January/February 2016
Several negative economic trends combined in 2015 to create some of the worst scrap market conditions in a generation. With many of those trends expected to continue into 2016, recyclers are scanning the horizon for opportunities to develop new markets, improve efficiency, and recapture margins.
By Joe Pickard
Scrap commodity markets encountered a host of challenges last year, prompting recyclers to focus their gaze on the far reaches of the global marketplace in search of opportunity, and hope, for the future. Unfortunately, bullish scrap market indicators were nowhere to be found, given China’s slower growth and scrap demand, excess commodity production around the world, the stronger U.S. dollar, and continued transportation bottlenecks. The result was that in 2015, U.S. export sales of scrap had their worst year since 2006, and the ReMA Index—a weighted index of scrap metal and recovered paper prices—fell to the lowest year-end level since 2008.
Many of the market forces that hurt scrap company bottom lines and led to some firms either curtailing or closing operations in 2015 may remain in effect well into 2016. With Chinese financial market turmoil spreading to markets around the globe, crude oil prices plunging to the lowest levels in more than a decade, and nonferrous metals testing multiyear lows, it is far from clear when commodity and scrap prices will hit bottom. While few recyclers expect a sharp V-shaped recovery, many would welcome a return to more stable pricing, supply, and demand. Here’s a look at factors that could define the scrap marketplace in 2016, including some that might offer signs of life.
Houston, we have a supply problem. For better or worse, the scrap industry is still a commodity-based business, and commodities have been among the worst-performing asset classes for several years. In 2015, the Bloomberg Commodity Index—a basket of 22 commodities—was down 25 percent. One commodity in that index—oil—has a disproportionately large impact on other commodities as well as equities, currencies, and other assets. The major oil producers continue to pump out excess supply even in the face of cooling demand and plunging prices. Nymex crude oil futures have been trading at their lowest levels in more than a decade—and that’s before Iranian oil re-enters the global marketplace later this year.
Excess supply is not limited to oil, of course, as producers of everything from iron ore to copper to aluminum continue to generate more supply than demand requires. Even though prices for those commodities plunged in 2015, many major producers appear unwilling to scale back their investments. Copper producer Rio Tinto and its partners “have lined up a combined $4.4 billion from 20 lenders to fund the expansion of a Mongolian copper mine as the Anglo-Australian company continues to invest in big, new projects despite a rout in global commodity markets,” the Wall Street Journal reported in December. Although some companies—such as Freeport-McMoRan, Glencore, and Anglo-American—announced production cuts and debt-reduction plans in 2015, excess supply looks to be a recurring theme for commodities for a significant part of 2016.
For scrap recyclers, excess primary supply and falling prices affect the revenue they generate from scrap sales, the flow of obsolete material into their yards, and the attractiveness of scrap substitutes. Falling prices eventually should lead to diminished supply of both primary and secondary materials and a rebalancing of the market. But this business cycle hasn’t exactly gone according to plan, in part due to major producers’ willingness to sacrifice short-term profitability for long-term market share and in part due to what’s happening in China.
More of the same in China? What is happening in China today, and are its leaders up to handling its growing list of problems? According to the Financial Times, Glencore’s chief executive, Ivan Glasenberg, “regarded by many as the savviest trader of his generation, conceded that he could not read the Chinese economy and had been ‘surprised’ by the savage downturn in commodity prices.” Despite the collapse of metal prices last year, China is not a bust, Reuters said, though it called the nation “a confused and confusing reality.”
The recent turbulence in the Chinese stock market has only added to existing doubts about whether China can successfully manage both slower growth and a transition to a more consumption-based, environmentally friendly economy. While its economic blueprint for 2016 reportedly includes plans to eliminate excess industrial capacity, rein in financial market volatility, and reduce the overhang of unsold homes, investors remain unconvinced. Most analysts agree that manufacturing output in China is slowing, producer prices are falling, and economic growth could decelerate further in 2016. Goldman Sachs expects Chinese GDP growth to slip from 6.9 percent in 2015 to 6.4 percent in 2016.
Dollar strength and the Fed. The scrap industry and other manufacturers also are worrying about the effect of rising Federal Reserve rates on the U.S. dollar. A stronger dollar makes imports more competitive, U.S. scrap exports less competitive, and dollar-denominated commodities cheaper. While economic theory holds that higher real interest rates lead to currency appreciation, short-term foreign-exchange-rate movements are notoriously difficult to predict. It’s clear that the Fed now is moving in an opposite direction from other major central banks. As the European Central Bank and Bank of Japan continue to pump liquidity into their systems, the Fed began raising rates in December 2015 for the first time since 2006 and is expected to continue increasing rates into 2016.
