Steel firms taking a massive bet on furnaces fed on cheaper scrap metal rather than more traditional iron ore could find themselves in trouble as scrap supplies become both more expensive and increasingly difficult to find. Around 40 percent of the world's new steel capacity being built this year will be in the form of electric arc furnaces, double the share built last year.
These so-called mini-mills are being forced to scour the world for new sources of scrap steel as traditional sellers like Japan and Russia reduce offers. Scrap prices have doubled this year and are set to rise further, and unlike larger blast furnaces, which rely mainly on iron ore bought under long-term contracts with prices agreed once a year, mini mills are exposed to the volatile spot market.
"Aggressive capacity expansion by mini mills globally from Turkey to Russia and to South Korea will push scrap prices higher and that means they will be exposed to great risks," said Moon Jung-up, an analyst at Daishin Securities. "They'll be able to pass on higher material costs, but when economies slow, it will be small mills, rather than bigger blast furnaces, who will be dealt a bigger blow."
The proponents of mini mills point out that they cost around a fifth as much as large mills to build, making it easier to add extra capacity to ease the current steel supply bottleneck. Companies with expansion plans include Korea's Hyundai Steel and Dongkuk, China's Baosteel and Shagang Group, Russia's Novolipetsk and Severstal and Turkey's Colakoglu, Samsung Securities said.
Bigger rivals like Nippon Steel and POSCO are still focused on blast furnace projects, with POSCO planning $12 billion integrated steel mill in India and $5 billion in Vietnam. Japan, along with the United States and Russia, has long been a major source of steel scrap, as its mature economy guarantees a relatively standardised and stable supply from used cars and electrical goods. But the Asian nation reduced exports of iron and steel scrap by 20 percent in May and June from a year ago, and quadrupled imports to meet strong domestic demand, according to the Japan Ferrous Raw Materials Association.
South Korea, the world's No 3 scrap importer, consequently boosted scrap imports from the United States by 60 percent between January and June. Purchases from countries such as the United Kingdom, Costa Rica, the Philippines and Dominican Republic surged from almost nothing to make up for a 13-percent fall in shipments from Japan, data from Korean trade body KITA showed.
"Mini mills are likely to increase their scrap purchases from such markets, as Asia is in short supply of recyclable metals due to strong steel demand and aggressive capacity expansion," said Chung Ji-yun, a CJ Investment & Securities analyst. That means steel mills in Asia may have to pay higher freight costs as they diversify suppliers to Latin America and Europe.
"Cost increases are something we are ready to accept because it is more important to diversify supply sources and secure stable contract deals when market conditions are so tight," said a major scrap importer in South Korea.
Their search for new scrap markets is also driven by concerns of falling supplies from the United States, the world's top scrap exporter, as its weaker economy could decrease consumer spending and slow scrap production from used durable goods. US auto sales plunged to a 16-year low in July in the longest monthly losing streak since the 2001 recession.
There is also speculation that Russia, the world's No 2 scrap exporter, may raise export duties to ensure domestic supply. "Such factors are likely to continue to bolster scrap prices, though they came off their record highs this month due to seasonal factors," said Lee Jong-hyung, an analyst at Dongbu Securities.
Average scrap prices in Japan, which quadrupled in three years, rose to a record above 68,000 yen ($618.5) per tonne last month, while US scrap prices also doubled this year to all-time highs, with the US composite scrap price index hitting a record above $523 in July. Other steel inputs also cost more, with iron ore up 380 percent and coal prices up seven-fold since 2001, while research firm CRU's steel price index has trebled over the same period.
But the impact of higher scrap prices on iron ore demand and blast furnaces is seen limited, as steel mills fed by iron ore still take a lion's share of around 70 percent in the global output and China, the world's top steel producer, is geared more toward blast furnace mills, analysts said.
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