January/February 2018
By Joe Pickard and Bernie Lee
At the start of 2017, scrap recyclers had good reason to be optimistic. Business sentiment was riding high based on expectations of significant U.S. policy changes that would reduce taxes, scale back regulatory oversight, increase infrastructure spending, and improve trade agreements. Market and policy developments in China held mixed implications for recyclers, but at the time, few could have foreseen the scope of China’s efforts to curtail scrap imports and how quickly those efforts would reshape the global recycling landscape. In the process, China is redefining the relationships among economic growth, manufacturing output, and recycling’s economic viability.
For a growing number of economic and commodity market forecasters, the overall outlook for 2018 is brighter, as growth across the world’s major economies has become more synchronized. The International Monetary Fund sees global economic output expanding 3.7 percent in 2018, up from growth rates of 3.2 percent in 2016 and an expected 3.6 percent in 2017. According to Bloomberg, Goldman Sachs Group says faster global economic growth will translate into improved demand for commodities, with a projected average commodity investment return of 7.5 percent in 2018 outpacing gains in other asset classes. Recyclers’ profitability tends to improve when rising primary commodity prices accompany solid economic and manufacturing growth, but policy choices—especially China’s decision to ban a range of scrap imports and impose other import restrictions starting this year—play an increasingly important role in today’s global scrap marketplace.
China changes the rules
Since 2011, China has exhibited weaker economic growth and diminishing scrap demand, creating significant challenges and adjustment pains for scrap exporters. But news last year of China’s multipronged program to sharply limit imports of some scrap commodities sent shock waves through the industry. China submitted two notifications to the World Trade Organization in 2017: The first, in July, announced a ban on imports of certain types of plastic scrap, mixed paper, slags, and drosses; the second, in November, spelled out maximum allowable “carried waste” thresholds for a wide range of scrap imports. At the same time, China began reducing the number of import licenses it grants to Chinese companies, especially those that failed stepped-up environmental inspections.
Given China’s position as the biggest buyer of exported U.S. scrap, its announcements had predictable effects on the market: For those commodities in China’s cross hairs—particularly recycled paper and plastics—U.S. scrap prices fell sharply, inventories rose, and worries escalated about whether sufficient other markets exist for such material. Some U.S. communities have already stopped residential collection of certain scrap materials, and some recyclers have petitioned local governments to landfill recyclables for which they can no longer find markets.
As 2018 begins, many questions remain regarding China’s import bans, including whether its manufacturing base can sustain the desired pace of growth without imported scrap, how willing Chinese scrap consumers are to convey their frustration to Chinese authorities, whether China’s strict carried waste thresholds constitute de facto import bans on all scrap commodities, and how much havoc China’s import restrictions will wreak on recyclers in the United States and around the world.
Factors overshadowing positive fundamentals
China’s scrap import restrictions are the most pressing trade concern for recyclers in 2018, but China doesn’t hold a monopoly on protectionist measures. In the past year, the United States launched a range of efforts aimed at stemming the influx of steel, aluminum, and other commodity imports, purportedly to support domestic manufacturers. The European Union also has been active on the trade front. Although these actions might provide short-term relief for steel producers and other manufacturers, they open the door for retaliatory measures and could dampen the volume of global trade, a key catalyst for economic growth. As the IMF notes, “global trade has slowed dramatically in recent years, mostly reflecting weakness in aggregate demand, but also the slower pace of new trade reforms and an uptick in protectionist measures.”
Beyond protectionism and the U.S. shift away from multilateral trade agreements, potential threats to growth in 2018 include high national debt levels, tighter monetary policy, financial asset bubbles (such as bitcoin), demographic shifts, and lackluster labor productivity growth. Many of these looming challenges might contain supportive implications for market fundamentals in the near term. The Federal Reserve’s continued tightening of monetary policy, for example, might impinge growth, but it also could eliminate some of the froth in the financial markets. Similarly, China’s efforts to protect its environment are curbing some scrap imports, but they also are prompting it to cut its production capacity, helping to rebalance global commodity markets in the first half of the new year.
In addition, even though China’s apparent willingness to relax its debt-reduction efforts in exchange for more rapid growth may not bode well for its long-term economic health, that willingness should help boost global growth in 2018. According to the IMF, China “will maintain a sufficiently expansionary policy mix to meet [its] target of doubling real GDP between 2010 and 2020.” China’s renewed emphasis on economic growth comes in response to concerns about the health of its real estate market, threatened trade sanctions from Western economies, and the perception that competition with the United States is heating up, the Wall Street Journal reports. The competitiveness of U.S. companies could be on the rise, thanks in part to the recently passed tax reform package, and other U.S. and global economic indicators are positive for 2018 as well.
