Last week was significant for the physical market, as some of the numbers that have been floated through the rumor mill started to show up in published HRC spot prices. As lead times continue to come in and limited spot tons enter the market, it is becoming clear that more mills are willing to negotiate to make sales. With mills operating at record levels of profitability, the big question around what the downside of this cycle will look like is if any of the big 4 are willing to cut into profitably per ton for the opportunity of larger market share. Over the last 5-10 years, we’ve looked to EAF mills as first movers with more flexibility in both output and cost to anticipate new trends. Looking forward, it is less clear how dynamics between EAFs and BOFs will influence the spot prices for both steel and scrap. In the remainder of this week’s report, we will dive into the global dynamics shaping the scrap market over the next couple of years and how the potential global energy crisis may bring that timeline forward.

The historic relationship/correlation between Scrap and HRC broke down early in the rally as HRC significantly outpaced scrap and the metal spread broke above the previous record high. With such a long-standing relationship, it is assumed that the two markets will act largely in tandem as the gap between their prices collapse. Meaning the metal spread will converge because of a more dramatic decrease in HRC prices than in scrap. However, recent global and domestic developments point to a more supportive market for scrap than HRC. To start, the natural gas shortage is shaping up to cause severe decreases in economic activity and scrap generation in the Northern Hemisphere, specifically in Europe, the World’s largest exporter of ferrous scrap. The pandemic fast forwarded the inevitable in the steel market (e.g., mill consolidation, and demand for new homes, cars, and consumer goods). We anticipate this energy crisis will also expedite already existing trends for scrap. This includes regional restrictions for exports, and a global push towards increased EAF production (starting in China and expanding from there). While existing EAF’s have shown the ability to reduce costs by adjusting their mixes, an increase in demand and a decrease in free-flowing supply suggests the old rules may not apply to the market going forward.

What will this all mean for the U.S. domestic steel and scrap markets? Additional EAF furnaces are coming online domestically and will only intensify the higher sustained demand for scrap. Long running symbiotic relationships between mills and the manufacturing sector have left mills less exposed to spot market volatility historically because supply and demand was largely balanced. However, the relationship between both pricing and supply/demand has changed for the HRC and scrap markets. The ambiguity around where these prices will converge is a significant risk, but it is certain that higher scrap prices will give support to falling HRC.

The increased uncertainty around fair value for steel has the potential to lead to a more severe buyers strike. In 2020 when prices dipped below $500, there was very little room left to the downside, in large part because of the tightness of the metal spread. This provided buyers a higher level of confidence for when to start restocking. In our current market, a tightening of the metals spread will likely have the similar impact, but at these prices, the consequence of being wrong about the timing of purchases will have far more of an impact on your businesses balance sheet.