Positive Outlook

Despite the volatile nature of the global economy, most forecasts now seem to indicate that the world economy will moderate somewhat, with overall business holding up fairly well.

The emerging economies of Brazil, Russia, India and China (the BRIC countries) each have their own dynamics that can influence the U.S. scrap market.

In looking at the economies in these nations and the effects they could have on the U.S. economy, some of these aspects also affect the scrap industry.

TORN BETWEEN IDEOLOGIES. Brazil has the largest economy in South America. The country is also the most densely populated of the BRIC countries and has some of the most sought-after natural resources in the world, including bauxite, gold, iron ore, manganese, nickel, phosphates, platinum, tin, uranium, petroleum and timber.

Characterized by large and well-developed agricultural, mining, manufacturing and service sectors, Brazil’s economy outweighs that of all other South American countries and is expanding its presence in the world’s markets.

However, the Brazilian economy has taken a number of hits throughout the past several years. From 2001 to 2003, Brazil’s real wages fell and the country’s economy grew only 2.2 percent per year on average, as it absorbed a series of domestic and international economic shocks.

Since 2004, Brazil has enjoyed continued growth that has yielded increases in employment and real wages. The three pillars of the economic program are a floating exchange rate, an inflation-targeting regime and tight fiscal policy, initially reinforced by a series of International Monetary Fund (IMF) programs.

The country’s currency depreciated sharply in 2001 and 2002, which contributed to a dramatic current account adjustment. However, from 2003 to 2006, Brazil ran record trade surpluses and recorded its first current account surpluses since 1992.

The Brazilian economy has benefited from gains in productivity, especially in the agricultural arena.

While Brazil’s economic management has been good, important economic vulnerabilities remain. The most significant are debt-related: The government’s largely domestic debt increased steadily from 1994 to 2003, straining government finances, before falling as a percentage of GDP beginning in 2003. Brazil improved its debt profile in 2006 by shifting its debt burden toward real denominated and domestically held instruments.

The Brazilian economy is showing modest improvements. Inflation in 2006 was the lowest it has been in eight years, and the economy expanded by 2.8 percent that year compared to 2.3 percent in 2005. Brazil’s gross domestic product grew by 3.8 percent during the fourth quarter of 2006 compared to 3.2 percent during the previous year’s fourth quarter.

As for recyclables, Adriano Assi, editor of a Brazilian recycling magazine Reciclagem Moderna, says that the Brazilian president is putting a major emphasis on growing the economy, which is creating greater interest from the steel market.

PET plastic markets also are growing at around 15 percent per year. A noteworthy aspect of the Brazilian recycling economy is that the overwhelming majority of material comes from the commercial/industrial sector, with a much smaller part coming from the municipal or residential segment.

WIELDING MORE CLOUT. The Russian scrap industry is becoming a much larger player in the global market. However, as it has grown, its challenges are becoming more pronounced. As it appears in every other country, strong demand for scrap metal from China has created significant challenges for many Russian steelmakers. To protect this industry, reports have indicated that Russia has restricted its scrap exports to meet the country’s internal demand. As a result, greater pressure has been exerted in other parts of the world to meet the demands. Consequently, exports from Russia declined last year.

Another factor influencing the Russian market has been the 50 percent export duty the Russian government has imposed on copper and aluminum scrap as a means of reducing, or more likely ending, the shipping of this scrap metal outside of the country. The government wants to maximize the amount of scrap metal available for use by its domestic smelters.

In a report at the BIR 2006 fall meeting, Denis Ilatovskiy of the MAIR Group, a large Russian scrap recycling firm, noted that earlier this decade there were a host of scrap metal recyclers in Russia in light of the low cost of startups. However, by last year, many of these companies had closed because of a combination of factors, including slowing growth, higher inflation and fiscal pressure that took away "easy money," he noted.

Several years ago in Russia, when the cost to start up a scrap yard was fairly minimal, there could be from 20 to 30 competitors in a city with a population of 300,000. However, as the market has become more challenging, many of these companies have left the industry, Ilatovskiy says.

The problem is not just limited to Russia, he says. "Scrap collection lost about 20 percent this year. More of the same is in Ukraine and Poland. The business has changed. Nobody keeps large stocks, easily obtainable scrap is in the past, and competition has pushed profits to zero."

With increased pressure on Russian scrap markets, Ilatovskiy says the name of the game is efficiency. "The question now is not how many yards or shredders a company has, but how efficiently you can manage them."

To squeeze efficiencies, Ilatovskiy says managing a company such as MAIR, with 400 yards in three countries, requires a more mathematical approach, with analysis taking into account competitors’ prices, volume, cost of production, mills and export prices, among many other things.

However, according to Ilatovsky, much of the new steel production in China will come more from pig iron and less from scrap, as EAF (electric arc furnace) steel production is not growing as fast as BOF (basic oxygen furnace) steel production.

