Tough to figure

Economic data from China and elsewhere has convinced investors and recyclers the boom era for metals pricing that started around 2003 has ended and is unlikely to return. Nonetheless, when ferrous scrap pricing bounced back by about $50 per ton in April 2016, recyclers could be forgiven for hoping that a prior stretch of prices at less than $200 per ton might be over for a while.

Forecasting the price of ferrous scrap is a perilous undertaking, especially as the trade has become increasingly global and can be influenced by events far from America’s shores.

Even as recyclers appreciated the April uptick in ferrous scrap values, many also expressed reservations about how the rest of 2016 might shape up for the global steel and ferrous scrap sectors. While some positive signs are visible, the ongoing glut of steelmaking capacity in China continues to loom as a factor in all projections and scenarios.

TEMPORARY RESPITE

From October 2015 through March 2016, the per-ton price for prompt ferrous scrap, as measured by the American Metal Market (AMM) Midwest Index No. 1 busheling survey, ranged between $161 and $194, never puncturing the $200 ceiling.

In the early April buying period, domestic steel mills finally were forced to increase their bids—by a substantial $50 per ton—to $244 for prime grades.

Mills needed to up their bids to draw out dwindling scrap supplies, and they also could afford to as domestic steel prices began to rebound in the spring after federal government action slowed down the tide of imported steel from China.

The effect of slower flows into scrap yards during the “sub-$200 era” was felt on the balance sheets of scrap recyclers and ultimately in the procurement efforts of domestic steel mills and overseas buyers of U.S. ferrous scrap.

The price-sensitive nature of obsolete scrap flows has been evident in the emergence of shredded grades of ferrous scrap as the highest value type of scrap in 2015 and early 2016 (surpassing prime grades). The April AMM Midwest Index had shredded steel scrap selling at $256.70 per ton compared with $244.08 for the No. 1 busheling grade.

The No. 1 heavy melting steel (HMS) grade, which consists of a healthy percentage of obsolete scrap, while still valued less than No. 1 busheling, is selling at $230.69 per ton, according to the AMM Midwest Index—just $13 per ton below the price of the prime grade.

Scrap recyclers will be the first to tell buyers that the sub-$200 pricing (and subsequent low scale house pricing) was causing severe supply problems. Speaking at the Platts Steel Markets North America Conference in Chicago in March, Pete Meyers, a vice president at Metalico Inc., Cranford, New Jersey, said, “The collection process has, to some extent, broken down because of lower prices.”

Meyers said of many types of obsolete scrap that flowed into yards from 2003 to 2014, “It’s simply not being collected. The lower level of the food chain [scrap supply network] is doing something else.”

If slightly higher scale prices, combined with pleasant spring weather, can increase flows into scrap yards, that will provide a much needed boost for scrap recyclers who endured a tough winter.

On the demand side, U.S. steelmakers continue to express concern that imported steel from China is gobbling up market share and, when the steel emanates from subsidized state-owned enterprises (SOEs), represents unfair competition.

China’s internal policies toward the steel overcapacity within its own borders continue to have a major effect on global steel prices and mill operating rates in the United States and elsewhere.

Even though China was only the sixth largest importer of ferrous scrap in 2015, Meyers remarked that because China produces half of the world’s steel, when it comes to global steel and ferrous scrap pricing, it’s “all about China—everything else is noise.”

THE ELEPHANT IN THE ROOM

Steel output figures collected by the Brussels-based World Steel Association are unmistakable in their portrayal of China’s dominance in steel production. The nation reached an output level of 820 million metric tons in 2013 and again in 2014, before tapering off to closer to 800 million tons in 2015.

For some perspective on China’s rapid ascent, slightly more than three decades ago, in 1983, the United States was producing 76 million metric tons of steel, while China was producing about 40 million metric tons.

The 800 million metric ton figure seems to represent China’s peak. Steel output in that country receded in 2015 and is starting out on the same path in 2016.

Little indicates China presently can engage in the levels of infrastructure building and apartment tower construction it accomplished in the previous 25 years. Central planning documents and Communist Party signals alike point to a pivot toward a more services and household-consumer-based economy.

