Last week, as the physical market started to wake up to the far-reaching consequences of the Russian invasion into Ukraine, spot prices began to mirror what we saw in the financial markets the day after the conflict began. Namely, few offers at elevated prices that rarely lasts more than 24 hours. While the severity of the price bounce was driven by the Russian invasion, the fact remains that prior to the conflict, the market was firming, and the bottom was in sight. However, due to the conflict, the main driver of what will propel spot prices in the physical market forward is very different than what was experienced in 2020 and 2021.

In last year’s rally, where assessed prices peaked just below $2,000 for HRC, the imbalance between better than anticipated demand and restricted supply led to rapid but steady increases over a long period of time. In 2022, demand for steel is expected to continue to grow, but raw material pricing and availability are shrouded in uncertainty. The CIS region is the main global source for scrap, and more acutely, Russia and the Ukraine accounted for 60% of the pig iron imported to the U.S. last year. The severity of this cannot be overstated – while the mix in the scrap blend in EAF’s does allow for some variability, there is a limit to how much of each component can be used. For instance, pig iron accounts for approximately 20% of scrap blend. It simply cannot be replaced by busheling, bundles, or shredded. Over time, and with significant capital investments, it would be possible to start producing pig iron domestically, however, this is not a switch that can be flipped to alleviate the problem today or any time soon. On top of that, auto manufactures remain constrained by the chip shortage, reducing the supply of busheling both domestically and globally. The takeaway is clear – the upside risk to the spot market is historically high as strong demand persist, inventories decline and raw material cost skyrocket.

Another important layer in all of this comes from the chart below, where we see the monthly percentage of import vs mill purchases in the U.S. domestic market.

We look at this chart as a reference to show how much negotiating power domestic mills have in the physical market. Intuitively, as the percentage of imports increases, mill negotiating power decreases. Since the peak in November of last year, domestic buyers have pulled back significantly on imports as the domestic price fell. Looking to the next couple of months, we do anticipate a slight uptick in import arrivals from the unexpectedly low level realized in February, as supply chains continue to work themselves out and existing orders make their way through the ports. However, by the middle of 2Q22, arrivals should slow dramatically because of the dynamics we have been highlighting over the last 6-weeks in these reports (i.e., rising global prices and a negative domestic vs. global differentials). This means that when buyers must re-enter the market as inventories decline, the only viable option will be buying domestic, and there is no telling how high domestic prices will be by then.