While there is both good news and bad news for Russian scrap recyclers, the trend toward global consolidation in the metals industry, according to Illaskvsky, will push competition and, in the long term, will make it difficult for some in the steel and scrap markets. Last year steel and pig iron production declined in Europe, Latin America and Ukraine.

Another factor in the Russian economy has been the relative strength of some of its metals businesses. Several larger Russian steelmakers are venturing outside Russia by seeking to make plays in the acquisition binge that is surrounding the global steel industry. These moves include Severstal acquiring Rouge Industries, a Michigan-based steel company, several years ago, as well as the company taking a stake in a new greenfield facility that could be built in Mississippi.

Not to be outdone, Evraz Group S.A. has signed a deal with Oregon Steel to acquire the company’s mills in the United States for about $2.3 billion.

CONTINUING TO BOOM. China and India have been two key drivers for not only the recycling industry, but for the overall global economy.

The world’s seemingly insatiable appetite for raw materials, specifically for ferrous and nonferrous metals, continues to grow as the global economic expansion of the past five-year period continues. The most notable drivers during this period of increased consumption have been China, India, Russia and other emerging nations of the Far East. As a point of comparison, the International Monetary Fund has estimated that China, whose economy has expanded in excess of 10 percent in each of the past three years, accounted for more than half of the increase in world demand for steel products during this time and about 50 percent of the growing consumption of aluminum and copper.

India, according to the IMF, should see its GDP growing at a rate of 7.3 percent this year and at a moderate rate throughout the next several years. In contrast, the IMF forecasts that the United States and the European Union are expected to expand their economies by a far less impressive 2.9 percent and 2.0 percent, respectively, this year.

The addition of a significant level of manufacturing capacity in these rapidly growing economies is in response to the need for growing infrastructure programs and consumer demand for non-durable goods to satisfy the rising wealth of its populace. Steelmaking capacity, for example, grew to a total of 1.24 billion metric tons last year, up by nearly 46 percent since 2001.

According to Ashok Kumar, director of A-1 Specialized Services & Supplies Inc., Croydon, Pa., China now accounts for a third of the world’s steel production, with the economies of Asia as a whole representing 54 percent of total supplies. To meet the required increase in the amounts of mill feed needed for domestic applications, more and more scrap metal is needed for purchase by China, India and Russia. China saw an 18 percent rise in steel production in 2006, India reported a 7.6 percent increase, with Russia increasing its steel production by 6.8 percent last year.

The result of these countries’ increased steel production has been a sharp decrease in the amount of available scrap metal for sale to other large steel producing nations outside of the region and, as a consequence, a ratcheting up of scrap metal prices.

The use of scrap metal in the melting process is important for several reasons. First, scrap metal is a necessary source of supplemental mill feed in periods of growing manufacturing demand, as has been the case throughout the past five years. In India, for example, the production of aluminum from bauxite and alumina is estimated to be some 800,000 metric tons, while available aluminum from recycled metal totals approximately 600,000 metric tons. Additionally, these secondary metals are more efficiently "mined" than underground material and has obvious environmental benefits over primary metal. Lastly, the comparative cost savings of using scrap over primary mining can be substantial.

More recently India has taken a more aggressive stand in regard to exports of iron ore. In India, domestic steel producers have been calling for the government to double the duty on iron ore exports to 600 rupees (U.S. $13.57). The country has the fifth largest reserves of iron ore, around 23 billion metric tons.

The call for the increased export duty is to assure that steelmakers in the country have enough of the raw material to meet their needs. Along with existing Indian steel mills, several large multinational companies, including Arcelor Mittal and Posco, have announced plans to build capacity in the country.

According to published reports, China could be most directly affected by such a move, as buyers in that country have been purchasing a significant amount of the raw material from India. If the proposed duty goes through, China could shift its buying to Australian suppliers.

In India, the Ministry of Commerce and Industry has mandated that all foreign suppliers must be registered to do business in the country by providing proof of their financial solvency and corporate identity. Suppliers will need to attest that any unshredded metallic scrap is free of explosive material, such as arms, munitions and mines.

The Chinese government has announced that a number of supply agreements have been structured with various African governments and mining concerns to ensure the steady flow of much-needed raw materials, especially metals, to manufacturing companies in China. As consumer demand for commodities from primary sources grows in international importance, so will the search for scrap metal increase in intensity, given its economic advantages and the need for a supplemental supply.

The recent correction in global financial markets that originated with the application of tighter governmental regulations on the Chinese equity markets and quickly spread to commodities and other markets illustrates the risks associated with an increasingly interconnected world market place. But the economic fundamentals that have driven the commodities markets throughout the past five years have not shown a material change, with the implication that this period of global economic expansion will continue, at the very least for the next few years, supporting higher prices for the supply of primary metals and secondary scrap.