The problem with zorba

As 2018 came to an end in the U.S. aluminum scrap market, plenty of mill and secondary grade scrap units were available to go around, while demand was weak and spreads continued to be very wide. Mills were adequately stocked, with no need to purchase more scrap, and demand for secondary scrap was light as secondary smelters worked down existing inventories before year-end.

Changes to China’s scrap import policies in the second half of this year will further affect the U.S. aluminum scrap market.

Persistent conditions

In early 2019, the market has picked up where 2018 left off—slow demand, ample scrap supply at the yards and very wide spreads. For example, the spread between P1020 and mill grade segregated scrap prices in January 2019 was around 23 cents per pound, the same as it was in late 2018, and 2 cents per pound wider than January 2018.

As of mid-January, scrap supply was not an issue as winter weather had yet to impact peddler traffic to the yards, shredders were still generating zorba and twitch, and industrial scrap continued to be generated at strong levels. However, severe winter storms and extreme cold experienced in late-January in the Midwest likely will affect load deliveries and peddler inflow and will cause a slowdown in shredding activity. While this will curb scrap generation for a short time, it will not cause the scrap surplus to shrink significantly.

As the early weeks of 2019 progress, mills and secondary producers are expected to come back to replenish scrap supplies that were worked down at the end of the year. On the mill grade side, demand isn’t likely to resume right away in 2019. High scrap inventories mean mills have no pressure to buy with wide spreads and ample availability. In fact, CRU understands that new deliveries are not being booked until the second quarter and that some orders from November/December 2018 have not yet been scheduled for delivery. This situation likely will support continued wide spreads.

Total U.S. exports of aluminum scrap actually rose in 2018 as gains in exports to other countries, such as India and Malaysia, outweighed the large decline in exports to China.

In addition, with a surplus of obsolete scrap units at wide spreads, secondary smelters are not moving up the food chain to obtain higher grades of scrap, removing a source of additional demand for mill-grade units. However, for secondary grades, demand has started to come back slowly at the start of the year as secondary smelters look to replenish inventories at low prices, and automotive manufacturers, die casters and original equipment manufacturers (OEMs) come back after end-of-year slowdowns.

As in most of 2018, as of the start of 2019, there is little demand outside of contractual shipments. Some mills have booked less scrap on contract for 2019 as they look to take advantage of lower spot prices. This has surprised some scrap dealers, who had anticipated mills would fully contract to take advantage of historically wide scrap spreads.

A potential scenario exists that when current inventories are depleted and mills enter the market for scrap units later in the year, a shift from a buyers’ market to a sellers’ market could occur.

Dramatic changes

A drastic change to U.S. scrap market dynamics has come in the form of an announcement from the Chinese government that as of July 1, 2019, scrap items under HS code 7602000090 are being moved from the list of raw materials that can be imported without restrictions to the list of solid waste items for which imports are restricted. In 2018, China imported more than 2 million tons of aluminum scrap from all trade partners under the HS code 7602, 99 percent of which would now fall under the restricted list.

HS code 7602000090 includes “Category 6” scrap items, such as twitch/zorba material, which makes up a majority of aluminum scrap the U.S. exports to China. According to regulations for restricted imports, importers must apply for a license to bring in these products.

The impact on the U.S. scrap market will be huge. Imports of aluminum scrap from the U.S. to China already are subject to a 50 percent import duty, which has greatly reduced volumes going to China. According to the latest trade data at the time this was written, exports from the U.S. to China were down by nearly 40 percent through October 2018.

With Category 6 scrap moving to the restricted list, on top of the existing 50 percent import duty, the writing seems to be on the wall. Unless policy changes are implemented between now and July 1, U.S. exports of such aluminum scrap grades to China will effectively end.

In addition, the 50 percent import duty on U.S. aluminum scrap into China likely will hinder potential efforts by importers/exporters to ship large volumes to China during the first half of the year in advance of this deadline. If exports to China effectively end at the beginning of the second half of 2019, the current U.S. scrap glut would become larger, unless alternative destinations are identified.

The zorba that typically goes to China is not used in the U.S. and needs to undergo further processing to create a twitch package.

U.S. exporters found alternate homes for their units in 2018. Total U.S. exports of aluminum scrap actually rose in 2018 as gains in exports to other countries, such as India and Malaysia, outweighed the large decline in exports to China. However, CRU questions the ability of these markets to sustain such levels of imports. Even if this were possible, it is highly unlikely they could absorb the full volume loss that would occur if U.S. exports to China ceased in the second half of the year.

Without new long-term homes to go to, material that once went to China will stay in the U.S. market. The zorba that typically goes to China is not used in the U.S. and needs to undergo further processing to create a twitch package. This could lead to capital spending to expand or enhance scrap processors’ separation equipment.

The steel connection

Zorba generation is tied to auto shredding, which is driven by steel prices. These prices incentivized shredding in 2018, resulting in a glut of zorba in the U.S.

With scrap export volumes set to drop this year, this situation could become worse. Even if more zorba is processed into twitch, homes for twitch are limited.

However, steel scrap prices have been weaker at the start of 2019, which might be the lone factor that can pull the reins on growing zorba and twitch supplies.

The author is senior analyst, aluminum, for London-based CRU. He is based near Pittsburgh and can be contacted at mike.southwood@crugroup.com.