US scrap prices will fall again in November. The cumulative decline over October and November will be in the region of $50/long ton and bring shredded scrap back to $330-340/long ton delivered to mills in the Midwest.
This, in our view, is a catch-up process and reflects changes in the global raw material markets. Iron ore and coal have slumped this year, but for an extended period US scrap prices stayed high reflecting strong demand. Yet, the US is not immune from global trends. It is a net exporter of ferrous scrap and as US prices stayed high while international prices fell, US exporters were unable to sell to overseas markets. Moreover, European exporters were able to shift cargoes to the US market. The result: scrap oversupply in the US and falling prices.
As with so many other commodity markets, China is at the heart of the matter. As the cost of integrated steelmaking fell in comparison with scrap-based EAF steelmaking, Chinese exports of billet and finished long products have soared.
Relative Cost of Steelmaking Using Raw Materials
The fundamental reason for the relative differential is that iron ore and coal prices plummeted from early 2014 while scrap has stayed high until recently. This took the cost differential between pig iron and scrap to more than $100 ton. Meanwhile the structure of steelmaking consumption is inelastic – just because iron ore has fallen a bit, a steelmaker does not suddenly decide to spend a billion dollars on building a new integrated mill and closing an EAF.
However, the cumulative impact of lower integrated raw material prices is having an impact.
Chinese billet exports (albeit disguised as bar to avoid punitive billet export duties) are replacing EAF melting in several markets e.g. SE Asia where melting utilization rates are now down to less than 50%. These billet exports (currently $440/ton cfr SE Asia) were only $50/ton above the cost of scrap a month ago. Moreover, Chinese billet is turning up in markets such as Turkey and Egypt that are big buyers of scrap.
Exports of Chinese long products have soared. They are now arriving in markets such as the Middle East, India and Latin America and largely displacing domestic or international suppliers such as Turkey that make scrap-fed steel.
The result is a slump in global demand for scrap and the consequent recent price fall. Assuming only a modest rebound in iron ore prices over the winter, this trend (barring a regulatory crackdown on Chinese billet that cannot be ruled out) is here to stay. So how low can scrap go?
One key issue will be how much Chinese billet can come out. This is complicated by the fact that billet exports are counted as alloy bar to avoid the Chinese customs system. These are now running at more than 1.5 million tons per year and were 1.6 million tons in September, of which we estimate 300-500,000 tons per million is billet or at least 3.5 million tons per year. However, assuming no regulatory crackdown, Chinese volumes could easily reach 1 million per each million in our opinion or 12 million tons. This is equivalent to around one-third of the global merchant billet market or around 10% of the global trade in ferrous scrap. Assuming CIS billet mills choose to compete on price (and we believe that they have no other option and will be able to do so thanks to currency devaluations), the bulk of the adjustment will be felt by smaller billet suppliers and the scrap market.
With iron ore at $80/ton cfr and coal at $130/ton cfr China, scrap would have to be around $250/ton to be advantageous. That is eye-wateringly low. We don’t think prices will get that low as freight and taxes out of China add to the cost structure but we do believe that shredded scrap at $300/ton cfr Turkey is not inconceivable next year or even below that for domestic US prices for a short period.