China's Increasing Scrap Usage in Steelmaking Likely to Face Headwinds

Since past few years consumption of ferrous scrap in steelmaking is gradually increasing in the world. Especially for worlds' largest producer China, these figures are more underlining. Rio Tinto - one of the world's largest miner has recently presented a report which talks about growing scrap supply in China. China's scrap supply is on uptrend and is expected to increase further in upcoming making it influencing dynamic for future steel making in the country.

According to CAMU statistics, Chinese scrap consumption in 2017 has reached 148 MnT prompting a dramatic increase in the proportion of steel scrap used in the country's steel production to 17.8%.

Although country's environmental aspirations support scrap consumption, there are various headwinds which are limiting the usage of scrap in China.

1. Scrap to iron ore price ratio has risen to historic highs on increased scrap usage - Increasing usage of scrap in BOF has increased 'scrap to iron ore' price ratio to historic high levels since past five years. According to report, this ratio was around 1.5 in the beginning of CY13 which gradually increased upto 3.5 in the beginning of CY16. After witnessing bottom at 1.5 again in the beginning of CY17, it has abruptly increased above 3-3.2 levels during first quarter 2018. Thus, higher costing of scrap-based steelmaking compelled Chinese steelmakers to prefer BOF route in 2018. During CY16, the average domestic ferrous scrap purchase price in China was approximately at USD 250/MT (RMB 1600) while in 2017, the average domestic ferrous scrap purchase price raised at USD 288/MT (RMB 1840).

2. Bottlenecks associated with scrap handling and transport - Although China is stepping towards automation in order to cut labor cost and investing more in the machine than man. There is still large room for developing scrap handling machinery and processing facilities. Many of the steel plants are actively planning to overcome the bottlenecks in this process however, recycling industry hardly to develop so fast to make it self-sufficient less than 2 years which is affecting the current consumption and processing of scrap in the country.

3. Higher electricity costs hurdle in EAF production - Chinese steelmakers are suffering from higher electricity costs which restrict EAF production in the country. This is affecting the development of new EAF facilities in the country which also impact the usage of ferrous scrap in Chinese steelmaking.

4. Fall in pig iron production may push its imports in China - Although hot metal/pig iron production in China was limited on stricter environmental regulations, imports of pig iron may get lift again looking at higher profit margins.

In past, major exporters of merchant pig iron to China were Russia, Ukraine, Brazil and Japan. According to reports, Chinese pig iron imports dropped significantly in the first quarter of 2018. Average quarterly imports in China fell to 45,000 MT levels during years CY14-17 which was earlier averaged at 170,000 MT during CY10-13. An estimated size of China's pig iron import market shrank in 2018 due to market liquidity as against 2.6 MnT during 2014-16. But imports may revive now as prices become attractive and competitive versus ferrous scrap. The average price gap between Chinese domestic HMS scrap and pig iron imports fell to USD 15-20/MT in CY18 as against USD 85-90/MT last year.

5. Scrap quality of Chinese local scrap is low as compared to imported - Low quality of Chinese local scrap as compared with imported makes it less preferable for many Chinese steelmakers. Few steel mills import premium quality scrap from major suppliers like Japan, USA and Australia to mix with low-grade local scrap in steel making. China imports around 2-2.5 MnT scrap annually.

6. Govt is ambitious about a complete ban on scrap imports - Particularly in last one year, the widening gap between iron output and crude steel production has been filled by higher consumption of relatively cheap and widely available scrap. However, the Chinese government is now ambitious about a complete ban on metal scrap imports in the country by next 2-3 years and it has already banned 32 types of scrap imports in the country. If it implements a complete ban on scrap imports then the market will observe supply shifts along with pressurized prices.

Although scrap ratio increased upto 18-20% in recent years there is a limit on scrap intake by basic-oxygen furnaces (BOFs) and huge investments into new electric-arc furnaces (EAFs) will take time. In 2017, the actual output of China's electric furnace steel was about 62.4 MnT, accounting for just 7.5% of the total crude steel output.