China's swelling junkyards are readying iron ore's next threat

As China's booming middle class junks aging cars and appliances, the next threat to the world's ailing iron-ore producers is materializing. Photo / Getty Images

As China's booming middle class junks aging cars and home appliances, the next threat to the world's ailing iron-ore producers is materializing.

In a country that uses more steel than any other, it's now become about as profitable to make the alloy by melting down scrap metal as it is from iron ore and coal in a traditional furnace, Bloomberg Intelligence calculates. China's scrap supply will double in the next decade and then accelerate at an even faster rate, according to Morningstar.

Expanded use of recycled metal in China at a time of a global steel surplus means even less demand for the ore that's the top earner for BHP Billiton and Rio Tinto Group, who've already seen profits plunge with prices. The nation's ore demand may contract 50 percent by 2040 as steel use dwindles and more recycled metal is used, according to Goldman Sachs Group Inc.

"The scrap wave is coming," said Oliver Ramsbottom, a Tokyo-based partner at McKinsey & Co, who sees a significant increase in China's scrap from mid next-decade. "There's no doubt that the iron ore industry is going to be pretty challenged over the next decade at least because you've obviously got a lot of supply out there."

Growth in China's iron ore demand is already being challenged by weaker economic expansion.

Steel prices plunged by more than 50 per cent since 2011 as consumption has declined. By 2020, iron ore prices will fall to $35 a metric ton, Morningstar estimates, below the record low of $38.30 reached in December, and decline to $30 a ton by 2025.

Blast furnaces using coal and iron ore had been the better money-spinners before a fall in scrap prices in 2015 improved the profitability of mini-mills that use electricity to melt down scrap, according to Yi Zhu, a Hong Kong-based Bloomberg Intelligence analyst.

The cost to China's mills of producing steel with ore and coal was about 2,130 yuan ($330) a metric ton last year, Bloomberg Intelligence calculates. Electric-arc furnaces. spent about 1,853 yuan a ton. Scrap prices in China tumbled 48 percent last year, outpacing the slump in iron-ore, according to Metal Bulletin Ltd. data.

Electric-arc mills now account for around 60 percent of production in the U.S. and about 50 percent of steelmaking in Europe. The China Association of Metal Scrap Utilization has set a target for 20 percent of the nation's crude steel output to come from scrap by end of 2020, said Liu Shuzhou, deputy secretary-general of its scrap steel division. Mini-mills were used for about 10 percent of output in 2014, according to Metal Bulletin Research.

"Government policy might be the most important factor," Liu said. "If the government chooses to give subsidies, favorable power tariffs or set up energy-saving funds, etc., the switch can happen very quickly."

It is only beyond 2030 that we envisage that an acceleration in scrap availability will translate into a faster decline in demand for iron-ore.

As scrap supply in China rises, the price should decline further, providing an incentive for steel producers to switch to the electric-arc furnaces, David Wang, an analyst at Morningstar, said by phone.

"We think that you can start seeing the beginnings of an acceleration of scrap availability," from cars, machinery and household appliances, which will take hold from 2020 to 2025, Wang said by phone from Chicago. "Beyond that, it's likely that we will begin to an even greater acceleration of scrap availability from construction. Essentially, as buildings are torn down."

Recycling a typical car saves more than a ton of iron-ore and about 635 kilograms of coal, according to the Washington-based Institute of Scrap Recycling Industries. Using scrap can reduce a steelmaker's carbon dioxide emissions by about 58 percent, it calculates.

China's scrap cycle may take longer to develop, according to BHP, which last year cut its forecast for the nation's peak steel output by as much as 15 percent after research in cities from Xi'an to Guangzhou. "It is only beyond 2030 that we envisage that an acceleration in scrap availability will translate into a faster decline in demand for iron-ore," the Melbourne-based producer said in an e-mailed statement.

We think that you can start seeing the beginnings of an acceleration of scrap availability.

China's pool of so-called obsolete scrap - metal recovered from cars to skyscrapers - will triple and displace about 130 million tons of iron-ore demand in 2030, Rio Tinto said in a September presentation. Rio declined to comment further on the outlook for scrap's impact on iron-ore demand.

The scrap take-up rate may not change rapidly because steelmakers are likely to use excess blast furnace capacity and there's a lack of scrap collection points, according to CRU Group senior consultant Chris Asgill. High energy costs and an overall excess of steelmaking capacity also will limit growth of electric-arc furnaces, he said in an e-mail.

The rise of the mini-mills is set to prove a big challenge for the iron-ore producers, Li Xinchuang, deputy secretary-general of the China Iron & Steel Association, said last month.

This threat from scrap, on top of a shrinking export market, will potentially act as a deterrent to long-term investments in iron-ore producers, Romano Sala Tenna, a portfolio manager at Katana Asset Management Ltd., said by phone from Perth. It sold holdings in BHP and Rio in 2014 on concern over iron-ore oversupply.

"The pool of scrap in China is growing out there," said Ian Roper, a Singapore-based director at Macquarie Group Ltd.'s commodities research division. "Ultimately that will be the rusty nail in the coffin."