Captain Obvious, if he or she was an industry analyst, might observe, “So far 2015 has proven to be a challenging year for the recycling industry.” Accordingly, red metals: coppers, brasses and bronzes are no exception. What are some of the challenges we are facing in addition to traditional (and ever present) price volatility?
I would contend, broadly speaking, that our challenges are not restricted to 2015. On the contrary, the significant challenges we are facing are paradigm shifts in our markets and products that actually began several years ago. More narrowly speaking we are experiencing significant changes in both overseas and domestic markets related to volume, products and value.
Hedging copper is still the most effective risk management tool to protect against the exposure to price volatility. But this discussion goes beyond exposure to price volatility. Perhaps price volatility is one of the only constants.
Old China or new?
One of the most prominent questions on everyone’s mind is whether China will return to the marketplace at or near its prior levels. It won’t. China’s growth has been slowing from around a 10% annual growth rate to around a 7.5% annual growth rate.
Despite the fact that 7.5% is still a considerable growth rate, all indications suggest China will not be as significant a destination for scrap as it has been over the course of the last 10 to 12 years. Complicating the matter further for recyclers in the United States is the strength of its dollar, which continues to discourage exports from the U.S.
China is maturing as an industrialized nation, which means at least two important realisations with respect to scrap metal: 1) China will generate more of its own scrap requirements internally; and 2) as its industrial base continues to mature, China will improve its manufacturing efficiency through the use of technology and better utilisation and allocation of resources.
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Price risk management and the role of brokers The risk of price volatility in copper can be managed through hedging, which can be an intimidating process for some recyclers. Not all scrap processors and consumers are in a position to have their own hedge program. Managing a hedge book is expensive and time consuming, and it often tends to be a hands-on process. Furthermore, funds are required to meet margin requirements. Yet there are opportunities for those who do not hedge on their own. Perhaps one of the most important functions that brokers play is hedging on behalf of their suppliers and customers. Hedging with your broker achieves price risk management without the added costs and time commitment. There are some misconceptions regarding hedging. Do you need a full truck load of material? No. In the United States, Comex contracts are for 25,000 pounds, so it is not unusual to hedge half-loads or other amounts. Can export loads be hedged? Yes. In addition to copper shipping within the U.S., those same grades of scrap shipping overseas can be hedged. Many export brokers offer hedging as well. One note of caution: it can be difficult to hedge brasses with full chemistries that include other components such as tin, lead and iron. — Mark Weintraub |
Either or both mean that China will require much less scrap from the open market. We have already seen indications of China’s industrial evolution in the form of more express requirements that suppliers meet quality standards and specifications.
A great example is mixed brass borings. Historically, mixed brass borings were shipped exactly as described. Now, as many have learned the costly way, among other exclusions, mixed brass borings are not to include manganese bronze borings above a designated (small) percentage.
Similarly, exclusions are accompanied by specific copper recovery targets (that may or may not be articulated to suppliers). This necessitates a change in the mindset of suppliers from “shipping to get rid of” to “shipping to meet specifications.” And that notion is a paradigm shift in exporting scrap to China.
Circling back to the view that China will generate more of its own scrap requirements, let’s look at steel as an example. We are already seeing China’s massive overcapacity in steel manufacturing. Significant amounts of finished steel are being exported to the U.S. and are affecting our domestic steel industry. Additional steel is being exported to other Asian nations, getting fabricated into parts and then entering the U.S. as “products.”
Yet, China is not importing ferrous scrap at a level reflecting such a significant level in steel manufacturing, even considering iron ore utilisation in the analysis. Likewise, China’s developing middle class will lead to greater demand for durable goods that are manufactured in China. Again, that growth will result in a greater increase in manufacturing and creating more scrap flow within China.
Returning to copper specifically, issues arising from 2014’s alleged warehouse collateral fraud in Qingdao, China, remain in play. China’s level of copper consumption will no doubt be affected by the outcome, if it has not already. We may never know the full extent of the fallout, but there will be reduced storage of copper, leading to greater availability of physical copper. The reduction in reliance on copper cathode as a source of collateral for financing also reduces overall availability of funding.
By no means is this to say that China will stop importing scrap, or more specifically red metals, but it strongly suggests that China will not import scrap at the levels that we got used to over the course of the last 10 to 12 years.
