addressed in
a formal way by the Symposium participants, the general  consen-
sus appeared to be that while a futures market would help de-
cision makers cope with the uncertain  nature of scrap material
supply and demand, the existence of  other technological  and
institutional constraints  limited any  potential increase in the
consumption of scrap inputs.
                               21

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                           SECTION  7

              DESIGNING A SCRAP FUTURES CONTRACT
     A significant portion of the Symposium was devoted to dis-
cussions on what a futures contract in ferrous scrap or waste-
paper would look like and whether such a contract would be
successful.  Before presenting the details of those discussions,
it would be useful to briefly summarize the criteria used by an
exchange to determine the feasibility of initiating futures
trading in a commodity.

EXCHANGE CRITERIA FOR TRADING

     Simply put, an exchange will list any commodity on a futures
market  that they feel will generate adequate trading volume.
While no one industry characteristic will insure a successful
market, the presentations and remarks made by the commodity ex-
change officials participating in the Symposium do provide some
guidance to the general industry features that they evaluate to
determine the potential for futures trading in a commodity.

     o  The market for the commodity must be characterized by a
sufficient degree of price volatility such that there will be a
demand for a market mechanism that limits exposure to the price
risk.  In other words, there must be a hedging demand for the
futures contract.  Furthermore, speculators are attracted to
markets with highly fluctuating prices.

     o  There must be an active and competitive cash market for
the commodity.  The cash market price is a major input into the
futures market price.  Only rarely, if ever, is a futures mar-
ket established in the absence of a strong cash market.

     o  The commodity in question and the cash market for the
commodity must be homogeneous enough to allow for determination
of a standard trading contract.  This would include description
of the commodity, size of the contract, delivery procedures, etc.
The point here is that if a contract is designed such that it
follows accepted industry practices and if a futures contract
favors one side of the market over another, trading in that con-
tract may be limited to the favored side.

     The remainder of this section will be devoted to a more


                               22

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thorough analysis of this last criterion.  Its importance cannot
be overemphasized.  This report has stressed the need for commer-
cial demand to insure a successful futures market.  Perhaps more
than any other criterion, an exchange will look at the potential
industry participation in futures trading to determine whether
to trade that commodity.  The level of hedging demand is heavily
influenced by whether or not the futures contract follows in-
dustry practices.  This is important for two reasons.  First, the
futures contract must be affected by the same market forces and
information that affect the cash price for a commodity.  If it is
not, the cash price and the futures price would not move together
and the futures contract would not be a useful hedging device.
Second, the contract must be designed so that industry members
will accept it and delivery on the market will occasionally take
place.

     The last point may seem trivial in light of the fact that
futures markets are rarely delivery markets.  Yet, while futures
markets are not strictly intended as delivery markets, delivery
on the markets, or more accurately the possibility of delivery,
assures the primary, risk-shifting function of the markets by
forcing the futures prices and cash prices together.  If, for
example, the futures price of a contract in the delivery month
was extremely low relative to the current cash price for the
commodity, buyers of futures contract would elect to take deliv-
ery on the contracts and thus force the futures price up.  A
poorly designed futures contract, that did not appeal to industry
members, would never lead to delivery.
CONTRACT GRADE

     There are many grades of wastepaper or ferrous scrap in com-
mercial use.  The first, and according to several speakers at the
Symposium the most important issue in designing a standard fer-
rous scrap or wastepaper futures contract, is the choice of a
grade of scrap for trading.  According to commodity exchange
speakers at the Symposium, this grade should account for a large
volume of the commerical market transactions in the scrap com-
modity.  Other criteria, mentioned during the course of the Sym-
posium, include a relatively well-defined or homogeneous grade,
and that the grade should be easy and inexpensive to inspect.
Although a futures contract would probably call for delivery of
only one grade, it should be designed so that other grades of
scrap can be hedged against it; that is, the price of the futures
contract grade should closely correspond to the prices of other
grades of the commodity.  In essence, the grade of wastepaper or
ferrous scrap chosen for futures trading should be one for which
at least some buyers of the contracts will want to take delivery
and some sellers make delivery.
                               23

