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Why steel companies benefit from lower scrap prices

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Mar. 20 2015, Updated 5:47 p.m. ET

Who uses steel scrap?

In the previous part, we saw the movement in iron ore prices. However, Steel Dynamics (STLD), and Nucor (NUE) use steel scrap to produce steel. This is because they produce steel through electric arc furnaces (or EAF).

U.S. Steel Corporation (X) mainly produces steel through traditional blast furnaces. However, it’s also considering producing steel through EAFs under its Carnegie Way transformation. You can read more about U.S. Steel’s transformation in our series U.S. Steel takes steps in transformation. Currently, U.S. Steel forms 2.86% of the SPDR S&P Metals and Mining ETF (XME).

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Scrap prices fall

The above chart shows the movement in steel scrap prices. As you can see, prices have corrected by more than 25% this year. Steel scrap prices fell by ~20% in 2014. Lower scrap prices should bring down the unit production costs for steel companies that use EAFs to produce steel.

Generally, steel scrap prices follow the trend of iron ore prices. Iron ore prices fell by more than half last year. However, steel scrap prices held steady. With the fall in steel scrap prices, unit production costs for steel companies using EAFs should come down. Nucor, Steel Dynamics (STLD), and AK Steel (AKS) would benefit from lower scrap prices.

Unit steel production costs have come down by ~$150 per ton for steelmakers that use blast furnaces. Most of the steel in China is produced using blast furnaces. Chinese steel companies benefit from lower iron ore prices.

Investors should watch the indicators of steel consumption. We’ll look at that in detail in our next part.

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