The remaining question is whether another nation emerges as the “next China.” Considering the size and population of China it is highly unlikely that we will see another nation fill that void completely. That is not to say that another nation or nations will not emerge as significant copper consumers. It does suggest, however, that the levels seen in the past will not return.
China will always have a significant impact on copper demand and pricing due to the fact that it accounts for 40% of world copper consumption. That said, as an industry we are seeing a fundamental change to a critical market.
How can we manage this challenge of losing such a significant market? Captain Obvious would answer “find a new market.” Well that is surely one option. More fundamental, however, is recognizing that many of those challenges and risks that were prevalent in the earlier days of trading with China will likely reappear with new trading partners: uncertain financial arrangements, payment and payment terms; and honoring contracts in light of changing markets and product definitions.
None of those considerations will inhibit the flow of scrap to new markets. However, we need to begin shopping. One caveat: a reminder that 2008 was not that long ago and those tough lessons should be part of the analysis looking at new trading partners.
Paradigm shifts in the west
Brass manufacturing has been rapidly changing over the course of the last several years. The introduction and development of lead-free brasses has already had a significant impact on brass scrap demand. Domestic consumers are changing their melt mixes and overall buys to meet lead-free specifications, which results in lower consumption and purchase levels of traditional brasses.
Likewise, identification of lead-free brasses that contain elements that harm traditional brass alloy manufacturing continues to be challenging. The scrap industry, not unlike manufacturing in the U.S. and Europe, is losing significant levels of institutional knowledge related directly to metal identification. Traditional methods of metal identification are not necessarily being passed down and taught.
Hand-held analyzers are useful, but they do not read all elements, including some that are harmful. It is not economical to test and analyze each piece of metal. Likewise the metal identification challenges facing scrap processors are also faced by ingot makers and foundries. As a result, ingot makers have to make fundamental changes to raw material purchases including the quantity and type of brasses purchased and the traditional pricing/value structure.
The loss of institutional knowledge is not just the result of technology. Although technology serves to make us more efficient it is not always the answer. To a large extent the loss of institutional knowledge is an issue in areas of manufacturing throughout the U.S. and Europe. Our industry is no exception. Yet, we may have the opportunity to prevent it further.
Metal identification is a value-added skill that often is a profit center. Perhaps reconsidering that “upgrade” mindset versus the “move out fast” method will lead to the return of a profit center. There is no substitution for sound metal identification knowledge.
It also prevents inadvertently shipping out-of-spec scrap. It is increasingly more difficult to sort brasses by use and shape. Materials that were made out of one type of alloy in the past now are made out of several different alloys, including some alloys that are lead-free and some alloys of lesser value.
Some of the newer alloys contain elements that are harmful to heats. Analytical guns do not read all elements, which may lead to misidentification—and possibly missed opportunities.
What does this mean for red brass/ebony, semi-red brass, and high-grade brasses? Will these items become as prominent an export item as the honey grade is today? Do we want red brasses to become generic? Scrap processors will likely find that the loss of institutional metal identification knowledge also reduces the opportunity for “upgrades” and profits.
The bright side
Now for the bright side, and there always is one. Is it all doom and gloom? Absolutely not. The industry has always faced challenges and has met those challenges with innovation, creativity and entrepreneurial spirit.
How do we manage the risk associated with so many challenges confronting the industry at one time? Sorry, there is no “wise guy” response from Captain Obvious for this one.
Certainly some of the old standbys still work. For example, hedging copper and certain brasses is a sound method for protecting against price volatility. Comprehensive and fundamental metal identification is a skill that drives a profit center.
This industry’s participants have always been creative, resilient and tough, rising to any occasion. Although we may want China to return as the market it once was, it does not appear to be realistic. Famous poets by the name of Mick Jagger and Keith Richards once wrote: “You can’t always get what you want, but if you try sometimes, well you might find you get what you need.”
Perhaps what we need is to take a step back, recognize the paradigm shifts and apply that resilience and creativity that built this industry.
The author is a nonferrous metals trader at Premier Metal Services in Solon, Ohio, United States, and can be contacted via email at mweintraub@premiermetalservices.com.