For all the hand-wringing about the negative impacts of higher target federal fund rates, there are a couple of important mitigating factors to consider. First, exchange rates are determined not by current monetary conditions alone but also by expected future policy changes. Expectations for higher U.S. rates already have influenced the run-up in the dollar’s value. In addition, interest rates in the United States are still extremely low by historical standards and likely will remain so for an extended period. Any significant tightening of credit availability would have serious consequences for U.S. manufacturers and scrap processors, but the Fed does not appear to be in a hurry to raise rates quickly. Instead, its moves to dial back monetary stimulus in response to improving economic and labor-market conditions could instill greater confidence in the business community, which has viewed interest rates as too low for too long.
Signs of life. More than a few variables could continue to exert downward pressure on scrap markets in 2016. The slowdown in U.S. industrial production—which posted monthly declines in nine of the first 11 months of 2015, Fed data note—and the growing list of geopolitical risks could fuel additional market uncertainty and volatility this year. Although recyclers can’t control the forces that determine commodity prices, their efforts to improve their safety, quality, and operational efficiency should position them well for growth when this market downturn subsides.
The scrap industry’s pursuit of new markets overseas also is starting to bear fruit. U.S. ferrous scrap exports to India in the January-to-November period were up 88 percent by volume, year on year, while ferrous scrap exports to Bangladesh surged more than tenfold, Census Bureau figures indicate. In addition, trade agreements in the works could eliminate or lower barriers to trade, and lower transportation costs could lend support. Shipping industry data provider Alphaliner reports additional shipping capacity that’s equivalent to 1.7 million 20-foot containers entered the global fleet last year, holding down container rates. That could help boost the volume of world trade, which the International Monetary Fund projects will grow 4.1 percent in 2016, up from 3.2-percent growth in 2015.
Policymakers in Washington might even be fostering growth and removing sources of uncertainty through the recent transportation bill and spending agreements. Although the shifting political and economic winds pose considerable risks in 2016, scrap company operational gains and product diversification, new market development, and other investments should create a leaner, more profitable U.S. scrap industry going forward. What follows is a more detailed look at the factors that could affect selected scrap commodity markets this year.
Aluminum
At the start of 2015, the light metal appeared to have relatively bright prospects, as healthy transportation demand and logistical bottlenecks contributed to regional supply shortages and record Midwest physical market premiums. Commodity analysts took note, with Natixis Commodity Markets predicting that the average aluminum price would rise to $2,054 a mt in 2015. Instead, the average London Metal Exchange official three-month aluminum price slid 11 percent last year, to $1,680 a mt, even as aluminum stocks in LME warehouses plunged more than 1.3 million mt. Expected changes in LME warehouse load-out rate rules, rising interest rates, and excess production in China factored into the shifting supply situation and downward price trajectory.
Secondary aluminum prices followed terminal market prices lower as overseas aluminum scrap demand faltered. U.S. exports of aluminum scrap through November had declined 9 percent, year on year, as the 19-percent drop in Chinese demand more than offset higher shipments to Mexico, Malaysia, and Canada, Census Bureau data show. China’s bearish effect on the global aluminum market continues to overshadow positive demand prospects from the airline and automotive sectors. Alcoa (New York) projects China’s net aluminum capacity additions in 2016 could approach 1 million mt, threatening the viability of U.S. aluminum operations even as the industry pursues trade remedies against Chinese imports.
Copper
Throughout 2015, the LME official three-month copper asking price decreased 25 percent to end the year at $4,701 a mt. Slower Chinese demand, excess supply, a stronger dollar, and investor flight all contributed to the red metal’s price weakness last year. World apparent use of refined copper in the first nine months of 2015 declined 1.5 percent, including a 0.5-percent dip in China’s copper use, the International Copper Study Group says. In the same period, world refined copper production increased 1.5 percent, yielding a 35,000-mt copper supply surplus, ICSG reports.
Worries about China have destabilized copper market sentiment more than the modest copper supply surplus. Even with significant investments in its copper-intensive power grid, China’s manufacturing slowdown and increased reliance on copper ores and concentrates have hurt refined copper prices and copper scrap import demand. According to Census Bureau data, U.S. exports of copper scrap to mainland China decreased 8 percent by volume in the January-to-November period in 2015 compared with that period in 2014. Falling copper prices also reduce copper scrap availability, and many analysts expect the prices to stay “lower for longer.” The Chilean Copper Commission recently cut its 2016 average copper price forecast to $4,740 a mt.