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     Several speakers at the Symposium made suggestions as to the
appropriate grade for futures trading in ferrous scrap.  Two
grades of scrap were most often listed: No. 1 Heavy Melting
scrap, and Shredded scrap.  Other grades such as No. 2 Bundles
were felt to be too difficult to inspect and did not constitute
a large enough portion of the cash market.  Of these, shredded
scrap seemed to many to be the best choice.  The quality of No.l
Heavy Melting was said to vary from one source to another and
thus there would be no way of assuring a constant quality. (One
scrap consumer did prefer No. 1 scrap.)  Shredded scrap, on the
other hand, was said to be easy to inspect and to be relatively
uniform across different production sources.  At least one
speaker did note, though, that while Shredded scrap made up
approximately 30% of the export market it made up much less of
total domestic consumption and therefore might not generate suf-
ficient trading volume.  The 1955 ferrous scrap contract was de-
fined in terms of No. 1 Heavy Melting which some observers say
was one of the reasons for its failure.

     The discussions on wastepaper were not as specific in terms
of possible contract specifications.  This was mainly due to the
fact that for many of the representatives from wastepaper con-
suming and supplying firms, the Symposium was their first intro-
duction to the concept of futures trading.  The references to a
trading grade that were made suggested that a grade of corrugated
containers or newsprint would be the best choice.  Of the two,
one speaker preferred corrugated because more of it is traded
in the cash market and it is generated through a more easily in-
fluenced system.  The bulk of newsprint comes from households,
whereas corrugated containers are mostly retrieved from a smaller
number of institutional sources.

     The choice of the grade of scrap for futures trading will
affect the quantity of the commodity called for delivery in the
contract.  The lot size defined in the futures contract should
be comparable to the size of normal cash market shipments of a
particular grade.  One suggestion for a wastepaper contract
called for 50 tons for each contract.  For ferrous scrap, the
estimates of the most useful contract size ranged from 100 to
200 tons.  A model ferrous scrap contract designed in 1976 calls
for delivery of 200 tons.  The 1955 ferrous scrap contract called
for 160 tons of No. 1 Heavy Melting scrap.


PRICING SCHEME

     The prices quoted for futures contract should be similar to
the pricing system used in the cash market for a commodity.  For
example, the copper contract traded on Comex is quoted in cents
per pound of copper delivered to the Comex warehouse.  If a
copper futures contract buyer accepted delivery on his futures
                               24

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contracts, he would have to pay the price called  for  in the con-
tract, plus the transportation charges from the warehouse to the
delivery point.  If delivery on the contract comes from current
production, prices are normally quoted F.O.B. as  some base point.

     Very few comments at the Symposium were directed at a
specific pricing scheme for wastepaper and ferrous scrap, except
that the scheme would have to follow the manner in which these
commodities are priced in the cash market.  In general, this
would be dollars per ton delivered to the consuming mill.  The
finer points would ^depend on the specific delivery terms out-
lined in the contract.  An example was provided by one speaker
who mentioned that the model 1976 ferrous scrap contract called
for price moves in multiples of 25 cents with a price move limit
of $10 per day.

     There was a significant amount of discussion on an issue
closely related to design of a pricing scheme; that is, the im-
pact of transportation costs on the feasibility of a scrap
futures contract.  The major point was that transportation costs
make up a large portion of the price of scrap materials because
of the bulky nature of these commodities.  The question was
raised whether the high ratio of transportation costs to total
per ton scrap value relative to other commodites for which there
is futures trading would, in some way, work against the success
of the market.  The Symposium discussion did not generate an
entirely clear answer.  It does not appear to be a problem,
though, since both wastepaper and ferrous scrap are transported
and traded through normal commercial channels.  The high trans-
portation costs would only serve to limit the distance the scrap
would be shipped under futures trading.  It would not affect the
hedging use of the market.  The question of high transportation
costs does act to reinforce the need for a futures contract de-
sign that mimics standard industry practices.
DELIVERY TERMS

