Is China’s lean toward scrap sustainable?

The closure of some induction furnaces in China in 2016 followed by the government’s crackdown on all unlicensed IFs in mid-2017 freed up some scrap volumes, albeit arguably of low-quality material.

Chinese domestic scrap prices came under pressure from the increased supply, which prevented them from keeping pace with the rise in steel and other raw material markets in the fourth quarter of 2016; they stayed depressed throughout the first half of last year. Only in June 2017 after China became a net scrap exporter did local prices finally start to pick up, as the first chart below shows. Scrap sellers had to export the surplus supply to tighten the local market even while domestic scrap consumption was growing.

We believe that China will continue to export scrap, albeit with some downside risks to this forecast, but it is the pace of further growth in domestic demand that is more uncertain. China seems to be on track to boost scrap consumption at the expense of iron ore and coke in the steelmaking process. Indeed, Metal Bulletin Research calculations indicate that Chinese scrap usage exceeded 130 million tonnes in 2017 compared with around 90 million tonnes in 2016 (we publish details of Chinese scrap market developments on a monthly basis in our Steel Scrap & Metallics Market Tracker).

The increased usage of ferrous scrap at integrated producers has filled the gap between crude steel and BF iron output, which had widened to as much as 121 million tonnes in 2017 from almost 89 million tonnes in 2016. Government environmental restrictions on Chinese iron output from mid-November 2017 to mid-March 2018 contributed to the trend. Indeed, while domestic steel production has continued to rise on a year-on-year basis, BF iron output declined over the winter.

Chinese scrap prices have not followed steel, rising only after exports started to soar

The widening gap between crude steel and pig iron output has been filled by rising scrap consumption in China

While not completely discounting China’s aspiration for more environment-friendly (i.e. scrap-based) steelmaking, we think that higher consumption of scrap instead of hot metal - a pattern that started several months before the winter cuts on iron production - is mainly a cost-driven issue. BOFs can raise scrap use to 30% and EAFs to 100% - but will they? As the charts show, scrap usage spiked when the material was cheaper than the estimated production cost of hot metal. By late 2017, scrap had regained its premium over hot metal: The weekly gap has averaged $25 per tonne over the past two months.

While cost-efficiency and availability initially boosted scrap demand in China, rising overseas consumption subsequently prompted sellers to raise prices. But with scrap prices now at a premium to iron, as was the case before the boost in scrap demand, we believe that scrap prices must now retreat; the speed of any corrections will largely reflect developments in primary iron. We forecast a lower trend in Chinese domestic heavy scrap prices for most of 2018. Exports, at 2.13 million tonnes in May-December last year, appear to be done out of necessity. But, as with billet trade in recent years, exports may fall should authorities increase their efforts to impose the existing 40% tariff on exports.

A notable trend during the export boom has been in imports. China imported 2.32 million tonnes of scrap in 2017, which was 8% higher than the previous year, with 79% of the total coming from Japan. This indicates a shortage of higher quality material in China for integrated steelmakers and simultaneously an oversupply of lower-quality scrap resulting from the shutdown of the induction mills.

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