Iron and Steel
Ferrous scrap prices were among the worst performing of the major scrap commodities in 2015. The monthly composite price for No. 1 HMS fell from $325.83 a gross ton in January to $150.17 in December, according to Scrap Price Bulletin. Scrap prices weren’t the only casualty along the ferrous supply chain, with The Steel Index reporting its benchmark China iron ore import price fell to “historic lows” around $37 a dry mt in December. The global iron ore market offers a case study in how a few large-scale producers can send prices spiraling downward, allowing ore-based Asian steel producers to flood global markets with excess steel, a problem the strong dollar has exacerbated.
As steel imports have crowded out demand for domestic steel, the U.S. steel capacity utilization rate dropped as low as 60.2 percent. While several high-profile steel trade cases and the recent price-induced shortage of obsolete scrap could provide some market support in the near term, the problems associated with excess global steel capacity persist. According to a recent report from The Steel Index, the OECD Steel Committee “has warned that excess steel capacity is set to grow further [in 2016], adding to the more than 500 million tons per year of surplus it estimates has been in place since 2008.”
Lead and Zinc
The prices of sister metals lead and zinc diverged sharply in 2015, as investor sentiment turned particularly negative on zinc in the second half of the year. Zinc prices slid 26 percent as world zinc production rose 5.2 percent from January to October, outstripping a 1.1-percent increase in zinc demand, the International Lead and Zinc Study Group says. Lead, meanwhile, experienced a 7.2-percent decrease in world refined production and a 7.4-percent decline in global demand in the same period, resulting in a minor 22,000-mt surplus, ILZSG says. Despite those fundamentals, lead prices slipped only 3.7 percent—the lowest dip among the major base metals.
Why did zinc fare so much worse than lead on the price front? Reduced demand for galvanized steel hurt zinc consumption, according to Fastmarkets. While the U.S. Department of Commerce’s preliminary countervailing duty ruling on corrosion-resistant steel imports from China, India, Italy, and South Korea could provide some relief for domestic producers, global market dynamics have prompted analysts to scale back their price forecasts. Macquarie Research projects average lead and zinc prices of $1,740 and $1,833 a mt, respectively, in 2016.
Nickel and Stainless Steel
The LME official three-month nickel asking price fell from $15,025 a mt at the end of 2014 to $8,700 as of Dec. 31, 2015, a loss of 42 percent and the worst performance among the major nonferrous metals. Concerns about rising nickel inventories and lackluster global stainless steel demand contributed to nickel’s price weakness, with nickel stocks in LME warehouses increasing sharply in December. Although nickel producers have reacted slowly to the price collapse, several analysts see a nearly balanced global nickel market going forward.
The International Nickel Study Group says world primary nickel use in 2016 will reach 1.965 million mt, exceeding nickel production in 2016 of just over 1.94 million mt, but the stagnant global stainless steel market has weighed on market sentiment. According to figures from the International Stainless Steel Forum, world stainless and heat-resistant steel production in the first nine months of 2015 slipped 0.5 percent, year on year, to 31.28 million mt, as lower output in Europe offset gains in the Americas and China. Given uncertain Chinese demand and seemingly adequate nickel supplies, Société Générale predicts an average nickel price of $12,500 a mt in 2016.
Paper and Recovered Fiber
Compared with scrap metal prices, recovered paper prices held up relatively well in the first three quarters of 2015. The PPI Pulp & Paper Week Recovered Paper Price Ticker held steady around $151 to $155 a ton from January to September before slumping to end the year at $140. Average OCC prices in the Southeast fell $12, to $90 a ton, FOB seller’s dock, while average OCC export prices off the West Coast declined $20 for the year, RISI says. On the domestic front, the American Forest & Paper Association reports U.S. paper and board production from January to November decreased 0.8 percent, year on year, to 72.5 million tons, as a 3.6-percent decline in paper production overshadowed a 0.9-percent increase in paperboard output.
As for overseas demand, U.S. recovered paper exports slipped to 1.68 million tons in November, the lowest level in nine months, Census Bureau figures show. But healthy demand from China, Thailand, and Vietnam pushed U.S. scrap paper exports in the first 11 months 3 percent higher, year on year, to 19.88 million tons. Quality concerns, Chinese demand, dollar strength, freight rates, and trade barriers will be key factors for paper recyclers to navigate this year.
Joe Pickard is chief economist and director of commodities for ISRI.