The backdrop: Covid-19 induced scrap volatility
The United States' ferrous scrap market has whipsawed in recent months due to the pandemic's impact on global commodity prices, with No1 busheling in Chicago declining by $30 per gross ton in April trade before rebounding by $40 per ton in May.
Moreover, the price for ferrous scrap and that for oil generally trend together, Fastmarkets understands. And if recent oil news is a harbinger for scrap, then market participants are in for a wild ride.
Nymex’s West Texas Intermediate (WTI) light sweet crude oil futures contract, for example, settled at minus $37.63 per barrel on Monday April 20 - the first time the contract has ever settled in negative territory. In contrast, WTI futures settled at $33.25 per barrel on May 22, a difference of $70.88 in slightly more than one month.
“Over the past few months the Covid crisis has injected unprecedented uncertainty into the US domestic steel market, and the busheling market has been no exception,” according to steel derivatives expert Phillip Price, founder of Pool and the Board Report.
“For [electric-arc furnace] steelmakers, the disruption has been twofold: On the one hand, the contraction in manufacturing output caused by lockdowns has dramatically reduced demand,” Price said. “And, on the other, these same manufacturer outages have capped busheling supply. At face value, this supply restriction has risen to something of a shortage, which has been reflected by nearby prices at the front end of the CME busheling curve.”
This volatility was reflected in CME Group’s Midwest No1 busheling ferrous scrap futures trade, which surged to 3,940 lots in March and 5,078 lots in April from 1,238 and 951 lots in January and February respectively.
The dramatic escalation in busheling trade has been a function of increased price volatility, High Ridge Futures LLC industrial metals specialist Daniel Uslander said.
“The significant and sudden drop in capacity utilization at steel mills across the country and around the world drove the expectation that the immediate need for scrap would drop precipitously,” he told Fastmarkets. “Not long thereafter, the auto sector and other steel consumers started giving some clarity to when and to what degree they would restart.”
Crude steel production in the US totaled 1,191,000 net tons for the week ended May 23, with mills operating at an average capacity utilization rate of 53.2%. This is down dramatically from the equivalent week last year, when domestic producers churned out 1,880,000 tons at an average capacity utilization rate of 80.8%.
Globally, crude steel production across the 64 countries reporting to the World Steel Association totaled 137.1 million tonnes in April, down by 13% from 157.7 million tonnes in April 2019.
Uslander noted that while steel mills made substantial production cuts in response to weak demand, scrap flows into recyclers and processors also fell dramatically due to a decline in active job sites generating scrap and fewer drivers needed to move material into scrapyards. These factors combined to lower both scrap demand and availability.
“This influenced scrap prices in the opposite direction,” he added. “That is a formula for price movement, which in turn is an impetus to use futures markets."
The flow of scrap into recyclers' yards diminished, putting further pressure on No1 busheling consumers that were unable to offset lower industrial production of the product. Mills that rely on busheling have had a difficult time substituting the material with shredded scrap due to weak inbound flows, and also were unable to source plate and structural scrap because demolition jobs were put on hold after "stay at home" measures were implemented to contain the spread of Covid-19.
So while it appears that prime scrap dealers are currently in an advantageous position, Price said the dynamics could shift. He cited multiple import cargoes of No1 busheling and prime scrap substitutes that are heading for US shores, and could make landfall later this month and in June, along with the restart of production at major automobile plants. These could entice market participants to hedge their exposure to price volatility.
“Mills are working hard to adjust their melts wherever possible to reduce the concentration on busheling. This perceived near-term shortage, combined with medium-term uncertainty, is a perfect environment for increased futures market participation,” Price said. “In the [near term], those who are short are racing to get ahead of price increases, while those with a structural exposure to inventory of this material are starting to see attractive levels at which to mitigate their exposure to the market.”
Futures: Kneecap risk, lock-in margins
“Where there’s volatility there’s opportunity... We’re going to have a huge shortage of [busheling] for the next 60 days because the auto plants have pushed back their restarts. It doesn’t matter how much you raise your prices [if] the material isn’t out there,” one physical scrap dealer said.
“Normally, low demand means unsold supply and increased inventories while low supply would suggest robust demand and higher prices,” Uslander said. “Driven by [Covid-]19, we had a low demand, low supply environment, which provides an opportunity for a futures market to function as an instrument for price discovery.”
Financial tools, such as CME's busheling contract, offer scrap dealers a means to sidestep market volatility and utilize their knowledge of the physical market, Price noted.
“Undoubtedly, scrap dealers should consider trading the CME busheling futures contract - now more than ever. These market participants have unrivalled insight into movements in the spot market as they occur, but often do not have the means to take advantage of this edge,” Price said. “Now that the supply picture for busheling may be changing, futures provide ample opportunity for prime scrap generators - like service centers - to lock in aggressive price levels over the next few months."
Asked why scrap metal dealers might consider trading CME's busheling futures contract during a time of market turmoil, the dealer responded that “the scrap industry is a tough business. You need a wide range of weapons in your arsenal to survive. I’m not sure why more people don’t do it.”
Sean Barry in New York contributed to this report.
Physical market participants who buy or sell busheling scrap could capitalize on their knowledge of how the spot market moves during the current period of price volatility brought about by Covid-19, industry participants told Fastmarkets.