An oversupply of ferrous scrap in the Chinese market following a government clampdown on the production of substandard steel is affecting iron ore consumption among mills that use blast furnaces, according to market participants.
Producers of substandard steel typically operate induction furnaces, which use ferrous scrap as their main raw material.
As one by one of these induction furnaces get shut down by the authorities ahead of a June 30 deadline set by China’s top economic planner, scrap supply in the country increased, putting pressure on prices.
In the span of three months, China’s largest ferrous scrap consumer Shagang lowered its scrap purchase prices by a total of 350 yuan ($51) per tonne, culminating in a ten-month low of 1,470 yuan ($216) per tonne on May 16.
The drop in scrap prices so far this year is somewhat weighing on iron ore prices, which rose to a 2.5-year high in mid-February.
Metal Bulletin’s 62% Fe Iron Ore Index stood at $54.41 per tonne cfr on Friday June 9, down from $94.86 per tonne cfr China on February 21.
Scrap usage
Most Chinese mills produce hot metal using iron ore in blast furnaces (BFs).
This hot metal is then channelled into basic oxygen furnaces (BOFs) for the production of crude steel. Typically, some scrap is added in the BOFs at this stage.
A smaller number of mills also use electric arc furnaces (EAFs), which use scrap as their main raw material feed to produce crude steel.
In 2016, the scrap consumption rate among steelmakers was 111kg per tonne of steel, or a scrap ratio of 11.1%, according to the China Assn of Metal Scrap Utilization (Camu).
The scrap ratio for BOFs alone averaged 6-7% in the last couple of years, according to a source at the Camu.
This year, however, Chinese mills have increased the scrap ratio in BOFs up to 20% – the technical upper limit – to increase production rates, Wu Jingjing, the China Iron & Steel Assn’s raw materials market research director, said at a forum in Shanghai recently.
With scrap becoming cheaper, mills are feeding their BOFs and EAFs more of it this year to either reduce cost or increase their crude steel output. At the same time, this eats into their consumption of iron ore.
Iron-steel balance
As iron ore is the input for the production of hot metal or pig iron, its potential replacement by ferrous scrap hinges on the difference between a mill’s iron production capacity in comparison with its crude steel production capacity.
A mill with higher crude steel capacity than pig iron capacity can typically boost its steel output by increasing its intake of scrap, according to market participants.
But most integrated mills’ ironmaking capacity is the same as their steelmaking capacity.
For such mills, the substitution of iron ore with scrap takes place when they lower their hot metal output.
There are two ways of doing this.
The first involves putting their blast furnaces on maintenance or reducing the oxygen flow to them to lower hot metal yield, mill sources said. This will result in a general drop in demand for iron ore.
The second method is to use lower-grade iron ore to reduce the blast furnace yield, they said. This results in a drop in demand for higher-grade products.
The shortfall in hot metal output is then compensated with a higher consumption of scrap for the production of crude steel.
In previous years, mills were unwilling to consume too much scrap as its price was higher than the cost of producing hot metal. But this changed with the reversal of the situation caused by the rising supply of scrap.
Compounding the preference for lower-grade iron ore is the relatively weaker prices for such materials. For instance, May and June shipments of 56.7% Fe Super Special fines – the typical product in the lower grade 58% Fe segment – that are priced against a 62% Fe index carry a record high 30% adjustment.
A retreat in coke prices this year has also made the use of low-grade ore more cost effective. This is as the use of low-grade materials typically results in a higher consumption of coke in BFs, a mill source in east China said.
North China’s steel major Hesteel lowered its purchase price for first-grade coke to 1,810 yuan ($266) per tonne on June 1, compared with 2,100 yuan ($309) per tonne at the start of the year.
Steel prices
The choice of raw materials is also determined by the profit margins mills are seeing from their steel products.
“In the first quarter when [hot rolled coil] prices and margins were high, no one would sacrifice output even for the sake of lower cost, so high-grade iron ore was prized and the scrap proportion [in BOF] was relatively low,” the source in east China told Metal Bulletin.
In the second quarter, however, the margins for flat steel products fell in tandem with prices, which led producers to use low-grade iron ore to lower their BF utilisation rates and consume more scrap, which is cheaper, to make up for the lower hot metal output.
HRC prices in east China in the second quarter to date are averaging about 3,100 yuan ($456) per tonne, down some 600 yuan ($88) per tonne from around 3,700 yuan ($544) per tonne in the first quarter.
In contrast, the average for rebar prices in the same region is close to 3,500 yuan ($515) per tonne, just slightly higher than a mean of just over 3,400 yuan ($500) per tonne for the first three months of the year.
With rebar producers making a profit of over 1,000 yuan ($147) per tonne at the moment, there is no reason for them to trim their production rates, the source said.
“It is likely they will continue to use higher-grade iron ore in their BFs and add even more scrap in their BOFs to maximise output,” he added.
EAF
In previous years, when the cost of hot metal production was below scrap prices, many EAFs underwent technical alterations to enable them to consume more of the former.
Because of this, as much as 60-70% of their raw materials consisted of hot metal, while scrap only made up the remainder of 30-40%, according to the CAMU source.
Some EAFs even used hot metal to make up 70-90% of their feed when there is a big enough price advantage, the source in east China pointed out.
But this year, the balance has tipped back in favour of scrap.
For EAFs that have not been restored to their original technical specifications, the proportion of hot metal usage may have fallen to 40%, the source said. It they have, then hot metal makes up as little as 10-20% of their feed, he said.
A source at another major eastern Chinese mill, which had been using scrap for 50-70% of its EAF feed last year, said that the proportion was now 70-80%.
“We haven’t realised 100% scrap usage in our EAFs yet but it’s possible after some technical adjustments,” he added.
This higher consumption of scrap in place of hot metal by EAFs has inevitably dented demand for iron ore.
A number of new EAFs, with up to 30 million tpy of steel production capacity, are expected to come on stream in the June-August period to take advantage of the low scrap costs and strong rebar prices.
EAFs, which account for 70% of the USA’s steel production, remain in the minority in China where BFs still dominate.
But as they are seen as the future of the country’s steel industry, it will only be a matter of time before their numbers increase and their output eat into the market share of BF operators.
When that happens, the dynamics of scrap consumption in China, as well as that of iron ore will once again shift.