HRC prices continued to rally last week, with spot prices moving firmly above $550 and upside momentum intact. ArcelorMittal “unofficially” announced a price increase last week, targeting $600 HRC. Nucor and other mini mills followed, but the market consensus was that the spot prices was slightly below that level. On Monday, US Steel officially announced a $60/st increase, solidifying the new spot price at $600. Despite increased volatility in the price, activity in the spot market at mills has been depressed for two main reasons:

1. Prices have moved up so fast that buyers are even more skeptical and/or business is no longer viable with these higher input costs – spot prices are up over $120/st in just 6 weeks
2. Lead times have been pushed out so far that buying from the mills does not fill current needs

This pushes those buyers who are willing and able to pay higher prices to service centers that are able to deliver the needed inventory quickly. However, this drives inventory levels across the supply chain down, as mills are still producing at reduced rates, and continues to support the price rally. This week, we will dive into additional factors needed to push prices above $600, which was the peak price in the two previous price cycles of 2019.

To understand the current price rally, we must first examine the dislocations created during the coronavirus pandemic that laid the foundation for this upcycle. As mentioned above, domestic production and utilization rates remain depressed, after mills took drastic steps in the spring to match supply with diminished demand. Another dislocation, which is related to production levels, was the collapse of the metals spread – HRC price minus scrap price. As global commodity prices, including US HRC prices, plummeted in the spring, scrap prices actually increased as limited steel scrap was created due to the economic shutdowns. This pushed the metal spread significantly below the historical average until just recently when the relationship normalized. The China export price differential was has also normalized after its recent dislocation. The below chart of this historical differential shows the domestic HRC price minus the China export price, including transportation costs.

The origin, nature and spread of Covid-19 in itself create geographic dislocations that uniquely influence numerous industries and prices. While the Chinese economy was the first economy affected by the pandemic, it was also the first, and quickest, to recover. The recovery has been substantial, and specific stimulus measures considerably supported the industrial metals sector recovery i.e. steel prices. However, domestic prices continued to fall throughout the summer, creating an abnormal convergence in price. Over the past few weeks, this relationship has normalized closer to its historical average, signaling that factors that historically drove the domestic price may be returning to importance. This brings us to the question – What is needed to drive prices above $600? Based on these normalized relationships, we see further increases in scrap prices, continued global HRC price strength, and restocking across the domestic supply chain as the most important conditions needed to push prices higher. However, there are prevalent downside risk, centered around dislocations that have not yet normalized. Specifically, it will be difficult for prices to continue significantly higher if production levels return to the pre-pandemic levels, and if supply chain disruptions ease, driving commodity prices, namely iron ore, back down to sustainable levels.