How Post-2008 Ferrous Scrap Price Crash Colors 2014 Outlook

In 2014, profound changes in the US steel sector are expected and along with them, significant consequences as well.

Federal monetary policy, sluggish economic recovery and lack of cohesion between the steel mills and buyers are some of the key factors contributing to the changes. As the new quarter and year has just begun, intense negotiations between mills and large consumers are under way for new contracts for the upcoming quarter and year.

The announcement by major mills of discontinuing the practice of discounting on the CRU index (commonly referred to as “CRU-minus” in the market) has raised many questions among consumers.

How About Some Background?
Steel contracts in the US (between mills and service centers and between mills and large consumers) have witnessed a lot of changes over the past five years.

The economic recession of 2008 and the subsequent recovery was the starting point for the series of these changes. Increased volatility in raw material cost for mills prompted them to shorten the contract periods. Beginning from early 2009, steel mills have gradually migrated away from long-duration fixed price contracts to more flexible short-term pricing models.

Onset of the Changes
The economic depression of 2008 had a profound and long-term impact on the steel market and its consequence triggered the changes in pricing models.

The US steel mills operated at a utilization rate of over 85% in the 2007-08, and this supported ferrous scrap prices. Price of scrap reached a peak of US $510 per ton by Q2 2008, on the back of strong demand from steel mills. However, the onset of the recession led to mills lowering their production and this was reflected in the subsequent scrap price.

Price of scrap fell to US $123 per ton, a 75% fall in a period of just over four months. This steep fall in the ferrous scrap price was a never-before-seen phenomenon. Following this steep fall, the pre-recession stability in ferrous scrap prices was replaced with volatility.

Steel Price Volatility
Increased volatility in ferrous scrap prices resulted in varying input costs for the US steel mills. The gradual post-recession recovery in demand led to lower revenue, compounding further the plight of the steel mills.

This meant that steel mills were no longer in a position to commit to fixed long-term prices with their customers. Varying raw material cost and weak market conditions resulted in mills adopting a more flexible approach in their pricing mechanisms with customers. Mills replaced 1-2 year long fixed price contracts with 6-months fixed price contracts.

The practice of linking the selling price to market price also took off, as mills started incorporating index linked pricing mechanisms:

by Badri Narayanan