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Have surcharges taken the snap out of price elasticity?

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Scrap dealers and many of the companies that supply them with steel clips from their stamping presses re-learned an old lesson a month or two back. Simply stated, the ferrous scrap market has a downside as well as an upside, that prices can plunge as well as soar.

And often, the decreases come at a much quicker pace than the increases. The prices of No. 1 busheling and No. 1 bundles climbed by $160 a long ton in April and another $140 in May, but they gave all that back in a single month September. Industrial steel scrap grades plummeted by $300 a ton or more that month.

Such drops were no surprise for many veteran traders and scrap processors. They have ridden the steel scrap price roller coaster many times in the past and know its peaks and valleys, but few—if any—ever expected to see No. 1 busheling and bundles at $900 a long ton. Many were astonished when industrial steel scrap prices soared to $450 a ton in fall 2004. Who knew that less than four years later it would be double that?

The same could almost be said about obsolete grades like No. 1 heavy melt and shredded scrap, which soared to about $350 a ton and $500 a ton, respectively. Almost—but not quite. The heavy melt and shredded prices never caught up with the price gains achieved by prime steel scrap. There are a couple of explanations for that. One is the weakness of the U.S. dollar, which served to draw obsolete scrap overseas. The weak dollar also discouraged foreign steelmakers from shipping much of their finished steel products here. The domestic steel producers became pretty much the sole suppliers to the U.S. service centers and other flat-rolled steel users.

Another explanation is the possible disincentive of steel scrap surcharges, particularly for flat-rolled steel products. For many of the mills that produce flat-rolled, surcharges often are based on a regional busheling or bundles price or some combination of the grades from two or three cities. In some ways, it has helped steelmakers, especially mini-mills, deal with the often unpredictable ups and down of prices in the ferrous scrap market. But some steel users complain that it has made mills less willing to stand up to the price demands of scrap dealers. Why haggle over the price of scrap when it can be added to steel prices?

But the strength of a market can sow the seeds of its own destruction. The sharp and steeper rises in the prices of industrial steel scrap opened up a huge disparity between the primary grades, like bundles and busheling, and the prepared obsolete melt materials, like shredded and heavy melt—a price disparity that became too big to ignore this year, even with steel base price increases and the scrap surcharges.

Four years ago, when bundles and busheling spiraled up to that $450-a-ton level, shredded could be bought for $300 a ton. That may not seem like much of a disparity now. At that time, though, it was a huge price gap between what some regarded as competitive and interchangeable raw materials. Traditionally, prices for mill grade No. 1 busheling ranged from $10 to $20 a ton over shredded prices. When the export market was active, shredded might even surpass the price of busheling by $10 or more a ton. This year, the pricing disparity grew even greater. Busheling prices rose to $900 a ton and higher while shredded peaked at about $600 a ton in most of the domestic markets—a differential of $300 a ton.

If freight costs are discounted, shredded was about the same price here as it was overseas. Steelmakers in eastern Mediterranean countries, like Turkey and Egypt, paid about $725 a tonne delivered at the market's peak. Bulk freight costs soared to $100 a tonne or more in some months, about triple or quadruple the transportation cost that a U.S. scrap dealer would pay to ship shredded to a nearby steel mill, which made the f.o.b. price at a dealer's yard or the docks about the same.

As is often the case, huge price differentials in competing raw materials force a re-thinking by consumers. We don't yet have a practical alternative to gasoline, but the steep increases in oil prices have made the once-popular sport utility vehicle a paria unless it's a fuel-sipping hybrid.

It's not that much different in the steel market, where many purchasers and melters have reformulated their raw material mixes. Integrated steelmakers, for example, use less densified scrap like No. 1 bundles and 5-foot plate and structural scrap and instead rely more on iron from their own blast furnaces. When they do buy scrap to use as a coolant, it includes a more diversified mix of heavy scrap like rail crops.

Several mini-mills have modified their appetites as well. Some have shifted their formulas to use more of the so-called gamma-ray shredded, the fragmented scrap that been scanned by X-rays and subjected to additional picking to ensure a lower copper content. (Most of the flat-rolled mills require less than 0.2-percent copper in their scrap.) Cleaner shredded along with the use of imported pig iron has helped to dilute the proportion of copper and other unwanted tramp elements.

Fortunately for steel mills, scrap dealers and even the steel users paying those scrap surcharges, scrap has a very elastic price. Bundles and busheling that sold for $450 a ton in 2004 were down to $150 a ton nine months later. Will they drop that low again? Or even lower?

Who knows?

MICHAEL MARLEY


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