     Great concern was expressed by many of the industry repre-
sentatives at the Symposium over the terms of delivery under a
scrap futures contract.  Most of the concerns came from scrap
consumers who saw futures markets as delivery markets not as
risk management markets.  We have stated earlier that only a
small portion, perhaps 1-2 percent, of all futures contract
traded end up with delivery.  At the same time, we have also
stressed the need for a contract design that facilitates deliv-
ery for the few times delivery will take place.  Here again,
existing delivery practices in the industry are the guide for the
definition of delivery terms in a futures contract.
                               25

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     On most futures contracts, delivery is made from inventor-
ies, or if inventories of the commodity are not held, from cur-
rent production.  If delivery is made from current production, a
shipping certificate is used as the instrument transferring title
to the commodity.  In essence, it states that a contract lot of
the commodity is ready for delivery in a railcar or truck and
will be shipped to the buyer.  When delivery is made from inven-
tory, a warehouse receipt serves the same purpose.  It describes
the contract lot and the location of the warehouse or holding
area in which the lot is stored.

     The implicit consensus at the Symposium was that deliveries
of wastepaper and ferrous scrap would be made from warehouses or
storage lots.  Questions were raised as to where these ware-
houses would come from.  Several answers were provided.  One, the
market could provide the warehouses.  Individuals might see an
opportunity for making money by providing the service of ware-
housing.  This is done for several agricultural commodities for
which there is futures trading.  Two, the exchange could provide
warehousing facilities.  Three, the exchange could designate a
number of existing processing yards as points from which deliv-
ery can take place.  Only those dealers/processors licensed by
the exchange could make delivery on a futures contract.

     If the commodity is to be delivered from current production
or warehouses, the method of shipment to the buyer must be
spelled out in the futures contract.  There seemed to be general
agreement that for ferrous scrap, transportation would undoubt-
edly be by rail.  One speaker suggested that for wastepaper, the
contract could be defined in terms of railcars, (for example,
each contract involves one railcar lot of scrap), but delivery
could also be made by truck with the same quantity being de-
livered.  This would recognize the fact that most wastepaper is
shipped bv truck not rail.

     To insure that the grade of the commodity called for in the
futures contract is actually delivered, the futures contract must
specify how the commodity will be inspected for delivery.  In
cash market scrap transactions, the buyer generally has the right
to inspect and reject deliveries if they do not meet his require-
ments.  On a futures markets, since the exchange guarantees all
deliveries, the buyer does not have the same inspection preroga-
tives; he must accept delivery.  Of course, if the grade of
scrap delivered under the contract was not as described in the
contract, the buyer would have recourse through the exchange.

     Several Symposium participants expressed the opinion that
because of their inability to reject shipments under the futures
contract, no buyer would ever take delivery.  Since they produce
to order, and each different output requires a different grade
or quality of scrap input, any uncertainty over the delivery


                                26

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grade would be detrimental to  the  success of  the contract.  While
this point was debated back and  forth at the  Symposium  there are
ways for a commodity exchange  to minimize the uncertainty.  One,
as mentioned before, the exchange  should choose a grade of scrap
that is as clean as possible and have a great deal of buyer con-
fidence.  Two, the contract could  call for inspection of the
commodity at the point of shipment, be that a warehouse or a
scrap dealer's yard, by an independent third  party.  Three, only
those scrap dealers with a sound reputation in the market, or
those who post a bond guarantee, could be allowed to deliver on
the futures market.  The first and the last points would inevit-
ably be taken into consideration by an exchange.  The second
point did not receive great support for those attending the Sym-
posium and is probably not feasible.

