Ferrous scrap on a delivered Turkey basis has fallen $50/tonne over the last month with shredded now standing at $350/tonne cfr. This is a long-overdue correction.
As the chart highlights, the differential between producing a finished product from scrap versus the integrated route has been high all year and at its peak has been $150/tonne. In our opinion, the lower relative cost of making steel via the integrated route has a direct correlation with Chinese exports.
Relative cost of steelmaking raw materials
The fundamental reason for the relative differential is that iron ore and coal prices have plummeted while scrap has stayed high. 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 materials is having an impact:
- Chinese billet exports (albeit disguised as bar to avoid punitive billet export duties) are replacing melting in several markets e.g. SE Asia where melting utilisation rates are now down to less than 50%. These billet exports (currently $440/tonne cfr SE Asia) were only $50/tonne 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 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?
With iron ore at $80/tonne cfr and coal at $130/tonne cfr, scrap would have to be around $250/tonne 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 $300/tonne cfr Turkey is not inconceivable next year.
Meanwhile, there will be other effects. Integrated CIS mills can compete at lower price levels, particularly given the sharp currency devaluations this year. We would not be surprised to see billet at $450/tonne fob Black Sea at current raw material prices if CIS mills are serious about grabbing back market share.
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 around 1.5m tpm, of which we estimate up to 300,000 tpm is billet or around 3.5m tpy. However, assuming no regulatory crackdown, Chinese volumes could easily reach 1m tpm in our opinion or 12m tpy. This is equivalent to around one-third of the global 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), the bulk of the adjustment will be felt by smaller suppliers and the scrap market.