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Scrap industry's freshly squeezed margins

Sep 30, 2013 | 08:00 PM | Gregory DL Morris

Tags  ferrous scrap, ferrous scrap exports, Adam Weitsman, Upstate Shredding LLC-Ben Weitsman & Son Inc., scrap shredders, Joseph C. Pickard, Institute of Scrap Recycling Industries, scrap volumes Charles Bradford

It has been a vexing year for scrap­yards, with strong volumes but without much accompanying price increases. To the contrary, operators report a significant margin squeeze. Both scrap players and industry analysts said there is variation grade to grade and region to region, making trend-spotting all the more difficult. The short-term consensus is that the supply of scrap, both obsolete and prime grades, is strong, and that demand from mills also is holding up well.

The more-ominous long-term trend seems to be that pressure on margins is hurting the two ends of the business: small yards and the largest integrated operators. Many local players are facing steep payments for recent expansion and equipment upgrades, while the corporate scrap divisions are under pressure from parent organizations to meet profitability targets. Several industry analysts said the basic reason that large steel companies moved upstream to acquire scrap operators in the first place--security of supply--seems to have been supplanted by the idea that those divisions should be profit centers on their own.

Scrapyard operators report ample flow at the day-to-day supply level. “We are actually seeing historic high levels of supply into our yards,” said Adam Weitsman, owner of Upstate Shredding LLC-Ben Weitsman & Son Inc., a midsized private operation based in Owego, N.Y. “We are especially seeing strong flows of obsolete grades, not so much of the prime material.”

Weitsman said that while there are local variations in grade, overall “there is just as much scrap in the supply chain. The difference we are seeing recently is that the flows are being organized differently. The larger companies have lost some ground because their cost per ton is higher. In some cases they have become noncompetitive.” He declined to cite specific companies, but referred to stories in AMM and broader business publications about major companies cutting back operations.

At the opposite end of the scale, Weitsman also sees many small scrap operators struggling. “A lot of guys bought big new shredders with grandiose ideas, and some of those guys are hurting right now. You never like to see that, but the margin compression we are all facing right now is among the most severe we have seen in a long time. The next few years in the scrap business are going to be brutal.”

There is an analogy to the 1970s and 1980s, when many small farmers bought expensive combine harvesters and other equipment to improve their efficiency and productivity. For some it worked, but for others it merely imposed an unsustainable cost. “You can’t run any kind of company on the idea that the good years are the norm,” Weitsman said. “I have always tried to run this company with the rainy days as the norm. That way we can try to expand in the down times--growing supply and customer base--and then hold the line in the good times and try to put a little something in the bank.”

Weitsman said that Upstate continues to open feeder lots to keep up the flow. That is essential these days because the rule of thumb often cited in the scrap business is that operators break even on ferrous and make money on nonferrous metals and in some cases non-metals. Many operators report they are losing money on ferrous, and just breaking even on nonferrous. Hence, the margin pressure.

Weitsman said his emphasis in down times is volume and value. “Other yards are cutting back on hours, on people, on volumes, but we are trying to add volume, add hours, increase the flow, and use technology to extract more value from the stream. We are extracting insulated wire and plastics from the fluff, trying to turn what used to be a disposal cost into a source of new revenue.”

On a broad scale, scrap prices are still the strongest indicators of trends in the industry, said Joseph C. Pickard, chief economist and director of commodities at the Institute of Scrap Recycling Industries. “For most grades of scrap, prices are lower than they were a year ago. As prices decrease, that is an indicator of decreasing demand.”

He also noted that volumes have been slightly lower year on year. “Through May, 22.4 million tons (of ferrous scrap were purchased by domestic mills), as calculated by the U.S. Geological Survey, which is down about 6 percent from the same period in 2012. Exports have decreased as well. And all of that tracks well with steel production levels,” he said. ISRI calculated that ferrous scrap exports, excluding stainless steel and alloys, fell 13 percent to 9.3 million tons in the first half of this year.

Several industry observers suggested that the drop in scrap demand has less to do with scrap quality, price or volume, but rather with the slump in iron ore prices, leading many large mills worldwide to favor ore over scrap for raw material.

“In the scrap industry we see ourselves as price takers,” Pickard said, “and that is similar to what we see in aluminum, copper and other metals. Price is a function of demand, which is determined by the mills.”

Within the scrap supply chain, Pickard said, “there are more shredders and more shredder capacity, so there is greater competition among yards. The modest price firming that we saw in July over June was still within an overall softening trend.” August prices generally moved sideways, while September was down.

