US pig iron premium faces erosion on weak steel, scrap

Spreads between basic pig iron (BPI) and ferrous scrap in the US are expected to tighten toward more typical levels in the coming quarter, resulting mainly in lower BPI prices amid weakened mill demand.

Spreads between basic pig iron cfr New Orleans and average Midwest #1 busheling prices hit an Argus historical record high in the third quarter of 2019 as steep drops in the ferrous scrap market outpaced declines in pig iron.

BPI averaged $78.50/t more than its closest scrap counterpart, #1 busheling, in the third quarter, more than doubling the spread from the second quarter. As a result, market participants widely expect a tightening of the two prices as a weak steel complex outweighs comparatively high iron ore costs for merchant BPI.

The raw material for steelmaking became the least cost-effective option in the quarter for steel mills relative to scrap since Argus began assessments. Pig iron has only traded at a similar premium to scrap in late 2016, at a time when scrap prices and weak mill demand mirrored current market conditions.

Weakening US steel demand

Falling US mill output is expected to drag on BPI prices through the end of the year.

Mill utilization rates have fallen below the healthy benchmark level of 80pc in five of the past seven weeks, according to data from the American Iron and Steel Institute (AISI). While year-to-date output is up, steel mills have scaled back buying of raw materials as hot-rolled coil (HRC) lead times shrank to 4-5 weeks lately compared with 5-7 weeks in July.

The US imported 3.24mn t of pig iron for the year through July, a 15pc decline from the same prior year period, according to customs data. August shipments were potentially below 300,000t, down from 430,000t a year earlier, according to an Argus analysis of vessel tracking data. Shipments for October appear likely to drop further as Argus has tracked only 120,000t of cargoes on the water and with roughly a one-week window left for ships to sail in order to reach the US in time to be accounted as an October delivery.

In addition, mills have planned a wave of outages in October totaling over 1mn t in steel output, according to market participants. This coupled with abundant supplies of both obsolete and prime scrap and already reduced scrap-buying programs are projected to undercut near-term BPI, even though mills cannot fully replace the raw material with scrap in melts.

Few alternatives

BPI exporters from Brazil and the CIS have looked for alternative sources of demand to supplant potentially lower US import volumes.

Suppliers booked a handful of cargoes totaling about 170,000t in the previous week to mills in China, but most do not expect that country to become a regular outlet at this time.

Freight rates as high as $50/t from Brazil to China cut into already tight margins for the suppliers. Market participants expect competition with local Chinese pig iron production will prevent significant imports from abroad.

Chinese steel mills are still largely blast furnace-based operations, which mainly use iron ore and can use as little as 10pc BPI or scrap as coolants for hot metal compared to electric arc furnaces (EAFs), which can use as much as 80pc scrap to make steel. It will likely take several years before the country executes its plan to bolster its share of EAF production, increasing demand for scrap and BPI.

Early Indications

BPI prices already began falling over much of September.

BPI fell to $315-320/t cfr New Orleans in the latest assessment on 26 September, down from $365/t at the start of the month and largely mirroring the drop in scrap prices from August to September.

And with at least a $30/gt drop in scrap prices in October expected, BPI prices will face added pressure to fall in line even after a temporary expansion in spreads.

Still, producers have resisted further downward momentum, citing squeezed margins. In Brazil, the kick-off of the rainy season portends higher costs. Producers in the country will battle against higher humidity, since they typically use charcoal as a reductant in the furnace which tends to shatter into fines in such environments, according to sources. Increased rain also tends to impact trucking, delaying shipments and raising costs.

Both CIS- and Brazil-based producers have struggled with a comparatively high iron ore cost as well. While down from the July highs, prices for iron ore fines (62pc Fe) cfr Qingdao remain 36pc higher at $93.80/dmt on 1 October from the same prior year period. The raw material could place a floor on lower BPI in the near term if declining pig iron is not matched by losses on iron ore.