Steel production is raw material intensive in nature. Globally, iron ore is primarily used to produce steel. Steel scrap is widely used in the US. The country is also the second-largest steel scrap exporter. Most of its steel scrap shipments are to Turkey. While global steel prices, especially in China, generally follow iron ore prices, US steel prices and steel scrap prices tend to move in tandem with each other. We’ve also seen steel buyers hold back their purchases if they anticipate a downward correction in steel scrap prices (XME).
In 3Q17, as was the case the previous quarter, steel prices didn’t keep pace with steel scrap prices. Since Steel Dynamics (STLD) and Nucor (NUE) primarily use steel scrap, their margins took a hit due to the disproportionate rise in steel scrap prices. Both of these companies gave a lower-than-expected 3Q17 guidance. The companies blamed margin compression due to higher steel scrap prices (X) (AKS).
We’ve seen some moderation in steel scrap prices. According to Platts, some of the mills recently canceled their undelivered scrap orders. The report also states that “Mills generally only cancel undelivered scrap when they believe they can buy it back the following month for less money.” In Should US Steelmakers Be Asking for More? we noted that steel scrap prices might have run ahead of their fundamentals.
Could we see weakness in US steel prices as a result of lower scrap prices? We’ll discuss this more in the next part.