Steel Industry Insight

Scrap & Steel: A love/hate relationship

It goes without saying that the steel industry needs the scrap industry; without an abundant supply of leftover steel from consumers, manufacturers and demolishers, steel plants would have to rely entirely on iron ore for their raw material.  Sure, iron ore is more pure than scrap and can produce higher-quality steel, but it’s costlier to produce, dirtier to use, and at some point, the discovery of new deposits will dry up.

And likewise, there’s no doubt that the scrap industry needs the steel industry—who else besides steel mills would want a pile of filthy, rusted out appliances and cars, or useless manufacturer droppings?  Without the steel industry’s insatiable appetite for scrap to melt down and transform into new steel products, scrap yards would be indistinguishable from landfills (although they probably wouldn’t smell as bad).

Despite the two industries’ undeniable need for each other’s existence, there is an underlying current of tension in the market, starting with scrap producers and trickling all the way down the supply chain to end-users.  While it’s unlikely that any specific complaint can be addressed in a mutually satisfying way, often the simple act of airing grievances can relieve tension in the short term and open doors of potential long-term opportunity.

Mills to scrap producers:

Stop the rollercoaster, we want to get off!

For many years, US scrap prices fluctuated rather mildly—$5/long ton up here, $10/long ton down there—while maintaining a general upward trend.  Depending on market conditions, sometimes steel mills would choose to absorb the movements, and sometimes they would pass them downstream.  It was a harmonious partnership that could easily withstand seasonal cycles of supply and demand.

Looking at the past decade, scrap prices followed this moderately fluctuating upward trend until the end of 2003.  Average scrap prices jumped approximately $100/net ton between November 2003 and March 2004, then promptly dipped $50/nt in the next few months.  From that point on, dizzying peaks and devastating declines defined the scrap price trend, culminating in the infamous spring-autumn of 2008, during which prices doubled, only to crash down immediately to circa-2002 levels.

US scrap producers were not entirely to blame for this tragic arc—worldwide scrap prices followed the same trends and suffered the same ramifications.  But since then, during an epically slow recovery in both the economy as a whole and the steel industry in specific, in which a modicum of stability was necessary to lifting confidence in the market, you would think that scrap producers would do everything in their power to soften price fluctuations.

Unfortunately, every little tightening of supply or increase in demand (from both domestic mills and export destinations) has led to two years of nearly constant ups and downs in a range—for the most part—of $20-$40/lt.  Typically, scrap movements underneath the $20/lt level do not have a significant impact on steel prices, whereas deeper fluctuations translate directly to steel products, affecting every link on the supply chain.  Steel mills, which almost always try to pass on higher prices to distributors and service centers, are not always successful—they often have to “eat” higher raw material costs, negatively affecting their quarterly results even if sales volumes are higher.

“Profit margins are not exactly wide,” said a purchasing manager at one of the US’ major mills.  “Despite what some might think, we don’t have this huge cushion to fall back on, so when scrap is so unpredictable, we don’t really have a choice but to react in turn.”

So what, if anything, can be done to soften the blow of substantial scrap price fluctuations?  Not much, especially considering outside forces that US scrap producers have little to no control over.  One example: the weather.  Last year, mid-winter conditions blanketed 49 out of the 50 United States with snow (Hawaii being the exception), and this year, the Midwest and Northeast regions were blasted with snowfalls of up to 20 inches in a late-January blizzard, after already getting pummeled over the holidays.  Scrap flow in those regions screeched to a halt, yet steel mills kept churning along and demanding scrap.  Owing to the basics of economic theory, it’s perfectly reasonable that scrap producers raised prices in the face of short supply, but many wonder how much that increase really needs to be.

Another uncontrollable factor: scrap consumption overseas.  Part of the reason scrap prices were able to rise to such heights in 2008 was because major export destinations, such as Turkey and China, were importing US scrap like there was no tomorrow. Even now, China’s ever-emerging economy and Turkey’s dominance in the Euro-region longs market have a direct impact on the US scrap export market.  Every ebb and flow in foreign demand, such as the Chinese government-mandated slowdown in the country’s construction sector, or the Middle East’s growing appetite for Turkish steel, are reflected in US scrap prices—and because such movements have been sharper over the past six to seven years, the effects on US prices have been more dramatic as well.

Distributors/Service Centers to mills:

What about demand?

Every month, steel distributors and service centers sweat it out during the days between the official scrap number release and steel mills’ official letters indicating their response.  While there is usually a solid expectation in place, anything can happen, and all downstream operations can do is brace themselves for the worst but hope for the best.

This cycle has continued month after month for quite a while, but in the last few years, one aspect of the process has been particularly frustrating for distributors and service centers: the balance of raw material costs and demand conditions in determining steel prices has become increasingly lopsided.  Instead of blending the two in a way that accurately reflects what the market can—and is willing to—absorb, mills have seemed to place more weight in scrap prices than any other determining factor.