     While there are finer points  to be resolved in outlining
the inspection procedures and  other features  for a scrap futures
contract, it should be noted that  most commodity markets are
characterized by long-term relationships between buyers and
sellers.  Raw materials users  tend to deal with trusted suppli-
ers.  In this sense, the markets for scrap materials are no dif-
ferent.  Futures markets do not  impinge upon  this process.  If
a scrap futures contract buyer cannot use the specified contract
grade in his production processes, he does not need to take de-
livery, but he can still use the market for hedging purposes.
               i
     As an alternative to the  delivery requirements reviewed
here, one commodity exchange official introduced a concept that
would greatly ease the design  of a scrap futures contract.  The
idea involves settlement of a  futures by cash transfers rather
than physical delivery.  The idea  would require that all con-
tracts are settled at some relation to the cash price for a
commodity.  While the cash settlement concept would eliminate the
need for specification of a contract grade and delivery pro-
cedures in a futures contract, a well developed cash market for
the commodity where prices are known must be  present.  If one of
the benefits of a futures market,  price discovery, is already
being provided by the cash market, then a futures contract based
on cash settlement might be feasible.  If this were the case,
the futures markets would be a purely hedging market.  It is un-
clear whether cash settlements could be applied to wastepaper
of ferrous scrap futures contracts.  Doubts were expressed
whether the cash markets for ferrous scrap or wastepaper fit the
requirements noted above.  Furthermore, the cash settlement con-
cept still must be approved by the Commodity  Futures Trading
Commission, although modified  forms of cash settlement are used
in some current futures contracts.
                               27

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CONCLUSIONS

     Of all the points discussed in this section, the ability to
define a standard grade for trading seems to be the most crucial
as far as initiating a successful futures contract in wastepaper
and ferrous scrap is concerned.  However, while several speakers
addressed this subject and reviewed the weaknesses of the current
specifications for futures trading, most parties agreed that a
grade of wastepaper or ferrous scrap could be defined for futures
trading with little adjustment to current practices.  The guide-
lines suggested by industry participants were that the grade must
be specified with enough flexibility so that scrap dealers and
processors could meet delivery requirements and stringent enough
that at least some scrap consumers would take delivery.  As a
general rule, this applies to all of the contract design consid-
erations raised here.
                               28

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                           APPENDIX

             SCRAP FUTURES SYMPOSIUM PARTICIPANTS
Speakers

Robert C. Anderson
Director, Resources Program
Environmental Law Institute

Peter Block
Consolidated Fibres, Inc.

I. Michael Coslov
Eastern Vice President
Tube City Iron & Metal Co.

Robert Davis
Director, National Raw
Materials Development
Garden State Paper Co., Inc.
William Hancock
Manager, Recycled Paperboard Div.
American Paper Institute

Irving Kaplan
Vice President & Secretary
Copperwald Corporation

Charles E. Rasher
President
McMahon Iron & Metal Co.,  Inc.

Richard E. Rieder
Dunnington, Bartholow and
Miller
Diana Friedman                  David J.S. Rutledge
Office of Basic Industries      Vice President
Industry & Trade Administration Commodity Exchange, Inc.
U.S. Department of Commerce
Haynes Goddard
Solid & Hazardous Wastes
Research Division
U.S. Environmental Protection
Agency
Steve Youngren
Chicago Mercantile Exchange
                               29

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Attendees
Susan J. Baldyga
Rhode Island Solid Waste
Management Corporation

H. Neill Bell,
President
Exton Paper Manufacturers, Inc.

Alfred R. Bideauz
Vice President
Paperboard Products Div.
Packaging Corporation of America

James J. Bowe
Commodity Exchange, Inc.

Richard M. Boyle
The Purdy Company

Mark K. Bruscke
Director of Economic Research
and Treasurer
Mid America Commodity Exchange

Richard H. Darnell
Exton Paper Manufacturers, Inc.

J.J. Ferrigan
Asst. General Purchasing Agent
Bethlehem Steel Corporation

Michael Galoob
Interstate Metals Corporation

V. Gordon Gerttula
Vice President, General Manager
Containerboard Division
Crown Zellerbach Corporation

Joyce Harvey
Lowe Fibre Corporation

Dewey Holcombe
Director, Purchasing & Traffic
US Pipe and Foundry Company
Glenn W. Inman
Vice President of Purchasing
and Materials
Clow Corporation

R.T. Jaffre
Raw Material Manager
Chaparral Steel Company

William S. Kimball
Director of Purchasing
Bird and Son, Inc.

