STEEL May 2017
China's Cheap Scrap

China’s crackdown on Induction Furnaces may remove up to 50Mtpa of production from mid-2017. An excess of scrap availability may shake up scrap pricing and use within the industry. A successful removal of Induction Furnace production may be a double win for China’s BF & EAF production.

The true magnitude of Induction Furnace steel production in China is unknown. Estimates range from 100–150Mtpa of capacity and 20–50Mtpa of production. We estimate the capacity and production to be at the lower end of these ranges. A successful removal of this production by mid-2017 may release a flood of excess scrap onto the market, lowering prices. Additionally, this will increase China’s reliance on BOF and EAF production, improving efficiencies.

 

Why Remove Induction Furnace Production?

Induction Furnace (IF) steel producers are being targeted in the latest of a series of supply-side structural reforms being implemented by the Chinese Government. IF production is often considered a “backyard operation” with many operating without proper approvals or oversight. IF operations are typically small, averaging less than 100ktpa. We estimate there is currently around 100–120Mtpa of IF production in China, producing 20–30Mtpa. Despite lacking economies of scale, IF’s can compete due to low domestic scrap and consumable prices, relatively low power requirements, and high product yields. IFs are being targeted as they are considered to produce sub-quality products, and the difficulty in regulating then makes it difficult for the government to meet its restructuring and capacity removal targets.

Scrap steel is the primary feed stock for an IF, and if the government follows through on their promise to cut all IF capacity by June 2017, then an additional 30-50Mtpa of scrap could flood the Chinese market this year, flowing through the global supply chain.

 

 

 

The Scrap Pool

A nation’s “scrap pool” is a function of its steel consumption over time, and scrap is often split into 3 categories—Home, Prompt and Obsolete. Home scrap is generated within the steel making process, Prompt scrap is generated in downstream manufacturing processes, and Obsolete scrap is what is collected once steel products reach the end of their useful life. The recycling of home scrap is immediate, and prompt scrap is usually recycled within a year. The percentage of obsolete scrap that is recycled is dependent on local recycling networks developed over time by scrap merchants. The majority of the growth in Chinese scrap is expected to be in the form of obsolete scrap, coming from ageing infrastructure, and first generation Chinese steel products which are approaching the end of their life. As shown in the figure below, AME believes that the amount of scrap used in crude steel production globally will grow moderately over the next 10 years as the majority of new capacity is forecast to come from BOF technologies, putting increased pressure on scrap merchants.

AME expects that the Chinese domestic scrap supply will begin to rapidly increase from 2020, fueled by obsolete scrap that will form a larger share of China’s scrap pool. While China has publicly stated several times that it wants scrap to make up 30% of its iron feed by 2030, we don’t believe this will be achieved. Our assumption is that China will focus on building further out from city centres and duplicate infrastructure where needed, as opposed to tearing down and rebuilding. If this eventuates, then an obsolete scrap oversupply caused by the shutdown of IF production would likely be a short-term issue only. Notwithstanding IF’s currently play a crucial role in absorbing domestically generated Chinese scrap. In late April, there has been some signs of low-priced Chinese scrap being offered on the seaborne market despite exporters having to pay a 40% tariff.

Developing countries generally do not have access to a reliable scrap supply or a coordinated distribution network, and is a major factor why greenfield steel projects in emerging countries such as Vietnam and India are mainly selecting vertically integrated BF-BOF operations. Developed economies such as the US and EU-15 nations have vastly different steel industries when compared to that of China. In the US, EAF’s technologies are expected to account for two-thirds of its total crude steel output in 2017. As such, efficient scrap distribution networks already exist in most developed regions resulting in high recycling rates. China will be looking at these mature industries as a template for its own development.

 

Can China Make Use of Its Scrap Pool?

If Chinese steelmakers cannot absorb the excess scrap that it likely to come into the market in the short-term, the government may temporarily reduce or remove export tariffs that would flow through to scrap steel prices globally. In the short-term, We expect that the scrap oversupply in China will flow into the global market, but over the longer-term, growth in obsolete scrap production will be lower than forecast, returning the market to a more stable equilibrium. Additionally, China still has a long way to go in creating recycling and distribution networks to take advantage of what obsolete scrap does become available going forward.