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Scrap Market Outlook

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Scrap Rebounds, But Worries Linger For service centers, the price of scrap is a predictor of metals prices to come. Pricing for most recycled metals has risen in 2016, but the conditions that led to a catastrophic 2015 continue to challenge the domestic collection industry. By Dan Markham, Senior Editor The scrap market has recovered significantly in 2016, with prices firming for most recycled metal products, but it still has a way to go. How long it will take to return to even mid-year 2015 levels remains to be seen. “While 2016 has been better on the pricing front compared with the end of the year, we’re still in negative territory year-over-year,” says Joseph Pickard, chief economist for the Institute of Scrap Recycling Industries in Washington. “Prices were creeping up through May of this year, but nowhere near what our industry needs to recoup its losses or even be close to a healthy environment.” First-half gains weakened with the onset of summer, particularly for obsolete scrap. In 2014-15, obsolete grades of steel scrap actually sold for more than prime grades, particularly in markets such as Detroit that were heavy with industrial product. Since then the market has returned to the historical norm in which mills must pay a premium for prime grades. In fact, the gap between prime and obsolete is approaching all-time highs, at least on a percentage basis. After the July buy, prime grades such as No. 1 bushelings were selling for a $50-$70 per ton premium over obsolete material. Driving the growing price disparity are a number of factors. Industrial shutdowns in the summer have reduced the supply of higher-quality scrap, raising demand for the material that is available. Recent trade case rulings have reduced imports of flat-rolled steel, clearing the way for more production by domestic steelmakers that prefer prime grades versus long-products mills that favor obsolete material. Still, the spread between prime and obsolete is likely to narrow, if only because the mills have the ability to adjust their raw material mixes. Producers use an optimizer to determine what kind of inputs to use given the prevailing price structure. “One mill had an optimizer tell them to buy zero prime scrap. That’s operationally impossible, but it is telling how prime scrap is very expensive compared to obsolete,” says Nick Tolomeo, managing editor for S&P Global Platts. Ultimately, the prices will begin to converge—one way or the other. “Is obsolete going to come up or is prime scrap going to come down?” Tolomeo asks. No way to know. Price shifts over the last 12 months have not been limited to steel. Aluminum and copper have both experienced similar rides, with dramatic drops at the end of 2015, followed by solid rebounds in 2016 that are still short of last year. Scrap’s other issues are multi-fold. Domestic manufacturing has been lackluster over the past 18 months, muting demand for steel and other metals. Prices of all commodities, most notably iron ore, have been depressed, keeping a ceiling on scrap. But perhaps no trend is more significant for the scrap industry than the rest of the world’s decreased appetite for the United States’ recycled material. “The No. 1 biggest headwind is exports,” says Tolomeo. Since peaking in 2011 at 24.8 million tons, scrap exports have dropped every year. And 2016, through the first half, appears to be no exception. Scrap exports this year are likely to be about half what they were at the peak. Two prime culprits behind the declining exports are Turkey and China. The Turks have long been the largest consumers of North American scrap, but they’ve consumed less material each year since 2011. Moreover, in the last two years, the Turks have found an alternate raw material source to temper their scrap buys—Chinese billet. Prompted by their massive overcapacity of steel production, Chinese producers are cranking out billets for sale as feedstock to mills around the world, especially Turkey. “It’s pretty much up to the Turks to decide what their cheapest raw material is,” said Commercial Metals Chairman, President and CEO Joe Alvarado during his company’s recent quarterly conference call. “The billets are readily available to the Turks. You should expect that to continue until the overall capacity issue is addressed in China.” Tolomeo says the Turks actually prefer to run scrap in their mills, but won’t pass up any cost advantage they may get with billet. “The real benefit to them is the billet makes the scrap price go down, so they can turn around and buy scrap.” Chinese billet is running around $310 per ton on the world market. Subtract the $80 conversion cost advantage of billet, and that explains scrap’s current ceiling in the low- to mid-$200 range. Scrap does