“We have seen ore prices decline worldwide, and that has driven substitution of scrap by ore where mills have that option. We have seen some firming in ore prices in recent months, and we know China is still producing steel,” Pickard said. “But there has been a production decline in Turkey, which is the No. 1 scrap market. That, in turn, is driven by the demand for steel in Europe and the Middle East, which has been down. Scrap exports from the U.S. to Turkey are down 20 percent from where they were this time last year.”

Another wrinkle in the export picture, Pickard said, is the increase in volume due to the ability to export scrap in containers has been normalized, if not somewhat played out. When prices were higher, that new capability meant that any yard in the middle of the country could fill a box and be a player in the global market. The novelty is gone and so are the premium prices, so that volume has diminished.

That said, the essential challenge today is too much capacity. “There are more than 300 shredders in operation today compared to 170 in the late 1970s,” Pickard said. “And there are not just more of them, they are bigger.” He noted a contrast between scrap shredding and other heavy industries, where new and more-efficient operations tend to drive smaller, older and marginal operations out of service. “There just seems to be less rationalization of shredder capacity in our industry. Yards will put in a big new unit, but keep the old ones operating,” he said.

Paying for those new units in the face of margin compression means “this has been a tougher year for scrap operators than anyone would have anticipated,” Pickard said. But he remains sanguine. “The U.S. is still a leading supplier of scrap, not just in terms of volume but most importantly in terms of quality.” In the domestic market he is even more optimistic. “Most economists expect the recovery to continue and even accelerate through this year and into 2014,” which should translate into more demand for steel, particularly as infrastructure projects pick up, and demand for steel means demand for scrap--and demand is good for prices.

Charles Bradford, principal of New York-based Bradford Research Inc., agreed with the macroeconomic outlook for the economy as a whole and the improvement that should foster in steel demand. He questions, however, how much increased steel demand will translate into scrap demand, given the new direct-reduced iron (DRI) projects nearing completion.

“With just Nucor Corp.’s plans at St. James Parish (La.) you are looking at 2.5 million tons of iron units,” Bradford said. The first train was due to come into service by the end of September, and the company is expected to make a firm decision about the second train before the end of the year.

“How Nucor will balance its inputs remains to be seen,” Bradford said. “They may reduce pig iron imports from Brazil. But however that is done, those millions of tons have to be figured into the supply chain for the industry overall. Beyond that, there are at least three other DRI plants being considered for the U.S. and if a second plant is built beyond Nucor, that will have a bigger impact on scrap prices.”

Beyond the supply chain question of reckoning new DRI production into the equation, Bradford said, “the biggest issue in scrap today is the humongous conflict of interest in the mills. They bought scrap companies to get low-cost inputs, but because the integrated companies have higher fixed costs that is now imposed on the scrap operations.”

While not taking issue per se with the fundamental logic behind those acquisitions that brought scrap operators under mills’ corporate umbrella, Bradford noted that historically scrap and steel prices are very highly correlated. “Long term, the correlation is remarkable--about 0.97. Week to week it is lower, but still 0.8.” The point where the prices differ, he said, is that “scrap is priced in gross tons, while steel is priced in net tons. That helps margins on the upside, but hurts more on the downside.”

All of which is not to say that overcapacity in shredding is not a serious problem for the domestic scrap industry. “There are just too many units in the field,” Bradford said. “I hear it all the time.” He suggested that part of the reason there has not been much rationalization of older capacity could be the declining amount of steel in each vehicle, which means more vehicles need to be shredded to recover the same volume of steel. “This is a growing problem,” he said, “and next year the Ford F-150 pickup truck is going aluminum.”

A source at one midsized Midwest scrapyard agreed that there is sufficient feedstock in the pipeline. “There seems to be a good balance, both domestically and globally. It varies by market and grade, but not by too much.” But he is dubious about how big the issue of declining steel in vehicles will be in the near term. “We are already seeing those lower-steel cars in the supply chain, and auto sales have improved, so I think most of the replacement has already happened,” he said.

He also agreed that the smaller yards are under increasing pressure, but believes increased rationalization among older processing units could help. “The older balers and shearers that can’t extract nonferrous can’t really help with margins,” he said. “The new shredders that can extract more streams are necessary to compete.”

Another argument for rationalization, he added, is that the bigger, newer shredders have higher operating costs--about $80 to $100 per ton compared with older units at $30 to $50 per ton--so the newer units have to be run at higher rates consistently to make money. “That is fine if you’ve got the volume, but once you get behind it is very difficult to catch up,” he said.

Beyond rationalization of shredder capacity, there is likely to be rationalization among scrapyards, he said. “Among the smallest yards, the country dealers handling 5,000 or 10,000 tons a month, some of those may just go away. There will also be some consolidation among the country yards, either full combinations or situations where one buys another for the feedstock but closes the other yard. Some bigger operators may buy some smaller ones for the same reason--that link to the crushers. But it will be very specific.”

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