Earning Different Grades

The prices for obsolete steel scrap and the prompt industrial grades, such as automotive bundles, in the United States often move in the same direction. Yet, at times, the spreads between these two grades expand or contract to such extremes that they confound most scrap buyers; in effect, they defy historic norms. We witnessed "disconnects" in 2004 and 2008, when the spread between No. 1 heavy melting scrap (HMS) and prime industrial scrap rose from the historical norm of $25 to $75 per gross ton to a peak of about $200 per ton in November 2004 and then to another peak of about $400 per ton in July 2008.

These aberrant price spreads may have been partly in light of higher use of scrap in blast furnaces (BF) and BOFs (basic oxygen furnaces) to boost production in a time of runaway steel demand. Another factor was the limited supply of obsolete scrap at a reasonable price relative to the need for it. Then, there was "price pull"—when the price of finished steel products is so lofty, such as a price for hot-rolled band in the United States in July 2008 of $1,100 per net ton, that the mills "can pay almost anything" for the scrap and still make money.

Especially when the steel market is in shortage—i.e., during periods of brief price spikes—the spreads between different grades of ferrous scrap become volatile and unpredictable.

Conversely, in unusually weak markets, the spreads compress to minor levels. For example, in October 2008, U.S. No. 1 HMS, shredded scrap and busheling scrap prices hit brief lows of $95, $120 and $125 per ton, respectively. The highs in July 2008, for a week or so, were $560, $700 and $960 per ton, respectively.

Ferrous scrap has "reverse economics." Vendors of steel scrap that have large quantities of it for sale usually get a higher price than those with only small quantities for sale.

Ferrous scrap price movements are considered by many steel industry participants and other observers, including World Steel Dynamics (WSD), to be the single best leading indicator of where the industry is headed. The obsolete ferrous scrap price is so volatile because it is consumed last, or after the pig iron, ferrous scrap substitutes, home and new scrap have been built into the supply equation. About 325 million metric tons of obsolete scrap per year was required globally in recent years, which, compared with the size of the ferrous scrap reservoir 10 to 40 years old, on average, was about 340 million metric tons.

FACTORING UP

There are eight factors listed below that act to push the price of ferrous scrap upward; there are many more, of course:

• A weak U.S. dollar makes the price of U.S. ferrous scrap more attractive to foreign buyers. Since the spring of 2009, the U.S. dollar has weakened significantly versus the euro. (Note: The hot-rolled band price in the United States, as the dependent variable, correlates well with the U.S. prime industrial scrap price and the value of the U.S. dollar per euro as the independent variables.) Wild cards regarding the U.S. dollar include what China will do with its holdings of more than $1 trillion in U.S. debt and how global investors will value the dollar as the country’s fiscal deficit continues to climb to mammoth—some say irresponsible—levels.

• EAF-based steel sheet mills in the United States, which have a capacity to produce hot-rolled band via the thin-slab route of about 20 million tons, need about 70 percent high-grade scrap in their metallics charge. This requirement, it turns out, is close to the generation of prime industrial scrap in the United States that, at present, is probably no more than 13 million tons per annum. This tightness in available scrap is why these mills have become sizable pig iron buyers. The tight supply of prime industrial scrap adds to its price volatility.

• The price of obsolete scrap, except for brief episodes, has a support level that is determined by the incentive to collect the scrap (much less is collected when the price is below $100 per ton) and the cost to process the scrap and get it to the steel mill (often from $50 to $60 per ton). Hence, WSD thinks in the future that whenever the price of No. 1 HMS in the United States falls to less than $150 per ton, it will not be for long.

• Improvements in EAF (electric arc furnace) steelmaking technology have cut production costs and permitted the production of ever-better-quality steel products. It’s also far cheaper to build an EAF-based steel plant than to build a BF/BOF-based plant. EAF steelmaking capacity outside of China has continued to climb. In the United States, when steel production began to rise in the summer of 2009, EAF production for a brief period accounted for 69 percent of the country’s steel output.

• Lower ocean freight rates, FOB (free on board) the port of export, promote higher scrap prices because it is less expensive to ship the scrap metal long distances.

• The minor growth of the obsolete steel scrap reservoir that’s 10 to 40 years old is a factor promoting high scrap prices when demand is strong. The reservoir (consisting of apparent steel consumption in prior years less the ferrous scrap recovery in those years) is growing slowly because steel demand 10 to 40 years ago was expanding only slowly, and the "recovery rate" from the ferrous scrap reservoir has risen throughout the years.

• Recurring steel scrap price spikes in recent years have "mined" the reservoir of easy-to-collect scrap. Hence, when the scrap price spikes, the supply response is somewhat muted versus what’s happened in the past.

• The likely shortfall of BF production outside of China will begin in about 2012 because of so much reduced investment in this sector. Steel mills have learned they can purchase slab to meet their incremental needs rather than sustain high-cost reserve blast furnace capacity.

FACTORING DOWN

Of the factors that tend to drive the steel price downward, here are eight examples; there are more:

• Scrap price trends downward in the aftermath of steel shortages when the "price-pull" phenomenon, i.e., the extreme buyers’ panic to purchase finished steel products, goes away.

• Lower-than-expected steel demand in 2009, which means that far less obsolete scrap needs to be extracted from the obsolete scrap reservoir than has been the case in recent years.

• Steelmakers’ metallics, i.e., steel scrap, pig iron and steel scrap substitutes, all reside in the same "global bathtub." Developments in one region of the world, which in the past year often have been negative except for China, impact all the other regions.

• Much lower costs to produce pig iron in 2009 in light of reduced iron ore and coking coal prices. The steel industry’s "World Cost Curve" is far flatter in the fall of 2009 than it was in the summer of 2008.

• Rising scrappage of ocean vessels. This development increases the steel scrap supply.

• Turkish EAF-based steel mills, which are among the world’s largest importers of steel scrap and exporters of rebar, no longer are cost-competitive over much of the steel cycle because they must import 90 percent of their steel scrap needs and electricity prices in their country are so lofty. These are the same reasons why the BF/BOF steel production route is so much more popular in China than the EAF route and also why the number of Bresciani EAF-based steel mills making rebar in Italy is down from about 24 to about three since 1977.

• China’s supply of obsolete steel that’s 10 to 40 years old is growing rapidly, albeit from a low base. In another five to 10 years, the supply of steel scrap in that country may be sufficient to attract more EAF-based steelmaking capacity.

• Steel scrap price volatility at times makes it less attractive to purchase than iron ore and coking coal because these products often can be procured on an annual one-year-fixed-price-contract basis. The steel mills like to fix their costs to offer longer-term pricing deals to their key customers. (Note: This problem can be addressed once ferrous scrap is traded on the World Steel Exchange on a liquid basis and ferrous scrap buyers and sellers can hedge the price risk a year ahead.)

The author is a managing partner of World Steel Dynamics, Englewood Cliffs, N.J. He can be contacted at pmarcus@worldsteeldynamics.com.