As the physical market continues to heat up, we at FGM have noticed a stark contrast in customer reactions to the current price rally over the last month. There still appears to be a significant portion of buyers on the sidelines, eerily similar periods in last year’s rally where participants tried to hold off purchases until the very last minute. We are highlighting the similarities because our view is that the existing upside risk is being severely discounted by most analysts and market observers. Through our analysis, the physical spot market and future market both remain hundreds of dollars below levels that would lead to any type of significant demand destruction based on the current environment. This leads us to believe there will be very little resistance in rising prices until HRC starts approaching last year’s peak. While pace and timing remain unclear, evidence of this type of monumental upside risk has already started. We have already seen record level increases in the spot market, and this rally is only 2 weeks removed from the bottom.

During the 2020-2021 rally, mills were reluctant to raise prices, due their own operational issues and the unprecedented nature of the rally. No one in the marketplace knew whether steel consumers would be able to turn inventory above $1,400 or if buyers would ever be willing to pay $2,000 for steel, until it happened. It has not even been 6 months since prices peaked and anyone who thinks mills don’t remember how much you were willing to pay last year is only fooling themselves. The difference between then and now, however, is that pricing decisions are going to be largely driven by a shortage in raw materials, thus directly impacting margin at the mills. The chart below shows pig iron (blue), busheling (white), and shredded scrap (green) over the last 5 years.

Estimates suggest that most mills have approximately two months of raw material inventory on hand at any time. That means that the ripple effect of them reckoning with input costs that are already 20-50% higher than last year’s peak has not started. Taking a step back, the real problem today is that there is not a straight-forward solution to the problem we currently face. Even an overnight resolution to the war does not fully bring back global production that has been sucked out of the market, and it likely does not normalize trade and sanctions between the West and Russia. This suggests that the factors driving this upcycle are even more uncertain than the previous cycle which led to record high prices. Moreover, $2,000/t HRC prices are no longer uncharted territory, and the most likely result of all this cost pressure is that those previous highs will eventually be tested.