January/February 1992
While copper scrap prices have resisted any major declines through the last four years, scrap availability and industry profits have been dwindling. Here are some explanations why.
By Frederick D'Agostino
Frederick D'Agostino is a Rye, N.Y.-based consultant to the copper industry.
For the past 12 months, while the overall copper market has remained entrenched in an unprecedented four-year price rally, a remarkable depression has settled over the U.S. copper scrap industry: The volume of metal available to the trade has declined dramatically, and profit margins all along the line—from the peddler to the consumer—have just about vanished.
Experiencing tough times is certainly not new to copper scrap recyclers. Since the era of peddlers with horse-drawn carts, every decade has presented the copper scrap industry with troublesome, as well as profitable, periods.
What is surprising about the current predicament is that it's come at a time of good copper prices. In the scrap market, previous setbacks in profit and volume have always occurred either during periods of declining prices or shortly after such declines when values remained at relatively low levels. In fact, when copper trades at 50 or 60 cents per pound, industry participants generally expect minimal volumes and break-even business. Today, for the first time in history, this situation is taking place with prices at the $1-plus level.
This condition has sparked a number of questions in the minds of copper scrap executives, who are asking: Where is the scrap? Where are the profits? And why aren't volumes and margins reflecting positive prices?
Breaking the Trend
There are several interwoven answers to all three. The lack of scrap at the processing level, for example, can be attributed to a variety of factors. The first emanates from the recent change in the historic pattern of copper prices. For more than 80 years, the movement of copper prices seemed fixed in its regularity. Typically, values would languish at low levels for six or seven years, rally sharply for a year or two, and then fall back to the previous low level.
Scrap processors were well aware of this pattern and acted accordingly: During low price periods, for every 2 pounds of metal purchased, 1 pound was sold and the other was placed in inventory. When prices exploded, inventories were liquidated and a portion of retained earnings was set aside to prepare for the next phase of inventory accumulation.
This sequence has now been broken. Since 1987, when prices rallied more than 60 cents in less than seven months, copper has effectively remained above the $1-per-pound level. Inventories acquired during the lean years of the 1980s have all been liquidated, and no accumulation phase has ensued.
And with prices remaining at lofty levels, processors have had no incentives to withhold metal from the marketplace. In fact, the fear of a sudden and drastic price decline has all but guaranteed that incoming metal is processed and sold as quickly as possible.
The net result of this change in pattern is that, regardless of price, most processors and brokers are unable to sell more than one or two trailerloads at a time.
No Spending, No Scrap
The economic recession that has been pounding on the nation since spring 1990 can also be blamed for today's lack of copper scrap in the system. Although statisticians in Washington, D.C., have categorized this current downturn as "mild," the balance sheets and income statements of most of the scrap industry clearly indicate otherwise. What has really devastated copper scrap availability, however, is the effect the recession has had on individual spending.
Whether because of unemployment, the fear of losing their jobs, or other factors, the American public has steadfastly refused to spend. Despite the fact that interest and inflation rates have plunged to their lowest levels in more than a decade, the priority among today's public seems to be the reduction of debt, not the acquisition of new products.
While every recession is likely to result in declining industrial production and, thus, diminished generation of new scrap, the current economic situation has had a double blow on the flow of copper scrap. The public-spending-driven recession has reduced the flow of both new and old scrap in two of the most important industries affecting the copper market: automotive and home construction.
The reason for this is simple: Rather than scrapping their current automobiles (generating old scrap) and purchasing new cars (generating new scrap), individuals seem to have chosen to repair and retain their older vehicles. Furthering this trend are the auto manufacturers themselves, who are building cars that last longer, offering longer warranties, and (last but not least) creating massive "sticker shock" with new-car prices.
The same reasoning applies to the housing market. Individuals are choosing to repair their old homes instead of demolishing them (generating old scrap) and building new ones (generating new scrap). Thus, until the American public returns to the market, literally creating scrap, processors and brokers will continue to experience great difficulty in acquiring material, regardless of price.
The Cost of Efficiency
Another explanation for the current shortage of copper scrap is increased manufacturing efficiency, resulting in less new scrap generation. In the 1950s and early 1960s, worldwide manufacture of consumer goods, durables, farm equipment, machine tools, and a host of other industrial products was firmly in the hands of American companies. During that period of near-monopoly by U.S. manufacturers, the amount and value of scrap generated held little concern for these corporations. The fact that copper prices averaged approximately 50 cents per pound did little to alter this indifference.
What has occurred since that time, however, has certainly swayed U.S. manufacturers' view of new scrap generation. In the past few decades, European and Far Eastern firms have effectively competed for and acquired significant market shares in practically every major product group manufactured today. Responding to this competition, U.S. companies have sought to lower their costs through a variety of means, including decreasing payrolls, slashing debt, installing more modern equipment, and reducing their scrap generation. In fact, according to some estimates, the amount of copper scrap generated by U.S. industry has declined by more than 50 percent per manufactured item over the last 20 years. Furthermore, many of these firms have introduced techniques to reuse internally most of the scrap formerly available to the processor/broker market.
While the first two factors cited here for the current scarcity of copper scrap seem likely to turn around, the competitive pressures on manufacturers worldwide to continue to reduce—if not eliminate entirely—the amount of scrap generated on the production line are unlikely to cease. In fact, though copper values are apt to decline at some point to a level that will enable many scrap processors to restock their inventories without fear, and the current recession will eventually end, leading the public back to normal spending habits, the trend toward manufacturing efficiency is certain to increase in the future.
A Maturing Industry
Vanishing copper scrap profits can be explained, in part, through economic reasoning: When the demand for a commodity remains relatively fixed while supply diminishes, the result is always higher prices, reduced spreads, and reduced profits for all but those with that commodity in their "back pocket." This is precisely the current situation in the primary and scrap copper industries, where, with the exception of the producers that own the mines, every participant has seen both margins and profits decline dramatically during the past two years.
Perhaps the most far-reaching cause for today's decline in spreads, however, is the distinctive level of maturity the copper scrap industry has finally achieved. For example, current metal prices, once strictly the provence of metal merchants, are now standard tools throughout the industry. Quote screens providing up-to-the-minute data from commodity exchanges in New York and London can be found in practically every copper scrap processor's and consumer's office. In addition, processors are well aware of the "basis" or spread between the scrap price and that of refined metal, whether in the spot or futures markets. The result of this knowledge is that opportunities to buy cheaply—thus maintaining wide margins—are rapidly disappearing.
If the maturation of the copper scrap industry follows a pattern set by other maturing industries, "growing up" could result in a decline in the number of levels of trade and in the number of participants involved. The automotive industry is a good example of this phenomenon: Less than three generations ago, there were more than 30 domestic automobile manufacturers in the United States; today, there are only three. Competitive pressures, the economics of scale, superior management, and similar factors related to the industry's maturation forced into merger or disappearance those firms unable or unwilling to survive.
This shrinking of the number and types of players is already occurring in the copper scrap industry. Since 1950, for example, the number of copper ingot manufacturers has dipped from more than 50 to only a dozen or so. In the same period, the number of metal merchants has declined by more than 75 percent, to fewer than 20. It seems inevitable that this process will evolve to the processor level.
Those firms that are clever, well-managed, well-financed, and willing to take steps to remain viable, however, should survive to once again see profits return to reasonable levels. Those that aren't will not have time and history on their side and could pay the consequences. As General Patton once said, "Lead, follow, or get out of the way." •
While copper scrap prices have resisted any major declines through the last four years, scrap availability and industry profits have been dwindling. Here are some explanations why.