By most measures, global manufacturing remains on the upswing. At 54.0, the Global All-Industry Output Index from J.P. Morgan and IHS Markit showed global economic output remaining at a two-and-a-half-year high in November 2017. Meanwhile, respondents to the Purchasing Managers Index survey from the Institute for Supply Management indicated manufacturers’ order books are in good shape and they expect “robust activity” in 2018. The Federal Reserve is projecting the U.S. economy will grow 2.2 to 2.6 percent in 2018, while the U.S. unemployment rate is expected to drop to about 3.7 to 4 percent. On Wall Street, investors clearly saw reason for optimism, as the Dow Jones Industrial Average surged past 24,000 in the fourth quarter of 2017.
For scrap recyclers, rising global growth and manufacturing output, declining unemployment, reduced taxes and regulatory burdens, and improving demand for commodities should be ingredients for success. But in late 2017, U.S. paper recyclers saw the value of mixed paper and similar grades fall by half in just one month. For commodities with rising primary prices, such as refined copper, scrap spreads widened to some of the steepest discounts in recent memory. That disconnect shows that even when macroeconomic fundamentals are looking bullish, recyclers might not reap the benefits.
Recycling hangs in the balance
To be sure, not all scrap industry sectors are suffering identical fates. Recyclers of ferrous scrap saw a rapid run-up in prices in December 2017, ending the year on a positive note. But ferrous recyclers are much less dependent on Chinese demand than recyclers of other commodities. In 2016, the U.S. ferrous scrap industry processed approximately 65 million mt of iron and steel scrap, the U.S. Geological Survey reports. Of that total, exports to China were just over 435,000 mt, or less than 0.7 percent. For most other recycled commodities, however, China is by far the largest overseas customer. Excluding ferrous scrap, more than 60 percent of the total volume of U.S. scrap exports went to China in 2016. No wonder, then, that China’s scrap import bans and related policy changes will be the market drivers for most scrap commodities in 2018 and beyond, even more than manufacturing output or primary commodity price movements. As a result, the outlook for the different scrap commodities varies considerably based on recyclers’ dependence on China and ability to adjust to market demands.
Aluminum
The outlook for aluminum recycling in 2018 depends on Chinese primary production and scrap consumption, the viability of U.S. producers, and the transportation bottlenecks that have stymied the flow of material. More than half of U.S. aluminum scrap exports in recent years have gone to China, leaving aluminum recyclers exposed to Chinese import restrictions. On the positive side, healthy Chinese aluminum demand and reported production cutbacks could open the door for production increases in other parts of the world. According to reports in the Financial Times, BMO Capital Markets says the growth in Chinese aluminum production likely will decelerate over the next five years, resulting in lower levels of Chinese aluminum exports.
Outside of China, rising aluminum prices have encouraged producers to restart idled capacity or expand production, Fastmarkets says. In the United States, Aleris Corp. (Cleveland) reportedly expanded production at its rolling mill in Lewisport, Ky., in November, while Alcoa Corp. (Pittsburgh) announced it would restart its Warrick smelter operations in Newburgh, Ind. Expanded U.S. aluminum production in 2018 and the results of the Section 232 investigation into aluminum imports could boost domestic market sentiment and fundamentals. Real Alloy Holding’s (Beachwood, Ohio) Chapter 11 bankruptcy filing last year, however, provided a painful reminder that significant industry challenges persist. As for prices, Macquarie Research (London) forecasts an average aluminum tag of $2,038 a mt in 2018.
Copper
China’s announced scrap import restrictions prompted commodity analysts to revise their projections upward for Chinese primary copper demand and refined copper prices—and for good reason: China imported more than 3.3 million mt of copper and copper alloy scrap in 2016, according to U.N. Comtrade data. Looking forward, the International Copper Study Group (Lisbon, Portugal) sees world copper mine production growing 2.5 percent in 2018 despite widespread labor contract negotiations scheduled for this year. But refined copper demand is still expected to outstrip supply in 2018, resulting in a supply deficit of more than 100,000 mt, ICSG says. Due in part to the more bullish primary copper market fundamentals, Goldman Sachs raised its 12-month copper price forecast to $7,050 a mt in December.
Copper scrap tags have not matched the price gains the red metal has seen on the commodity exchanges. The discount on No. 2 copper scrap delivered to U.S. refineries stood at roughly 42 to 43 cents a pound in early December 2017, American Metal Market (New York) reports. For comparison, the spread on No. 2 copper scrap was about 17 to 19 cents a pound in June 2016. Increasingly, scrap market participants question whether terminal market copper prices reflect physical market fundamentals or speculation. The pressing question for recyclers this year is whether copper scrap prices can keep up with cathode prices in 2018 in light of developments in China.