derive some benefit from its lead-time advantage over billet. As with most Chinese steel products, billet is a source of controversy. While Turkey and other countries may be purchasing Chinese billet for use as a raw material, some Chinese producers are selling it as square bar, which makes it untaxed at home, while also available for a rebate. “They’re technically exporting square bar. They do a couple of different things with the chemistry or even the paperwork,” Tolomeo says. There are some signs the Chinese government may begin to crack down on the questionable trade practice, though it has taken no action yet. China is importing much less U.S. scrap than in the past due to its oversupply situation and the slowdown in its economy. The Asian giant bought about one-sixth as much material in 2015 as it did in 2011. While few observers expect the Chinese to ever import as much scrap again, some believe China will eventually become a scrap exporter. At the Steel Success Strategies Conference this June in New York, World Steel Dynamics’ Peter Marcus and Karlis Kirsis estimated that China’s reservoir of steel scrap will eventually reach 400 million tons, material that may find its way into the world market. Scrap analyst Ralph Pinkert of Pinkert & Associates does not believe the Chinese scrap supply represents a major threat to steel prices. “I don’t see the scrap reservoir until 2025 at the earliest. And they may not ship scrap out. There is supposition they may want to get rid of their old blast furnaces and put in EAF mills, if they do more building.” Recycled scrap is the primary feedstock for electric arc furnace mills, versus blast furnaces that make virgin material from ore and other materials. Although world scrap demand has dipped, other developing markets may step in to fill any void left by the Turks or Chinese. India remains on a growth trajectory when it comes to scrap consumption, and other countries in the Middle East, Africa and Asia could become more significant purchasers as their economies build momentum. “Excluding China, the majority of new steelmaking production is coming through electric arc furnaces,” said Tamara Lundgren, president and CEO of Schnitzer Steel, during her company’s conference call. “We believe demand around the world will continue. We’re seeing that even in this environment of low and weak global GDP where we continue to uncover new sources of demand as countries develop their steel industries.” On the other hand, the strong dollar and weaker global markets have increased the amount of scrap coming into the United States, with European shipments being the most noticeable gainer. With the recent Brexit vote pushing the U.S. dollar up against the British pound and other currencies, shipments into the United States will continue. The decline in exports and increase in imports has given U.S. mills additional pricing power over domestic scrap suppliers. The price degradation of 2015 took a significant toll on the scrap industry. Consolidation, either through sales of one scrapyard to another, cutbacks in capacity or the closure of unprofitable facilities, was common last year. More is still to come, predicts Pickard. “It’s still ongoing, and there’s definitely the possibility for more,” he says. “Even with prices coming up, for a lot of companies the damage has already been done. They’re looking for an opportunity to sell.” Part of that desire to cash out is generational, as the scrap industry, like other metals businesses, has a heavy concentration of management nearing retirement age. One byproduct of the shakeout in the industry was the idling of scrap shredders. While precise numbers on shredder capacity are hard to come by, many yards were known to have shut down lines last year in response to the crisis. “Companies that were running multiple shredders are now running just one, and most times they’re not running anything close to capacity,” Pickard says. Looking ahead, there remain signs both positive and negative for the scrap market. Working in its favor are some positive macroeconomic trends on jobs, interest rates, housing starts and even industrial production. Working against it are the strong dollar and weakness in China. These kinds of offsetting forces are why Pinkert and Tolomeo don’t expect scrap prices to erode much further this year. “The mills have to be supportive of [scrap] prices. If they drop too much, it impacts their sales price,” Pinkert says. Meanwhile, the beleaguered scrap industry remains at the whim of the market. “They can’t control commodity prices. What they can really do is focus on operational efficiencies. They can make sure their operations are as efficient as possible and they can work on creating the highest quality products. That’s what separates the U.S. from our counterparts overseas, the quality of our products,” says Pickard.