AMU Explainer: Netback calculations

Netback calculation is a mechanism to determine the highest revenue return for a product expressed on an FOB smelter basis. The metric used is the premium expressed over LME cash and takes into account the realizable physical premium in each destination market being considered, less freight and logistics costs to reach that market.

In this discussion, we are going to focus on P1020 rather than get into the weeds on wire rod, billet, foundry, and slab where there may be other factors influencing allocations.

The mechanics of netback

Here is the simple formula for determining netback:

+ Delivered premium
– Less freight to delivery point
– Less duty costs where applicable
– Less financing costs where applicable (terms in US, cash in Europe)
– Less logistics costs of delivery
= FOB netback premium

Now, let’s layer in some real numbers for a Canadian smelter looking at their netback selling into the US Midwest duty paid market:

+ Delivered premium is $1.04 per pound over LME
– Less freight to delivery point is $0.03 per pound
– Less duty costs are $0.7765
– Less financing costs are $0.0125 per pound for 30-day terms Midwest
– Less logistics included above
= FOB netback premium is $0.221 per pound FOB smelter

At this point, the $0.221 per pound premium is a static number. For netback calculation to be meaningful, we need to compare the Canadian smelters’ alternative market options. That is the European duty paid Rotterdam market. Canadian metal enters Europe duty-free under the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union. Therefore, Canadian smelters look at the Rotterdam duty paid market as their alternative to the U.S. Midwest.

Let’s layer in some real numbers for a Canadian smelter looking at their netback selling into the Rotterdam duty paid:

+ Delivered premium is $360 per metric tons or $.163 per pound over LME
– Less freight to delivery point is $0.04 per pound ($88 per ton)
– Less duty costs NONE
– Less financing costs NONE as it sold on cash against documents basis
– Less logistics included above
= FOB netback premium is $0.123 per pound FOB smelter

Comparing the Midwest to the Rotterdam premiums achievable, the netback for the US market is the superior return, netting nearly $0.10 per pound more. This means that when the commercial teams for the smelter are considering the allocation of their discretionary, unsold metal, it is going to be earmarked for sale to the US.

Producers in the Middle East and India employ the exact same approach as the Canadians with one crucial difference. They add consideration of the CIF Japan duty unpaid market premium to their netback calculations.

We are scrubbing our freight assumption for the Middle East and India to determine a more exact netback for them to the US vis-à-vis Europe or Japan. Informed sources tell us they believe these origins enjoy about a $0.05 per pound net advantage exporting to the US.

Why this matters

The math shows the US Midwest offers the highest return to Canada and the seaborne exporters. The fact that imports through February are still trailing year-on-year pace suggests neither origin has been able to free up discretionary unsold metal yet. This may mean Q1 sales into alternative markets may have pre-empted more metal being allocated to the US.

Q2 looms as the decisive test of whether higher imports will start given the premium incentives.

The Iran war will also distort this analysis as Middle East producers may be unable to execute on more exports to the US. India will certainly rise to the opportunity, and that’s where the largest delta will come from in boosting imports.

The market here needs it and is advertising a premium that ought to attract it. Now, it is up to the producers to execute on what their netback model tells them to do.