Argir N. Kondos
Senior Buyer-Investment
Recovery
International Paper Company

Harold Lipsitz
Secretary-Treasurer
Auto City Iron & Metal Co.
and Capitol Waste Paper Co.

John E. McKibben
Vice President
The David J. Joseph Co.

Dewey Michelin
Lowe Fibre Corporation

H. Bruce Nethington
Manager-Personnel Development
Laclede Steel Company

James Novak
Vice President
Grad Wastepaper Corporation

Myron Parks
Vice President
Parks Iron & Metal Company

David S. Platt
Manager of Purchases
Crown Zellerbach Corporation
                               30

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Gregory J. Protano
Protano Scrap Iron & Metal

Richard Rosenthal
The Purdy Company

Teddy Siegele
Orange County Scrap Recycling

Ray Siegele
Orange County Scrap Recycling

Neil J. Wortman
President
G&K Engineered Scrap Service, Inc.

Oscar Albrecht
U.S. Environmental Protection Agency

Roger C. Dower
Environmental Law Institute

Elizabeth Granitz
Environmental Law Institute
                              31

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                                    TECHNICAL REPORT DATA
                             (Please read Instructions on the reverse before completing)
 1. REPORT NO.

   EPA-600/9-80-002
               3. RECIPIENT'S ACCESSION-NO.
 4. TITLE AND SUBTITLE
   A HANDBOOK ON SCRAP  FUTURES MARKETS AND
   FUTURES TRADING
                                                             5. REPORT DATE
                                                                 March 1980  (Issuing Date)
               «. PERFORMING ORGANIZATION CODE
 7. AUTHOR(S)
   Roger  C.  Dower
   Robert C.  Anderson
               8. PERFORMING ORGANIZATION REPORT NO.
 9. PERFORMING ORGANIZATION NAME AND ADDRESS
   Environmental  Law Institute
   1346  Connecticut Avenue,  N.W.
   Washington,  D.C.  20036
               10. PROGRAM ELEMENT NO.

                    A73D1C
               11. CONTRACT/GRANT NO.

                   R804309
 12. SPONSORING AGENCY NAME AND ADDRESS
   Municipal  Environmental  Research Laboratory—Cin.,OH
   Office of Research and Development
   U.S.  Environmental Protection Agency
   Cincinnati, Ohio  45268
               13. TYPE OF REPORT AND PERIOD COVERED
               	Final	
               14. SPONSORING AGENCY CODE

                   EPA/600/14
 15. SUPPLEMENTARY NOTES
   Project  Officer - Oscar W. Albrecht - 513/684-7881
 16. ABSTRACT
   Market  prices for secondary  materials are generally  characterized by  a  high degree
   of variability and uncertainty.   Futures markets may be an effective  mechanism for
   stabilizing these prices, and  encouraging recovery of secondary materials  from solid
   waste.   The desirability and feasibility of implementing futures markets for ferrous
   scrap and  wastepaper were investigated and the results presented at a Symposium
   held in  New Orleans, Louisiana on May 14-15, 1979.   A handbook was prepared and
   distributed to the Symposium participants as a basis for the discussions.   The
   essentials of the handbook and a  summary of the comments by those attending are
   contained  in this report.
                                 KEY WORDS AND DOCUMENT ANALYSIS
                   DESCRIPTORS
                                               b.lDENTIFIERS/OPEN ENDED TERMS
                             c. COSATI Field/Group
   marketing
   financing
   selling
   credit
   consumers
   futures markets
   prices,   paper industry
   scrap markets
   contracts
   demand
   economics
   market value
 5A
 68C
 3. DISTRIBUTION STATEMENT

  Unlimited
  19. SECURITY CLASS (ThisReport}
   not classified
21. NO. OF PAGES
      38
                                               20. SECURITY CLASS (Thispage)
                                                not classified
                             22. PRICE
EPA Form 2220-1 (9-73)
32
                                                                    « US GOVERNMENT PRINTING OFFICE: 1980 -657-146/5647

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