Do oil prices still correlate with scrap and steel?

It is common for steel market participants to refer to high correlations between oil prices and the prices for scrap and steel. Among other reasons, this is related to supply chains, because the oil industry is a consumer of steel, the price of oil affects the processing and transportation costs of scrap, and oil is viewed as a reflection of a broader economic reality.

As our first chart below illustrates, at a first glance, the West Texas Intermediate (WTI) oil benchmark price appears to move together with the steel and scrap price series, as represented by the hot-rolled coil (HRC) index, fob mill US, and the steel scrap No1 busheling, consumer buying price, delivered mill Chicago, respectively.

The chart illustrates normalized values for monthly average prices since the beginning of 2000, or z-scores. This shows how many standard deviations a data point is from the mean, allowing us to place all the series on one scale.

Despite following similar trends, oil and steel prices have been changing at noticeably different magnitudes, which is also confirmed by the analysis of first differences.

A closer look at the correlations reveals that scrap is even more strongly correlated with oil than is steel. Over the period from the beginning of 2000 into the first half of 2020, correlations between HRC and busheling prices in the US versus the oil benchmark amounted to 76% and 84% respectively. Our analysis shows that there is no time lag, and the correlations are strongest in real time.

As our second chart highlights, however, the relationships between the price series have not been consistent over time. There was a significant drop in the period after the 2008 financial crisis, and an annual breakdown reveals even more inconsistencies.

There are a few significant reasons why the relationships between the oil and steel prices broke down from 2009 onward.

First, steel prices have been affected by a flow of lower-priced imports. And later, as a response to that, there was a rise in trade protection measures in the US, which somewhat shielded steel prices by reducing competition from imports.

Second, oil, being a more liquid market than steel, probably reacted more strongly to the financial crisis.

As a result, correlations for oil versus steel and scrap in the US fell from 75% and 86% during the five-year period 2005-09, to 42% and 28% in the following five years.

As the chart also shows, the situation has recovered since then, but has yet to return to the scenario seen in the early 2000s.

With regard to scrap, post-crisis years have revealed an increased dependency in the US on ferrous scrap sales to Turkey, introducing another important factor that affects US domestic scrap prices.

The share taken by Turkey of total US ferrous scrap exports has risen from 16% in 2009 to consistently above 20% ever since, peaking as high as 31% in 2015.