2008 Scrap Metals Supplement - Best Practices

A scrap executive offers seven best practices for buyers of scrap metal to consider.

I was originally asked to speak on the subject of "Supplying the World’s Demand for Scrap Metal." Although my comments will touch on that subject, I do not feel that citing an overwhelming number of statistics and estimates for the upcoming year will be as beneficial to serious buyers as is talking about best practices that will secure a portion of the available U.S. raw material supply in the future.

We believe that Behr Iron and Steel Corp. is a microcosm of most companies in the U.S. Our values and the principles that are the foundation of Behr, hopefully will shed some light on how to successfully transact business with U.S. companies and secure their raw materials in a competitive world environment. I will also touch upon a few key assumptions that could affect business for 2008 and upon a few of the challenges and opportunities facing U.S. scrap metal producers today.

Joseph Behr and Sons was founded in 1906 by Joseph Behr. His son Isadore became president in 1940 and established the corporate vision and ultimately the corporate culture of "integrity, service to our customers and quality in all of the products that we produce."

Isadore’s son Richard became president in 1964. He instituted two additional standards of "protecting our environment and safety in the workplace." These principles are the foundation of our company today and define the way that we do business every day. They form the foundation of the relationships that we have with suppliers and consumers.

Throughout more than 100 years in business, Behr Iron and Steel has transformed into one of the top-20 scrap metal processors in the U.S., with locations in four states and sales in excess of $300 million per year. We handle all grades of steel and metal scrap with specialties in tin- and lead-based babbits, tool steels, zorba, cast iron briquettes, shredded scrap and numerous other grades of recycled steel and metals.

Behr operates from 11 locations in the Midwestern U.S., employing approximately 300 people. Our company operates three 4,000-horsepower auto shredders, five balers and four 1,000-ton shears. This equipment produces more than 800,000 gross tons of steel per year and about 100 million pounds of metals per year. All of this metal is strategically sold in the marketplace, both domestically and overseas.

As U.S. companies like ours look toward 2008 and beyond, we have concerns and we see great opportunities. Demand in the U.S. and overseas for the products we sell is great. Pricing of scrap produced in the U.S. is competitive in the world market.

The outlook for scrap metal supply in the U.S. is tight. Some 65 million gross tons of scrap were produced in the U.S. in 2007, of which 16 million tons were exported.

Continued weakness of the U.S. dollar in 2008 seems to be inevitable. If this is true, there is great likelihood that U.S. exports of scrap will increase as they did from 2006 to 2007. Twelve million gross tons of scrap steel were exported in 2006, while 16 million gross tons of scrap steel are expected to be exported in 2007. We believe that at least 18 million tons will be exported in 2008.

The trend of "further sophistication and maturation of worldwide scrap buying practices" will continue, as emerging countries look for raw materials to fuel their development and growth. This trend is opening export markets to U.S. metal processors that are not bulk cargo shippers located on the water. These shippers now have the option to load containers with most grades of scrap metals and steel from almost any location in the U.S. These less expensive container freight rates are quickly becoming the mode of choice, even with bulk-capable shippers.

Low imports of steel into the U.S. are expected to continue into 2008 in light of the weak dollar. U.S. steel mills should see reasonably good operating rates for 2008, in light of the low imports of steel and U.S. growth forecasted at approximately 2 percent.

Strong growth is forecast for most parts of the world in 2008. Worldwide steel operating rates should remain firm in 2008, as should the demand for scrap, pig iron and scrap substitutes. In 2008 it is forecast that 65 percent of the world steel consumption will take place in China, India and the CIS (Commonwealth of Independent States). With world electric arc furnace capacity at 425 million tons per year and growing rapidly, the world demand for steel scrap should remain high for 2008 and the foreseeable future.

A widening differential between pig iron and prime scrap pricing will result in greater melting of scrap, as furnace charges are adjusted to more reasonably priced scrap. Pig iron and prime scrap differentials in the U.S. are as high as $180 per gross ton. These spreads are reaching record points and will only close if scrap prices rise in 2008.

Steel service center inventories in the U.S. adjusted downward for 2007, resulting in a current inventory level of approximately 2.8 months. This low level, along with other fundamentals, supports the likelihood of sound steel mill operating rates and good scrap demand at mills in the U.S. in 2008. The process of the de-stocking of steel service center inventories in the U.S. seems to be over as we move into 2008.

Consolidation of U.S. recycling companies will continue at a feverish rate in 2008 as private recycling company owners are motivated to sell their businesses before the U.S. presidential election in 2008 and possible capital gain tax changes. Steel companies as well as large U.S. domestic and offshore recycling companies are in a consolidation race to control tons of scrap steel and pounds of metals. More scrap in fewer hands will likely level out the peaks and valleys of scrap pricing that have been seen over the last few years, bringing wider discipline to the scrap markets and consistently profitable scrap companies. The most recent announcements of major mergers in the U.S. involve Sims Group and Metal Management Inc. and Steel Dynamics Inc. and OmniSource.

With current assumptions supporting the possibility of a continued bull scrap market in the U.S. and worldwide, what are some of the challenges facing U.S. metal recyclers in the years ahead?

