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Domestic markets buy ferrous scrap by the numbers

Keywords: Tags  obsolete ferrous scrap grade, prime grade ferrous scrap, ferrous scrap prices,

The past decade has brought a number of challenges to the scrap and steel industries, not least among them dealing with the comparative relationships of the escalating value of raw materials, to which both sellers and buyers have had to adjust.

Nowhere has this change been more pronounced than in the ratio of the dollar value of prime grades vs. obsolete grades. Exactly 10 years ago, the value of prime grades hovered just above that of the obsolete grades, with only about $12 per ton separating them in average annual price.

But on average through the first three months of 2012 the spread stands at its fourth-highest in history, with the primes outpacing obsolete material by an average of $51.95 per ton, according to AMM pricing data. (Prime grade prices are defined as the average of No. 1 dealer bundles and No. 1 busheling, while obsolete grade prices are an average of No. 1 heavy melt and shredded scrap; prices are delivered to consumers in the Chicago, Philadelphia and Pittsburgh markets.)

This trend has reflected the systemic changes in scrap supply, exports and imports, melt mixes and competition, which have occurred during one of the most dramatic decades in the history of the industry. Yet prime grades still hold an important role in industry thinking and usage.

“Some people like to look at heavy melt for a gauge of the market’s health, but a lot of mills, as well as brokers and dealers, still focus on the primes,” one Midwest dealer said. “But the changes we’ve seen have maybe made that not the best way to view the market. Prime grades may still be more valuable, but they don’t really necessarily tell the story of what is happening every month.”

While primes have never trailed the obsoletes in annual averages during the first decade of the new century, the gap between the two has widened dramatically, if not steadily, over the past 10 years (see chart).

The gap is somewhat smaller when comparing prime grades only to shredded scrap. In that case, the difference stands at about $32, slightly below last year’s $38 spread between frag materials and bundles and busheling.

Today’s overall spread of $51.95 per ton, as well as last year’s average of $48.56, are remarkably close to the roughly $50-per-ton average over the past 10 years. But measured in percentages, the differentials look somewhat different. Through the first two months of 2012, prime grade prices have averaged 12 percent higher than obsolete grades, not much higher than the 2002 difference of 11.8 percent, but the years in between have seen wild fluctuations (see chart) averaging 18.6 percent for the entire period.

The year that really triggered the major shift was 2004, when the trend more or less began. That also happened to be the year when exports began their surge. Prior to 2004, the annual spread had never climbed above $16 per ton; in 2004, the spread reached nearly $86, or 37.3 percent. The question is why. The answer has to do with changes in scrap availability.

Although demand for the prime grades has slipped somewhat over the years, they also have been in relative tight supply for most of the past decade. Users of the prime grades still have to compete with one another. During the past decade, domestic demand for scrap from dealers and brokers has not changed all that much, staying within a narrow range of 42 million to 45 million tonnes most years. The two exceptions to that range were the boom year of 2008, when 47 million tonnes were purchased, and the bust year of 2009, when that figure slipped to 37 million tonnes. The last two years have restored that number within the normal range, and this year appears no different so far.

But buried within the details of those numbers, something interesting is taking place. At the start of the new century, the ratio of obsolete grades sold to prime grades sold was about 2 to 1 for all materials bought domestically by mills from dealers and brokers. That number has eroded over time to its present ratio of about 3.3 to 1, according to U.S. Commerce Department data.

Last year, obsolete grades accounted for nearly half of all scrap sales, while prime grades were about 14.6 percent. Not counting the bust year of 2009, domestic obsolete scrap sales have been within a range of 19 million to 22 million tonnes per year since 2002, while prime grades have fallen to less than 8 million tonnes from 10 million tonnes. Clearly, prime grades are accounting for less overall usage, while obsolete-grade usage has held relatively steady—even when imports are taken into account.

Mills still have some hunger for the prime grades, but the United States has been generating less of them. In 2002, about 10 million tonnes of prime grades were available for sale to domestic and foreign markets. That figure is now less than 8 million tonnes. During the same period, the volume of obsolete grades available has surged to 35 million tonnes annually from about 24 million tonnes. The growth of shredded scrap has helped push obsolete grades to the top of the heap, as has the growth in exports.

Those figures show the basic supply-and-demand explanation for why the value of prime scrap has gone up slightly faster than have obsolete grades. Average annual prime-grade scrap prices have risen 335 percent since 2002, while obsolete grades have increased 326 percent.

Consolidation and vertical realignment have been among the main responses to this problem. Nucor Corp.’s acquisition of scrap supplier David J. Joseph Co. and Steel Dynamics Inc.’s purchase of recycler OmniSource Corp. are the most dramatic examples. The integration of scrap procurement and sales with mill production is one attempt to control both the availability and affordability of materials.

At the same time that domestic consumers have sought ways to ensure the availability of prime materials, foreign buyers have picked up their consumption of U.S. scrap. But while many millions of tonnes of obsolete scrap head overseas each year, less than 1 million tonnes of prime grades move out of U.S. export yards.

Over the past decade, U.S. exports of scrap have nearly quadrupled to nearly 24 million tonnes annually from about 6 million tonnes, with most of that growth in the obsolete grades. Despite sending a steadily increasing stream of obsolete grades—and a much smaller amount of prime grades—overseas, the price gap between the two has still opened up.

So exports have not helped close the price gap. This raises the question of scrap imports, where the prime grades now hold an edge over obsolete material. Ten years ago, prime grades accounted for about 8 percent of all scrap imports, but that figure has grown steadily to about one-third, while obsolete grades account for about 30 percent of all transactions.

Despite the import of more prime material, it has not been enough to shape most monthly domestic market movement in any meaningful way. U.S. imports of all scrap have held relatively steady at between 3 million and 4 million tonnes per year since 2000.

How does all of this affect monthly markets, or at least market behavior? Recent history has shown that even though some sellers are willing to bring prime scrap in from Europe in an attempt to both ensure availability and contain prices, such maneuvers are only stopgap measures, and the growing spread between primes and obsoletes may be a reality for some time to come.

Also, some mills try to buy early in months when there is a fear of tight or short supply, and that only serves to continue to drive prices up and further open the value gap. This has been the state of affairs for much of the past seven years.

Some have opted for substituting other metallics for prime scrap but, again, the results have been mixed. While pig iron can be used as an alternative, its prices also go up in boom times. And some obsolete grades can be used in addition to or as a replacement for the primes, although melt shop demands have placed limits on how effective such substitutions can be.

And the effects of the Great Recession may worsen the issue. Even after a recovery finally gains traction, less prime scrap will be available for some time to come because of the hit to domestic industrial production, durable goods sales and the automotive industry during the 2007-2009 period. There simply won’t be much prime scrap around, continuing the cycle of shortages.

That means following the price of the prime grades—and the gap between them and obsolete material—might no longer be the best bellwether of market strength, direction and health, market players say, and changing that mindset won’t be easy as sellers and buyers are accustomed to using primes and their value.

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