Iron and steel
The outlook for ferrous scrap in 2018 stands out from the rest of the major scrap commodities. Improved overseas demand, concerns about the availability of obsolete scrap, and the early onset of winter weather all contribute to expectations of rising U.S. ferrous scrap prices heading into 2018. U.S. ferrous scrap exports to Turkey in the first 10 months of 2017 exceeded 2.86 million mt, up more than 310,000 mt from the corresponding period in 2016, Census Bureau trade data show. Factors adding to the bullish U.S. market sentiment include potential trade remedies from the Section 232 steel investigation and other trade cases, steel production cutbacks in northern China, recovering iron ore prices, healthy domestic order books, and the new corporate tax cuts.
On the downside, the shifting trade landscape for steel poses risks for ferrous scrap recyclers. Reuters reports that “China will cut export taxes on some steel products and … ditch those for sales abroad of steel wire, rod and bars from January 1.” China’s incentivized steel exports and growing reservoir of ferrous scrap represent noteworthy threats for ferrous processors going forward. In addition, the renegotiation of the North American Free Trade Agreement could have significant consequences for the flow of steel and steel-containing products across U.S. borders. For 2018, the World Steel Association (Brussels) says steel demand in the NAFTA region will increase 1.2 percent, to 140.4 million mt.
Lead and zinc
Lead and zinc prices outperformed the other base metals for much of last year. As of late December 2017, the LME official three-month prices for lead and zinc were both up more than 26 percent, year on year, thanks primarily to supportive features such as ongoing supply deficits. According to the International Lead and Zinc Study Group (Lisbon), global refined lead metal demand will exceed supply by 45,000 mt this year, with U.S. lead demand expected to increase 1.8 percent. Rising lead metal prices have contributed to lead-acid battery recycling rates of 99.3 percent from 2012 to 2016, according to the Battery Council International (Chicago), keeping 1.7 million tons of batteries out of landfills each year.
ILZSG also forecasts a global refined zinc market supply deficit of 223,000 mt in 2018, as global demand for zinc is projected to rise 2.5 percent, to 14.28 million mt, including an expected 2-percent increase in U.S. zinc use. One major recent North American zinc market development was the end to the nine-month-long strike at Noranda Income Fund’s zinc processing facility in Salaberry-de-Valleyfield, Quebec. The strike ended in November after unionized workers voted in favor of a new collective agreement, the U.S. Geological Survey reports. For 2018, the World Bank sees average lead and zinc prices of $2,500 and $3,000 a mt, respectively.
Nickel and stainless steel
Investor expectations for rising electric vehicle demand globally and in China in particular helped push LME three-month nickel prices above $12,000 a mt in the fourth quarter of 2017. The uptick in nickel prices reportedly has had little impact on U.S. stainless steel scrap market sentiment. According to American Metal Market, “the stainless steel scrap market shows very little strength in the United States due to weak demand, with most processors and dealers cautious on pricing.” In contrast, Fastmarkets says robust Chinese demand for stainless steel has combined with restocking of both stainless steel and nickel. Chinese stainless steel production in the first nine months of 2017 increased 8.8 percent, to nearly 19.7 million mt, the International Stainless Steel Forum (Brussels) reports.
Looking forward, the large volume of global nickel stocks could keep a lid on prices even with potential nickel ore export restrictions in the Philippines and expected nickel supply deficits. Global refined nickel use will exceed production by 53,000 mt in 2018, although uncertainty persists regarding nickel pig iron production in China and Indonesia, the International Nickel Study Group (Lisbon) says. Although nickel prices remain notoriously difficult to predict, Macquarie Research forecasts average prices of $11,750 a mt in 2018 and $13,500 in 2019.
Recovered paper and plastics
China will remain the major market driver for paper and plastic scrap throughout 2018, as commodity markets readjust to the demand vacuum its newly implemented import bans and other import restrictions are creating. For the paper and paperboard markets, there is little indication that containerboard and boxboard producers will scale back their prices going into 2018. Several European producers already have announced price increases of roughly 15 percent. With ongoing horizontal supply chain consolidation in North America, the containerboard production market is concentrating buying power in fewer hands. While OCC and containerboard production will be the major topics in the months to come, the future for high-grade deink-quality fiber and pulp substitutes looks bright, particularly in developing economies.
Scrap plastic markets shifted in a different manner from paper markets because the Chinese import ban affects all categories of postconsumer plastics. There also is a widening preferential dynamic between specific grades in the various regional and country markets. PET and HDPE plastics have captured higher prices than other polymers, indicating that those polymers have more competitive consumer markets. Plastic recyclers increasingly will turn to technology to remain competitive, but their profitability will depend on their ability to figure out the right kind of technology to add. Another critical issue is whether municipalities are ready to change their collection systems to improve the marketability of the material they want recycled.
Joe Pickard is chief economist and director of commodities, and Bernie Lee is research analyst for commodities for ISRI.