While the physical market has been extremely quiet over the past week, spot price have continued to drift lower as mills are offering lower prices and buyers sit on the sidelines. During price cycles as spot prices fall, we attempt to find a level where prices will find support based on numerous indicators that we put in our report each week. Several of those indicators – including raw material costs, global price differentials, HRC vs scrap price spreads and lead times – are signaling that a bottom may be near based on historical levels. Despite these indications, we believe that additional dynamics are influencing the market right now and spot prices can continue to decline due the continued oversupplied condition in the market and the lingering impact of Covid-19.

Early in the second quarter, mills took swift action to idle furnaces and throttle down production in the mist of the economic shutdown and demand destruction in the steel market. The below chart shows the severity of these production cuts.

The production index bottomed in May and has steadily increased each week since. This rebound in production indicates that there is some demand returning in the market, possibly pent up during the shutdown. The slow, steady rise in production shows that EAFs are likely increasing their production slightly to meet new demand, rather than blast furnaces restarting at a near full run rate. The recent divergence in iron ore and scrap prices leads to better profitability at EAFs compared to BOFs, supporting the mini mill in producing and selling additional tons. However, this increasing production is occurring during a period when prices have fallen, which does not bode well for the price outlook.

As we look for a possible bottoming level in prices, we must focus on where a price sensitive buyer will step in and stock up on low cost material. At those levels, buyers will purchase large quantities of material, which allows mills to fill their order books and push out lead times as they raise prices. However, with spot HRC transactions occurring in the mid $400s, there is little incentive to re-stock right now. It was only a two months ago when there were large spot transactions in the $400-420 range. Buyers today are not going to purchase speculative material for prices higher than they did 60 days ago. Moreover, they likely are still holding some of that low cost inventory.

An additional possibility explaining the oversupplied inventory in the market is from something called a “carry trade”. This entails buying and holding inventory while simultaneously selling forward on the curve at expirations several months in the future. Due to the steepness of the contago in the curve over the past few months, hedgers are able to sell at prices significantly higher than the spot price, locking in profit come expiration time. While this is likely only a small portion of the market, it is an additional seller in the market who, like a mill, is more concerned with getting rid of their inventory when the hedge expires, rather than the price it is sold. With abundant inventory already in the steel supply chains, and mills likely to increase production, lower spot prices appear inevitable.