Finding and securing reasonably priced raw material is the first challenge. In the U.S., industrial and obsolete scrap are tight. There is a delicate balance between supply and demand.

The supply problem in the U.S. is compounded by the declining metals industrial base in the U.S., resulting in more competition for obsolete raw materials. Higher pricing does not always produce increased scrap flow at profitable margins. High prices can also inspire new small collection yards, adding to competition.

In volatile markets, less scrap can also be available at market low price cycles while larger quantities of scrap are available at market high points. The U.S scrap supply chain is very sophisticated and price sensitive. This environment has created "feast or famine" buying patterns by most consumers with pricing plateaus.

New price plateaus for all grades of scrap in the U.S. have been seen every year since 2005. As an example of this, the average selling price for No. 1 busheling in the Midwestern U.S. in 2005 was approximately $250 per ton. In 2006 the average price of this same grade was $280 per ton and so far in 2007 the average price for this grade has been $310 per ton. In line with this trend, we do not believe that the overall U.S. scrap supply will increase in the upcoming years.

The mix of scrap that is available will continue to change as more auto shredders operate in the U.S. marketplace. More zorba will also be available for sale from the U.S. in the years ahead as these additional shredders come online into operation.

A second challenge for U.S. recyclers in 2008 and in following years will be their financial ability to stay current with changing scrap processing methods. Large shredders are being ordered and erected by many large scrap metal processors. These super-size shredders are typically up to 135-inch machines, have power of up to 10,000 horsepower and have very sophisticated downstream and metals sorting components. They can process up to 350 to 400 tons per hour, or 30 times more tons per hour than existing shears or balers. They also can generate up to 30,000 pounds of zorba per hour.

The resulting processing cost per ton for the super-sized shredders is a fraction of the cost of conventional shearing, torching or baling. Some 30 to 40 of these machines are currently operating in the U.S. It is forecast that five to six additional super-sized shredders per year will be purchased and placed in operation in the next five years. Recyclers in the right areas that have the financial strength to purchase this equipment will be at a distinct advantage in the price battle for raw material.

Some U.S. scrap metal processors in smaller market areas will also be installing smaller, more traditional 3,000- to 4,000-horsepower shredders. Others will continue to operate and replace existing machines that fit the material flow patterns of their areas. Shredding will continue to evolve as the processing method of choice.

A third challenge that will continue to face U.S. metal recyclers in the years ahead is metal processors’ ability to get their metals sold and shipped in a timely, cost-effective manner. With the "feast or famine" nature of the buying cycles seen in the last few years, finding consistent, timely buyers and cost-effective transportation is a challenge.

The above challenges are forcing U.S. metal processors to a most important consideration in the process of successfully securing raw material supply from their supply chains, processing and selling their scrap products.

Even in the most volatile markets, "best purchasing practices" do secure an edge in competing in the local, national and global environments in which we operate. At Behr, we try to transact our business with companies that observe the following best purchasing practices. We believe that most U.S. companies are also inclined to sell their products to companies that follow these strategies:

1. Consumers who are consistent market buyers, purchasing product every month regardless of price;

2. Consumers who pay competitive market prices every month, helping their strategic supply base to be price competitive in its ability to attract raw material;

3. Consumers who recognize the value of consistent, quality material and who reward proven suppliers with price premiums;

4. Consumers who provide product feedback to their shippers;

5. Consumers who provide assistance with documentation and transportation logistics, typically purchasing on an FOB (free on board) basis loaded railcar, container or vessel;

6. Consumers who pay cash in advance on documents, easing cash flow issues for strategic suppliers and minimizing receivable complications; and

7. Consumers who value long-term relationships.

Consumers who build strategic supply relationships with proven suppliers benefit by eliminating many problems associated with open market buying. Having a steady flow of scrap from known sources is imperative in tight supply markets. Getting delivery of scrap with known chemistry, good recovery and trace contamination also minimizes surprises and melt problems at the consumer.

Building a partnership that is based on performance and trust creates a win-win environment for both parties. U.S. recyclers are looking for this environment from the companies with which they choose to do business.

In conclusion, scrap supplies in the U.S. will remain tight for the foreseeable future. The U.S. is a mature, industrialized country that has a declining industrial base. As prompt industrial generation reduces from year to year, the generation of obsolete scrap cannot make up for the industrial prime scrap losses. U.S. recyclers experience the reality every day of a tight supply stream entering their recycling facilities.

There are three ways to secure scrap resources: first, fully integrate and buy strategically located recyclers in the supply chain; second, form strategic alliances with proven, reliable scrap companies utilizing best purchasing practices, or, third, buy materials in the open market.

At Behr Corp. we have followed our established principles of quality in our products, good service and consistent, timely, purchases and deliveries.

These principles have allowed us to forge excellent relationships with our suppliers and with the consumers to whom we choose to sell our products. Most U.S. recyclers have established and value similar relationships with their customers and consumers. We are at this conference to add to this international discussion about the recycling industry and to find additional business partners that believe in "best buying practices" and in return value a strategic supply partner that will be there in all market conditions.

The author is president of Behr Iron & Steel Corp. and can be contacted at wbremner@behriron.com.