“We’ve been telling our customers this for years,” said one Midwest wire company executive.  “They don’t understand how prices can go up so much when no one’s buying, and to tell the truth, neither do we.  It’s incredibly hard to pass scrap costs through.”

Economics should dictate that when demand is low, prices will be low as well.  But demand seems to play a minimal part in mills’ decision making process—unless demand is strong, that is.  Last fall, for example, there seemed to be hope that US wire rod mills were embracing the notion of stability, when shredded scrap prices dropped $30/lt in October and mills only lowered prices by a portion of the decrease.  When scrap went back up $20/lt the next month, many expected mills to keep prices level—end-user demand wasn’t terribly impressive, but it wasn’t exactly weak, either, and distributor purchasing activity had ticked up a notch in response to lower prices.  Instead, mills overshot the scrap increase, explaining in their announcement letters that “strong demand” was instrumental in their decision.

A few months later, actual wire rod demand was trying to hold steady in a slow-growth pattern, even though harsh weather conditions shut down construction projects and delayed others.  But the same snowstorms also tightened scrap supply, and that situation, combined with firm export prices, caused shredded scrap pricing to leap up $65/nt in January.  Again, mills severely overestimated demand in the market and increased prices by $75/nt.  In just weeks, it became apparent that obtaining such prices was little more than a pipe dream.

The cry from distributors across the US was, “Mills just don’t get it.”  Even overseas wire rod markets seem to understand the demand situation—when Turkish wire rod mills were paying more for scrap over the summer and early fall of 2010, they resisted raising their prices too much because they knew they wouldn’t be accepted (the Turkish lira’s strength over the US dollar had a part to play, as well).  They knew that regardless of their raw material situation, demand for imported wire rod in the US did not warrant price increases.  However, their price management strategy paid off once US prices started rising near the end of the year, making import offers quite attractive—wire rod traders reported a significant increase in inquiries in December and January.

Ironically, high scrap-based steel prices are actually having an inverse affect on slowly-recovering steel demand.  While some major infrastructure projects and well-performing sectors such as automotive are keeping steel demand from slipping into the abyss, distributors have reported that many customers are holding off on non-essential projects until prices are more reasonable.  One East Coast rebar distributor, for example, said that an agricultural industry customer would like to install concrete slabs in his livestock barns, but has decided to hold off on any major rebar purchases until prices are more manageable.  Smaller-scale projects such as these do not make much of a dent in overall end-use demand on their own, but combined with similar projects across the US, they certainly add up.

Other distributors and service centers for a wide spectrum of steel products are also finding difficulty passing through scrap-based cost increases to customers when demand doesn’t warrant them. Especially in the flats market, which saw approximately one price increase per week during December and January, the lack of an accompanying surge in “real” demand (most purchasing activity was due to inventory restocking, some hedging against future increases, and moderate end-use activity) translated into only partial acceptance of the increase boom (by early February, the frenzy seemed to have stalled).

Is a solution in sight?

Several solutions to the scrap-based cost rollercoaster have been proposed, but unfortunately, many of them are not applicable.  Distributors have suggested quarterly, instead of monthly, scrap pricing, but many scrap producers are quick to point out that the conditions affecting scrap pricing—weather, export sources, domestic mill demand—change on a monthly basis (sometimes even weekly), not quarterly.  Others have suggested that the presence of more scrap processers in the US will result in a more competitive landscape, thus preventing severe spikes and dips in monthly pricing.  But according to David Hodory, Vice President of major scrap producer the David J. Joseph Company, more competition actually raises prices, because “the scrap market is like e-Bay—the more producers that are out there bidding for your scrap, the higher the prices will be.”

To arrive at any sort of solution to the tensions coursing along the steel supply chain, it might help to go all the way to the bottom and analyze the very last link—the average US consumer.  The automotive, construction, manufacturing, and virtually every other industry in the US depends on individual consumers deciding whether or not to buy a car, or a house, or an appliance or any other steel-related product.  And while consumers are always in the market for a bargain, discounts are more important now than they’ve ever been.  Coming out of the worst economic climate since the Great Depression, consumers are holding tight to their purse strings.  They have money to spend, but are cautious about doing so—a stark contrast to the mass spending binge of the 1990s-2000s.  And as evidenced from the recent holiday shopping season, they will spend, as long as there is some alluring incentive for them to do so.  Discounts are the name of the game now—offer a good enough deal, and the purse strings will loosen.

It seems almost obvious, but keeping steel prices at a comfortably low level (not too low for mills to go bankrupt, but low enough to lure end-users back to the market) could give the steel industry’s recovery a much-needed kick in the pants.  High prices can be a good thing, but only when consumers are already buying.  So instead of being solely concerned with profits, perhaps each link on the steel supply chain can focus on building up demand—starting, perhaps, with its influence on scrap prices.

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