The squeeze: steel mill buyers are feeling the squeeze of higher secondary commodity prices – Commodity Focus
Ferrous scrap dealers have been enjoying elevated secondary commodity prices thanks to the swell in overseas demand. As steelmaking continues to globalize, increasingly, what’s good for domestic scrap dealers is not necessarily good for domestic steel mills.
As scrap prices continue to increase in response to overseas demand, mini-mills particularly are feeling the effects. AS the majority of mini-mill charges are comprised of scrap, the material represents a significant portion of their costs. Michael Locker of Locker Associates Inc., New York, says that scrap is approximately 55 percent of a mini-mill’s cost when producing a sheet product.
Locker Associates is a business consulting firm specializing in corporate restructuring, buyouts and feasibility studies.
This escalation in basic operating costs has caused some mills to reassess their business practices. In some cases, mills are again exploring the use of alternative melting units, such as pig iron, direct-reduced iron (DRI) or hot-briquetted iron (HBI). Some mills are also reconsidering contract terms and inventory strategies.
The surge in overseas demand for domestic ferrous scrap inevitably leads to the lingering question concerning the overall effect globalization has had on the viability of the domestic steel industry in America. The elevation in domestic scrap prices has pinched the reserves of American steel mills.
ERODED PROFITS. “In light of the fact that the business for construction steels and structural steels is pretty awful in this country, higher scrap prices hurt our margins,” Dick Jaffre of TXI Chaparral Steel, Midlothian, Texas, says.
Another purchasing director for a Southern steel mill who prefers to remain anonymous agrees, saying that the construction-related steel markets have been “really flat” for approximately the last year, adding that bar mills did not benefit from the Section 201 tariff relief.
Thomas Danjczek, president of the Steel Manufacturers Association (SMA), Washington, says that mini-mills have responded to higher scrap prices by announcing price increases for their finished products. However, Danjczek says that these increases do not correspond to the magnitude of the price increases in ferrous scrap, further squeezing margins for electric arc furnace steel mills.
The SMA is an industry organization that represents electric arc furnace steel mills worldwide.
“The price of scrap is being dictated right now in the domestic United States by the world market, in particular, the demand from Pacific Rim nations,” Jaffre says. He adds that numerous secondary factors have also negatively impacted scrap availability and, therefore, have caused scrap prices to exceed equilibrium.
“In other words, we’ve had a bit of a buying panic, which has pushed prices well beyond what they need to be, so to speak, for demand to be satisfied and for the supply-demand curve to intersect,” Jaffre says.
The Southern mill buyer says, “I think the fuse was already lit on the firecracker,” adding that overseas demand helped detonate the scrap situation.
He says that for nine or 10 years, the U.S. was not exporting scrap, resulting in moderate to low scrap prices because the domestic supply and demand equation was balanced. However, the swell in demand from China unbalanced the equation. “China’s activity was so large and it seemed to be pretty deep in its demand, that it took a lot of scrap away from domestic demand,” the mill buyer says.
“In my 30-years experience, it’s the first time I’ve ever seen significant scrap increases not going along with domestic demand,” Danjczek says.
While popular opinion dictates that overseas demand is the primary factor behind the escalation of ferrous scrap prices, numerous secondary factors have contributed to the effect.
EXACERBATED EFFECT. “We had a bad winter,” Locker says, “which cuts down on transportation and recycling activities in some areas.
Jaffre also says that scrap supplies have shrunk as a result of the harsh winter. “That has constrained the amount that can be shipped to satisfy the importers of scrap.”
“Our markets are kind of like a yo-yo,” the Southern mill buyer says. “Right now, they’ve gone up way too high. They are probably going to adjust back down like they typically do in the spring. I think we’ll see scrap prices moderate some once weather isn’t a factor.”
Jaffre says, “Scrap prices have been very low the last few years relative to the prior five years. People kind of got used to low prices, and they began to operate with very low levels of inventory.”
Jaffre says the just-in-time approach to inventory management can backfire when applied to weather-sensitive commodities. “When people begin reducing their inventories so that they have minimum inventories at the end of their fiscal year, when they have bad weather, it can come back to bite them,” he says.
The Southern mill buyer adds, “People at steel mills and foundries had let their inventories drop during the fourth quarter of last year, because it had looked like business wasn’t going to pick up. Dealers, steel mills and foundries all ran their inventories down going into the winter, which is dangerous.”