This has become the global steel industry’s problem, however, because as China churns out 800 million metric tons of steel each year, it is consuming 700 million metric tons or less. By 2013, the overcapacity imbalance amounted to more than 120 million metric tons. That figure greatly exceeds the entire output in the United States and is about three times Germany’s annual production.

The pattern steelmakers have experienced historically in the U.S., Europe and elsewhere when overcapacity is present is plummeting steel prices, followed by balance sheet problems and then by mill closures and even bankruptcies. Indeed, throughout 2015 many steel mills did idle their furnaces. However, this occurred not necessarily in China but rather in the United Kingdom, Spain, Australia and the United States.

When steel industry managers, analysts and journalists see Chinese mills that are allowed to keep churning out steel quarter after quarter while losing large sums of money, that leads to questions. The foremost question is: How has this situation been able to linger for this long? The answer comes in several parts, but the role of SOEs, which produce two-thirds of China’s steel, is a leading factor.

When organizations like the American Iron and Steel Institute (AISI), Washington, complain about China not being a market economy, SOEs are a primary reason. Their detractors say they are subsidized, immune from regulations, avoid taxes and receive loans (largely from SOE banks) that do not stand up to independent underwriting scrutiny.

Another factor contributing to the prolonged existence of such “zombie companies” ties into China’s Communist Party’s attempts to please multiple constituents.

Abundant policy objectives and goals are spelled out in numerous documents that emanate from Beijing, but it is widely reported that lower level officials are truly judged by one yardstick: the gross domestic product (GDP) growth in their city, county or province.

A large steel mill not only acts as an important jobs provider, it also contributes to GDP. This is especially the case in China’s northeast quadrant, the traditional home of China’s coal fields and its steel industry. That part of the country is near to Beijing and traditionally loyal to the party. Its welfare is important for political and public relations purposes.

Thus, the hands of party leaders can appear to be tied to some extent. The northeast is where most of the inefficient, money-losing, high-emissions steel mills are located. And while statements from public officials refer to retraining workers for the high-tech or service sectors, those jobs are more widely present in Shanghai or Shenzhen and points in between—not in the northeast.

There is sentiment within China for SOE reform, including from managers of private sector companies who compete with them. But there also is resistance, and how or if the current party leaders resolve the overarching conflicting points of view on SOE reform is likely to get an early test in the steel sector.

DEMAND PRESENT AND FUTURE

The AISI and its steelmaking member companies continue to tell elected officials and the public that imported steel harms American companies and workers. In mid-April, speaking at a conference in New Orleans, Joseph Stratman of Nucor Corp. warned that Chinese steelmakers continue to look for ways to ship their products into the U.S., potentially via third-party nations, according to an AMM report.

Tackling Chinese trade issues will remain a priority for domestic steelmakers, but so will the health of the U.S. automotive and construction industries.

At the March Platts conference, panelists at a session on steel demand expressed concern that the United States may be nearing the end of a six-to-seven-year era of economic growth.

In the automotive sector, current vehicle sales figures are at an all-time peak. “Current conditions for U.S. auto demand are as good as it gets,” Richard Hilgert, an equity analyst with Chicago-based Morningstar, said. He cited low interest rates and a low unemployment figure as helping lead to the positive market conditions.

The “long, slow recovery” in the U.S. economy means those sales figures “should be bouncing along near the peak for a few years,” Hilgert added.

Business cycle and demographic reasons, however, means Morningstar has its forecast for vehicle sales “tailing off in 2018 and beyond,” he said.

In the construction sector, steel competes with a number of materials for market share, according to John Cross, vice president of the Chicago-based American Institute of Steel Construction.

Cross said commercial and industrial construction firms considered 2015 “an extremely disappointing year” in those sectors, which tend to consume the most steel. He said nonresidential construction was down by 2 percent in 2015 and construction in all the sectors considered steel-intensive “grew less than 0.5 percent; it was essentially flat.”

Although some forecasts see an increase in nonresidential and multistory residential construction in 2016, Cross said, “we see a flattening” in 2017 and by 2018, “a decline, as the current construction cycle runs its normal course” following a seven- or eight-year recovery.

Despite the April 2016 ferrous scrap price spike, recyclers and the steelmaking sector they serve still have numerous causes of concern to prevent them from feeling comfortable in 2016.

The author is editor of Recycling Today and can be contacted at btaylor@gie.net.