A week after integrated mills announced price increases for flat rolled products, the market does not appear willing to support the higher prices. The spot price continued to decline last week, and mini mills have maintained offers at low prices for new orders. When looking at support for price increases, the market tends to focus on the strength of mill order books. While integrated mill order books may be full – due to the large amount of capacity that remains idled- mini mills are continuing to struggle to fill their capacity with new orders, as evidenced by extremely short lead times. Part of this divergence has been driven by higher utilization rates at EAFs compared to BOFs. In SDI’s second quarter earnings call, the company reported that their flat rolled operations achieved a utilization of almost 90% versus an industry average of near 55%. With mini mills near full operating rates, they don’t have the ability to refuse orders at low prices. Moreover, they comprise a higher portion of the market through operating at these higher rates, and they are likely able to do so because of the recent declines in scrap prices. Iron ore and scrap prices have diverged, favoring EAF profitability.

Looking forward, these dynamics appear intact, with declining spot prices and a wide range of offer prices based on the type of producer. Additionally, US Steel also announced that it would bring back its #8 furnace at Gary Works starting August 1, which will limit any upside price rally. However, there are multiple possible disruptions to this status quo, and we will discuss a few this week.

First, there has been a change in the outlook in the scrap market. After July scrap traded down significantly more that original expectations, most expected further weakness in the succeeding months. However, the August scrap outlook has improved, with busheling expected to be flat to slightly down and obsolete likely to move higher. This is significant because strength in the scrap market will squeeze profits at mini mills and provide support in the market for higher prices. This change in outlook for scrap is partially driven by increased exports of scrap from the east coast, supported by the weaker US dollar versus other global currencies.

Another noteworthy dynamic, also supported by the weakening US currency, is the strength of the global steel market and the global HRC price convergence with the domestic market. The below chart, which extends the time frame of our usual differential graph, shows the price differential of the domestic HRC price and the China export price, plus $100/st to account for transportation costs.

The current differential is at the lowest level since August of 2011, and the differential will continue to decline if weakness in the domestic market persists. Interestingly, the “zero” line in the chart, representing points where the domestic price is exactly $100 above the China export price, has been a reliable lower bound over the past 6 years. However, with the current move significantly below this threshold, the pricing dynamics between the two appear to be entering a “new normal”, similar to the relationship before 2013. One possible explanation is the increased domestic production capacity on the back of the Section 232 tariffs, leading to more competitive domestic pricing. Nevertheless, as domestic prices fall and the differential declines further, there will be more upward pressure on the domestic market. The upside risks are starting to add up.