How Low Can Iron Ore Prices Go from Here?
(Continued from Prior Part)
Scrap steel
While lower iron ore demand by China is one of the biggest reasons for seaborne iron ore miners to worry about, there is one more potential threat to the Chinese iron ore demand—scrap supply. These miners include BHP Billiton (BHP) (BBL), Rio Tinto (RIO), Vale SA (VALE), and Cliffs Natural Resources’ (CLF) Asia–Pacific division. CLF forms 4% of the SPDR S&P Metals and Mining ETF (XME).
So far, the scrap supply has not played any significant role in the Chinese steel industry. Right now, the majority of the steel in China is produced using blast furnaces. The current proportion of scrap used in blast furnaces is just 8% while according to global standards, the scrap usage in blast furnaces can be as high as 20%. This means in the short term, scrap usage can increase in China without any need for building electric arc furnaces.
BHP has forecasted a rise in China’s scrap ratio to around 20% by 2020 and to around 30%–39% by 2030.
RIO also expects scrap to displace iron ore to some extent as Chinese scrap triples over the next 15 years. The total increase in obsolete scrap should displace ~130 million tons of iron ore demand by 2030.
Decision to use scrap versus iron ore
The decision for using scrap versus iron ore to produce steel depends upon the relative prices. According to Mineral Value Service, “The price to a Chinese coastal mill of producing one tonne of pig iron (including cost and freight of all iron ores, coking coals, sintering and pelletizing costs) is currently higher than benchmark scrap price (Platts Heavy Delivered mill Jiangsu Scrap) inside the country.”
According to the World Steel Association, an electric arc furnace uses on an average 880 kilograms (or kg) of recycled steel, 16 kg of coal, and 64 kg of limestone compared to a blast furnace, which uses 1,400 kg of iron ore, 800 kg of coal, 300 kg of limestone, and 120 kg of recycled steel to produce 1,000 kg of crude steel. The recent narrowing of spreads (as reported by Mineral Value Service) between pig iron and scrap, if sustained, could motivate steel producers to prepare for the future and install the infrastructure needed to use scrap steel.
Not a near-term threat
The steel used by Chinese consumers in the boom period might come back to the market in the form of scrap. While automobiles can be recycled every 10–15 years, the steel used in construction and infrastructure takes much longer, at 40–50 years, to be recycled. The Chinese government is putting in place scrap collection and sorting facilities to collect scrap. According to market experts, close to 200 million tons of scrap could be generated within China by 2020.
While scrap usage is not a near-term threat to iron ore miners, a key point is that once scrap generation starts accelerating, it will become increasingly more economical—as well as a more environmentally friendly form of raw material—to produce steel with the potential to displace some of the seaborne iron ore demand.
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