The Locked-In Price and the Falling Market
On March 1 you sold 500 gross tons of #1 HMS to a domestic mill at $380/GT, delivered, for shipment in the last two weeks of April. Your purchase side is not locked: you are buying from peddlers and small yards at prevailing market, which has fallen since March 1. By April 1 the prevailing delivered price for #1 HMS is $340/GT, and your own buy price has fallen with it, so your margin on material bought after April 1 is fine - but you must still deliver 500 GT against the $380 sale, and your current inventory is only 200 GT bought at the March price. Freight is $22/GT. The mill's contract allows delivery within April but charges a $10/GT late penalty after April 30 and can reject material below spec.
1. Assess your position and the exposure created by the unlocked purchase side.
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You are short the physical: you owe 500 GT at $380 but hold only 200 GT, and the replacement 300 GT must be bought at the April market of $340 (good for you) - so the falling market actually helps your replacement cost, not hurts it. The real exposure is different: your March-bought 200 GT is at the old, higher cost, and if you blend it with April-bought material the average cost may exceed $340. Compute the delivered margin: sale $380 − freight $22 = $358 net to you per GT. Replacement at $340 delivered leaves $18/GT on the 300 GT replaced. The 200 GT in inventory was bought at March prices - if March buy was, say, $360 delivered, that tranche is a $2/GT loss against the $358 net. The exposure is the inventory tranche, not the sale.
The bigger risk is that the unlocked purchase side means you have no hedge: if the market had risen instead of fallen, you would be buying replacement at a loss against a fixed sale. The lesson is that a fixed-price sale requires a matched purchase or a hedge.
2. What should you do between April 1 and April 30, and what contract term would you change next time?
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Between April 1 and April 30: (1) Buy the replacement 300 GT now at the $340 market rather than waiting - the market is falling, but you have a delivery obligation and waiting adds late-penalty risk ($10/GT after April 30 = $5,000 on 500 GT). (2) Ship the 200 GT of March inventory first to clear the higher-cost tranche, and blend carefully to stay within spec - do not let old inventory sit and degrade. (3) Confirm the mill's spec and probe schedule so no load is rejected. (4) Deliver within April to avoid the penalty.
Contract change: never sell fixed-price without a matched purchase or a hedge. Next time, either (a) buy the physical before or simultaneously with the sale, or (b) include a price-adjustment or market-based pricing clause tied to a published index, or (c) hedge the tonnage. Also negotiate a longer delivery window or a defined late-penalty cap.