METALSwww.platts.com/metals

AUGUST 2016Jarek Mlodziejewski Stefan SwanepoelTerry Chuay

www.thesteelindex.com

TSI MarkeT WaTch: Ferrous scrap – adapting to change

SPECIAL REPORT: METALS TSI MarkeT WaTch: FerrouS Scrap – adapTIng To change

2© 2016 S&P Global Platts, a division of S&P Global. All rights reserved.

Steel and ferrous raw material trading is a difficult matter at the best of times. Add price volatility, substitutable products and a highly price sensitive market, and it becomes even more challenging. Turkey, with a geographical location straddling Europe and Asia, a steel industry weighted towards steel production via the Electric Arc Furnace (EAF) route and a rich trading history, is a key customer for many in ferrous scrap. However, what happens when Turkey starts to look to alternative methods in producing its finished steel products? How will the established upstream and downstream industries cope?

Price (in)elasticity of scrapTurkey is the world’s largest importer of ferrous scrap. In 2015 it imported 16.3 million tonnes (mt) of ferrous scrap, while the next largest importer, India, imported a mere 6.2 mt. This places Turkey as the central driver for global seaborne scrap prices, so any impact on Turkey sends tremors throughout the world scrap industry. However, the EAF production method has been all but bypassed by global steel superpower China, whose preference for Blast Furnace (BF) technology means it predominantly consumes iron ore and coking coal, rather than scrap. Hence, 2015 proved to be a difficult year for the Turkish steel industry as plunging virgin raw material prices and a flood of finished products from resultantly lower-cost mills in China and CIS countries added to the competition that Turkish producers face in steel export markets.

The rising scrap-iron ore ratio (the relative cost to extract one unit of iron using scrap versus that of iron ore) above illustrates the difficulty the scrap industry faces as it became more cost effective to produce steel via the BF route. Whilst the ratio has been slowly increasing over time, the rise accelerated in late 2014, early 2015 as iron ore became cheaper and cheaper, relative to scrap. This lead to Turkish scrap imports falling in 2015, as EAF producers in Turkey found that it more cost-effective to source semi-finished steel such as billet from BF producers in China and the CIS countries, and then re-roll it into finished steel products such as rebar. Yet despite the cost of iron (FE) units produced via scrap continuing to rise relative to iron ore, whilst scrap prices are being pressured lower, they are not relative to iron ore. Indeed, as the graph below illustrates, Fe units sourced via scrap rose over 39% in the second quarter 2016 versus the first quarter, compared with a relatively paltry 15% for iron ore. Whilst Turkey does indeed produce some steel via the BF route, the majority of its hot metal comes from the melting down of ferrous scrap in an EAF.

The price of scrap, delivered Turkey, is shown to be relatively inelastic as the easy availability of BF produced semi-finished steel allows producers to cut down their scrap imports and re-roll rebar. Scrap exporters in the EU and US will have to either drive the cost of scrap (relative to BF raw materials) downwards or accept diminishing demand from not just their largest export market, but all their buyers. The recycling industry is clearly in pain as ferrous scrap prices fall, but the prices of other recovered metals (copper/aluminum) are also well off their highs. Recyclers opportunities for cross-subsiding ‘loss-leaders’ are diminished in today’s market.

enter the LMe scrap contractIn November 2015, the London Metal Exchange (LME) launched a new cash-settled steel contract, The Steel Index’s (TSI) CFR Iskenderun Port Turkey scrap index. The contract was launched with considerable industry support

This contract was put in place with a view to helping manage the volatility and risk that the scrap industry and by extension, the EAF producers, were experiencing every year. To-date, the

LME SCRAP VOLUMES

0

10

20

30

40

50

60

70

Aug-16*Jul-16Jun-16May-16Apr-16Mar-16Feb-16Jan-16Dec-15Nov-15

(’000 mt)

* as of Aug 19thSource: LME

SCRAP IRON ORE RATIO VS SCRAP IMPORTS

1

2

3

4

201620152014201320122011

($/Fe)

Source: TSI, Turkish Statistical Institute

Scrap/Iron ore ratio (left)Scrap imports (right)Linear

(million mt)

1

2

3

4

STEEL RAW MATERIAL PRICES

-100

0

100

200

300

201620152014201320122011

($)

Source: TSI

FOB Turkey rebar - CFR Turkey billet spreadFOB Turkey rebar - CFR scrap spreadLinear

Margins are improving as �rms import billet, roll into rebar and export...

...but falling if you importscrap and export rebar

TURKISH STEEL MARGINS

100

200

300

400

500

201620152014

($)

Source: TSI, Platts

Scrap HMS #1&2 80:20 CFR Turkey Blast furnace inputs

SPECIAL REPORT: METALS TSI MarkeT WaTch: FerrouS Scrap – adapTIng To change

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scrap contract has cumulatively traded over 140,000 tonnes, with steel mills and scrap recyclers taking part. The ability to hedge 15 months out has allowed steel mills fix input costs, regardless of what happens in their day-to-day spot business. Financial players such as LME member Goldman Sachs are a key source of liquidity for new contracts as well as firms looking to hedge their physical exposure

With strong correlations across the world’s steel scrap markets (see table above), recyclers, traders and end-users around the

world are able to use the LME contract to hedge their price exposures, shielding them from the effects of volatility, whether the international scrap spot markets rise or fall.

What is the background to TSI’s cFr Turkey scrap index?The TSI index has been published since 2010. It is widely viewed by recyclers, traders and end-users across Asia, North America and Europe as a proxy for the international bulk ferrous scrap trade. It is listed on London Clearing House (LCH), Istanbul Borsa and The London Metal Exchange (LME).

seaborne scrap correlations cFr Turkey cFr India cFr Taiwan containerised US domestic shredded hMS #1&2 80:20 containerised shredded hMS #1&2 80:20 mid-westCFR Turkey HMS #1&2 80:20 100% 95% 96% 94%CFR India containerised shredded 95% 100% 94% 90%CFR Taiwan containerised HMS #1&2 80:20 96% 94% 100% 91%US domestic shredded mid-west 94% 90% 91% 100%

Source: TSI