Last week, the slow rally in spot HRC prices took a pause, as physical transactions were limited among a wide range of offer prices. Mills with full order books have maintained their offers well above $500/st for HRC, trying to capture their recent price increase targeting $540. However, some offers slid at mills with very short lead times, signaling weaker order books despite continued low levels of production. The next few weeks will likely see mills attempting to fill their order book for July, with buyers having the upper hand in negotiations. One dynamic that will affect the mills’ willingness to negotiate is their scrap outlook, which we will analyze below.

Due to the functions of a mill and its profitability, scrap prices and finished steel prices are correlated over extended periods. However, supply and demand dynamics in each market can cause short-term dislocations to the relationship between prices. The below chart shows this historical correlation, as well as certain periods of diverging prices between scrap and HRC.

Busheling scrap prices have rallied since late spring, hitting their highest level in over a year this month, driven by a shortage of scrap created by the recent economic shutdown. While HRC price also moved higher during that period, the price increased only slightly, creating the current “gap” between the two. Looking forward, there is also a divergence in the price outlook for each market. The HRC forward curve is expecting further, steady price increases, while the busheling curve shows a decline to about $300/t expected in July, bringing this relationship back in line.

However, history tells us that forward curves are poor predictors of future prices, and should scrap prices perform differently, there will be ramifications for the finished product markets. If the scrap market remains strong over the next few months, mills will have cover to raise steel prices, likely at a faster rate than the curve is predicting in order to protect their currently depressed profitability. Should scrap prices continue to decline throughout the summer, it is likely that HRC prices will follow, as mini mills’ expanding profitability would allow them to sell spot tons at lower prices. This scenario appears likely, as scrap generation should increase over the next few months among a reopening economy, solving the supply shortage that drove prices to the current levels.