“Obviously, no one likes to pay one more dime for inventory cost than one has to,” Danjczek says. “But one has to evaluate that against need. When supply is short, then they pay excessive [scrap] prices. Sometimes just-in-time becomes just in case.”
Weather also affected imports from areas such as the Ukraine and Russia, Danjczek says. He also says the general strike in Venezuela as it relates to DRI and HBI production may have affected scrap prices.
Jaffre also says these international situations have affected the steel industry. In addition to the interruption in HBI production out of Venezuela, Jaffre says a Ukrainian tariff of 30 Euros on scrap exports, which was passed in early December and enacted January 1, has also affected the availability and price of ferrous scrap. However, the southern mill buyer has heard that this tariff is being removed shortly, which will free up scrap from the Ukraine and further help to moderate pricing.
In addition, diluted domestic manufacturing has affected the availability of prime scrap, further affecting the overall scrap supply. The amount of prime postindustrial scrap has weakened because the auto industry has cut back its production schedule, the Southern mill buyer says.
Despite the glum situation for domestic steel mills, they may be able to entice additional scrap by offering incentives to scrap dealers, using more alternative melting units or modifying their approach to inventorying.
ALTERNATIVES CONSIDERED. Danjczek suggests that steel mills could benefit from a number of optimizations in their operations, such as developing relationships with their consumers to funnel their “home” scrap back to their mills.
“Inventory control comes into play,” he adds, suggesting that mill buyers avoid shocking the marketplace with large purchases in favor of buying steadily over time.
Locker also suggests that steel mills may want to consider inventorying more scrap material. He adds that mills could re-evaluate their contract terms with scrap dealers. He suggests that if mills could shorten their payment terms–which he acknowledges isn’t easy in the current market–they might attract more domestic scrap.
The Southern mill buyer stresses the importance of developing and maintaining relationships with scrap suppliers. “The more directly we can purchase our scrap from the source, the supplier, I think the better off we’ll be,” he says.
Danjczek also suggests that mills could melt more virgin iron units with lower-grade scrap, or that they could incorporate alternative melting units to help alleviate some of the pressure caused by decreased scrap availability and mounting prices.
“I’ve been in this business for an embarrassingly long time–30 years or more,” Jaffre says. “Every time the price of scrap reaches a certain level, every steel mill goes to the file cabinets, and they dust off the HBI, DRI, pig iron project plans. When the scrap price goes down to a more reasonable level, and it will, then this stuff goes back into the file.”
He continues, “If you are in a country that has low energy costs, and you produce pig iron or HBI, what you are really doing is exporting low-cost energy. That’s why there’s none of that kind of production in the United States for merchant consumption.”
Locker says that mills are looking very seriously at alternative melting units, and some have already moved in that direction “seriously restarting or rearranging contracts.”
He continues, “There is backward integration in that sense in alternative units with the mills.” However, these alternative melting units are not without associated problems.
The substitution of pig iron, DRI and HBI is more difficult in today’s market, Danjczek says, as those prices have increased as well because of the situation in Venezuela.
Logistical issues related to shipping distances and limited supply channels in regard to DRI and HBI can complicate the use of these materials, Locker says. He advises better planning on the part of mills when using these units.
Locker also points out that HBI can provide benefits to mills when incorporated into charges. “It comes in regular sizes and shapes, and the composition is pretty uniform, so that gives it a great advantage,” he says. “You get minor residual issues [compared] with scrap. It’s easy to handle in the sense that its sizing is uniform.”
As more DRI and pig iron production comes online, he adds, that will have a capping affect on prices.
How the domestic steel industry weathers this constriction in ferrous scrap supply and the resulting elevated scrap prices remains to be seen. Considering the industry is already in triage, this episode might have a significant affect on the health and viability of some players.
FORECASTED OUTLOOK. The Southern mill buyer says the health of the overall domestic steel industry is marginal.
“It’s in a state of flux,” he says. “We still have several companies who are in Chapter 11 or fearful that they may have to go from Chapter 11 to Chapter 7. A lot of them are looking for financing. You have some that are healthier than others, that’s for sure.”
The mill buyer says he thinks consolidation within the steel industry will be an ongoing process. However, consolidation without rationalization is ineffectual.
“The thing that worries a lot of us in the steel industry is that consolidation is good, but there’s no rationalization going on. There’s no necessary cutback in the production,” he says.
“Maybe we’ll be an exporter of new steel products on a regular basis, which we haven’t really done that much of in the past,” the Southern mill buyer says concerning the evolution of America’s role in the emerging global steel industry.
