2004 Scrap Metals Supplement -- Tight Squeeze

It’s difficult to be a secondary aluminum smelter in the U.S. Their margins are dwindling in light of foreign demand for obsolete aluminum scrap, which has served to escalate prices and constrict supply of this vital raw material.

However, some secondary smelters noted improvements within the market during the third quarter of 2003 and predicted those improvements would continue throughout the fourth quarter. Certainly, 2004 brings renewed hope for a stronger market for secondary aluminum.

THE DEMAND SITUATION. "The margins are very slim," says a deox manufacturer based in the Midwest. "We are facing a tightness in the scrap supply that is partly due to all of the metal being exported, mainly to China. Also, the run-up in the price of the scrap is due to the tightness," he says.

A Midwestern secondary smelter whose finished products are going to the auto industry agrees with this assessment. "I think certainly the cost of raw material procurement has gotten very difficult," he says.

"Certainly the volume of scrap going to China right now is phenomenal. It’s just basic supply and demand," the secondary smelter says. "We’re out there trying to find metal units when there are a lot of them leaving the shores. Once they are gone from here, they are never going to return."

Richard Kerr, president of aluminum operations for Imco Recycling, Irving, Texas, said in the company’s third quarter conference call, "Perhaps we should not be surprised by [China’s] aggressive purchasing activity, which has been enhanced by the very inexpensive freight rates in China and also the decline in import duties and the under-valuation of their currency.

"Until this situation improves, scrap prices more than likely will remain high," he continued. "However, we think we can manage our way through it by working more closely with our major scrap suppliers and by continuing to improve our recovery of metal units that are available to us with our technology."

Despite the amount of aluminum scrap going overseas to China, it appears that little finished aluminum is being exported from China. "It’s mainly a factor of taking away our scrap supply and pushing up the price," the deox manufacturers says. "I don’t see any finished aluminum coming in that would affect the volume of sales," he says. "The effect is all on the supply side."

THE COST OF BUSINESS. The increasing cost of metal units is eating away at the profitability of secondary aluminum smelters. "The price becomes very important because in our business as a secondary smelter, 85 percent of our sales dollar is tied up in raw material costs," the Midwest secondary smelter says. "If you are not able to control those raw material costs, not much else matters."

He continues, "Natural gas is also another key factor. Natural gas costs are up 30 to 40 percent from what they were a couple of years ago."

Imco’s CFO and Executive Vice President Paul Defour also noted escalating natural gas prices in the company’s third quarter conference call, saying costs increased 20 percent in the third quarter of 2003 compared to the same period in 2002.

China’s demand for aluminum scrap is not the sole reason behind the tightness in scrap supply. The weak generation of industrial scrap is also a factor. "The sluggish industrial economy is not generating the scrap supply, the scrap flow, that we would like to see," the deox manufacturer says.

"The volume and income at Imco’s aluminum recycling plant has generally been in decline for about three years due to the unprecedented decrease in U.S. industrial activity that has prevailed during this period," Kerr said in the conference call. "Also, the drop in the can recycling rate has taken over 400 million pounds of scrap per year out of the U.S. scrap recycling system."

To address these circumstances, Imco has consolidated available volume at its most efficient facilities to strengthen productivity at those plants, Kerr says.

The secondary smelter adds that competition for aluminum scrap "up the food chain" is also affecting the tightness in supply. "For those companies to remain competitive and generate a profit, they are looking for ways to cut their costs," he says of major global aluminum producers such as Alcoa and Alcan. "If they drop down and use more raw material that is made from obsolete scrap, they can buy less primary aluminum, and, typically, it’s cheaper to use scrap than it is to go out and buy primary aluminum."

Secondary smelters who are selling finished products to automobile manufacturers are also feeling pricing pressure from their consumers, which is further diminishing profitability.

"I think the purchasing power of automobile companies has made our business very tough," the Midwest secondary smelter says. "They are always looking for lower and lower prices."

The secondary smelter says a longstanding customer from the auto-manufacturing sector approached him with a particular price for finished product. If he was unable to sell the material at the dictated price, the auto manufacturer said he would go elsewhere to buy the product. "There is no loyalty," he says.

While the various costs associated with business are affecting the profitability of secondary aluminum smelters, is overcapacity also a contributing factor?

THE CAPACITY QUESTION. The deox maker says the U.S. has excessive secondary smelter capacity. "It seems like every few months or every year there seems to be new furnaces being built and new smelters popping up," he says. "Whether the smelters pop up as deox guys or as automotive alloy guys, it [has the same effect.] There may be more new deox players showing up than the other, proportion-wise," he adds.

However, the secondary smelter who supplies the auto industry sees things differently.

"I’m going to tell you an answer that is probably contrary to what other people would say, and that is, no; I don’t feel there is excess secondary capacity," he says. "However, what has happened is there have been several people in the casting industry who have become self-alloyers or RSI (re-melt secondary ingot) consumers. In effect, the customer base has shrunk because these people are out doing it for themselves.

"In doing so, they are circumventing environmental standards," the secondary aluminum smelter says. "If they truly had to stand up to the new MACT (Maximum Achievable Control Technology) air standards, they would not be able to do it. But because they are considered to be a casting company and only charging plain scrap, they are circumventing the environmental standards."

The secondary smelter says that he feels 15 percent to 20 percent of the typical consumers of specification secondary alloy or ingot have become self-alloyers in the last eight to 10 years.

When will the situation alleviate for secondary aluminum smelters? Some already point to improvements, while others speculate that the second quarter of 2004 will bring relief to secondary aluminum smelters.

THE OUTLOOK. "While identifying major turns in the economy is always difficult, I am convinced that we saw the beginnings of an improvement in the aluminum industry market condition," Kerr said of Imco’s third quarter performance. "The major producers have reported increased shipments to customers in the building, construction and transportation sectors. The Aluminum Association said that net orders of new aluminum products were nearly 9 percent higher than they were a year ago," he said. "It’s the first year-to-year increase since January."