Jaffre suggests the condition of the various companies comprising the domestic industry is mixed. “I’d say that there are some markets and some companies that are in pretty good shape, and there are still some companies that are not.”
Locker says the integrated mill sector is still sick. “The reconstituted or restructured mills, particularly along the lines of ISG, are showing new life and new viability given their new, significantly reduced cost structure.” Locker is referring to International Steel Group Inc., Cleveland, which purchased the assets of LTV Corp. in March 2002.
“The information shows that the cost of a cold-rolled coil coming out of ISG has been reduced at least $100 per ton. That’s very significant. They are cost competitive with mini-mill product,” Locker says. He attributes the savings to reductions in labor, man hours and legacy costs.
“But the rest of the integrated industry that hasn’t gone through this restructuring is still distressed and under margin pressure, though it’s doing better than it was a year ago,” Locker adds.
While the prognosis is better for mini-mills, Danjczek says they are not out of the woods yet. “These are difficult times, whether it be our current economy, whether it be the war, whether it be global overcapacity, we are challenged to earn an adequate return on our investment,” he says. “It’s not just scrap. Energy prices are up.”
The mills could soon modest relief in the leveling of ferrous scrap prices, while the more bullish within the industry say a significant price correction will occur.
PEAK DETERMINED. In the near term, Locker says, “I think we are going to see some easing in scrap prices. I think China is going to soften some. I don’t think it is going to collapse, but it is going to soften some.
The Southern mill buyer says, “Prices seem to have peaked. We’ve had better weather for just a short time, and [obsolete] scrap is starting to flow a lot better.”
Jaffre also says the tight supply situation for scrap has peaked. “I would go a step further and say that there is going to be a correction that will occur,” he adds. “It’s not going to be a massive correction, but there will be a correction.
“Clearly, international prices reached levels that were not expected by anybody, by as much as $20 or $30 per ton. I think, over the next three to six months, we’re going to see the $20 or $30 given back, at least a substantial part,” Jaffre says.
This correction will occur in response to a softening of demand from China and an easing in related factors, such as weather, he says.
Jaffre predicts that the corrected level will last the balance of 2003, with overall pricing for the 2003 calendar year exceeding that of 2002. “Somewhere between the peak and 2002 is where it is going to settle out, in my opinion.”
World DRI production increases
World direct reduced iron (DRI) production exceeded 45 million tons, establishing a new record in 2002 according to data compiled by Midrex Technologies Inc., Charlotte, N.C. The figure represents a 12 percent increase from 2001.
The increase was the result of a variety of factors. First, and most importantly, was an extraordinary increase in the price of iron units spurred by strong growth in South and East Asia, primarily in China.
Beginning at the low point in the summer of 2001 and continuing to the winter of 2002-2003, the price of some common grades of scrap steels nearly tripled in Far Eastern markets. The effect was felt around the world and fostered increased iron production almost everywhere. This can be viewed as the long awaited recovery from the Asian crisis in 1997, which had precipitated the longest and deepest trough in iron prices in more than a century.
Next, there was unprecedented growth in India in coal-based DRI production. The higher value of the iron product brought forth an increase in capacity use there by numerous rotary kiln plants as well as the commissioning of some capacity that had been delayed. Indian coal-based DRI production in 2002 was 35 percent greater than in 2001.
Also, there was some recovery in North America (including Mexico) from the spike in natural gas prices experienced in 2001. Although gas prices remained volatile, North American DRI production was 46 percent greater than in 2001.
Higher prices also initiated more trade in DRI and HBI. In 2002, 11.3 million tons of the ferrous scrap substitutes were transported, a 20 percent increase from 2001. Of this, 57 percent was shipped as HBI, the remainder as DRI. Sea borne trade grew to more than 6.7 million tons, 76 percent of which was HBI.
Midrex forecasts continued growth in 2003, as favorable prices for iron production continue. However, following such a long period of extremely low prices, no new capacity has been contracted and, therefore, production increases will be from improved capacity use rather than the addition of new capacity. Therefore, for this year, only moderate growth should be expected.
Midrex is among the leaders in DRI plant construction. Plants built by the company produced 66.6 percent of the 45.1 metric tons of DRI produced last year. The HYL division of Hylsa followed with 19.7 percent. Plants made by other firms made up the remaining 13.7 percent.
The author is assistant editor of Recycling Today and can be contacted at dtoto@RecyclingToday.com.
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