(Bloomberg View) -- After this year's string of ferocious hurricanes and an 8.2 magnitude earthquake in southern Mexico, the markets assume that the destruction will produce an abundance of scrap metal that it is ready for collection and recycling. These markets hope the result will be falling prices in expectation of an oversupply.
The reality is quite different. There won’t be an excess of ferrous scrap. Instead, demand for scrap metal, rebar and steel products will far outstrip supply. And to make matters worse, the industry was largely unhedged despite having the tools available to do so -- not just insurance, but futures contracts.
Although the consequences were devastating, the remains of all of these storms predominantly consisted of water-saturated homes, destroyed white and light goods, unusable furniture and mass quantities of garbage. The earthquake in Mexico, meanwhile, took place in the south, in regions much less developed than the north and Mexico City.
Additionally, scrap metal remaining from these recent disasters isn’t easily accessible due to the ravaged roads and infrastructure leading to the damage.
According to Nathan Fruchter, founder of Idoru Trading Corp., an independent ferrous scrap metal trading company, “the cleanup needs to be well underway before the first bits and pieces come out.” He believes it will be at least a month if not two before the scrap is heading to scrapyards. “And when it does, it’s the light stuff and thousands of defunct cars that will go straight into the shredders,” he says.
But this will take time. Insurance companies need to assess damages, while infrastructure, trucking and other services have to get back on their feet. Not all transportation and logistics companies are up and running, and some may have to close permanently. In normal circumstances, much of U.S. scrap would be exported to Latin America, but for now, cannot move out. And the longer it stays, the more vulnerable it becomes to rust from water and debris. Many of the recycling facilities in Southern states are impaired, unable to ship their contracted tonnages to Mexico until the infrastructure is functional. Mexican mills, in need of replacement tonnage, will have to source scrap further along the East Coast, eating into exports typically bound for Turkey.
The result is that both the prices of metal scrap and steel prices should rally.
About 70 to 80 million metric tons of scrap are processed by the recycling industry each year, according to the Institute of Scrap Recycling Industries, making it approximately a $21 to $24 billion market. Included in that figure is 15 to 20 million metric tons that is exported, according to U.S. Census Bureau information. The value of exports at today's prices would be about $5 billion to $7 billion.
What can industry do to better prepare for such unforeseen idiosyncratic events? Fruchter suggests:
While there’s no direct link between the London Metal Exchange trading and recent natural disasters, the sudden speed at which they come about is a perfect reason why the industry should reconsider implementing futures contracts as a hedging tool. By hedging with futures whose prices are fixed basis the index, they can be better protected from price fluctuations and physical shortages.
London Metal Exchange steel scrap and steep rebar futures contracts are cash-settled, basis Platts, trading out 15 months. Their contract settlements are based on the monthly average index prices of specific Turkish imported scrap and exported rebar, as Turkey is the world’s biggest scrap metal market.
These contracts, introduced on the LME in 2015, have yet to gain sufficient traction -- not because they weren’t designed appropriately, but because the audience they were designed for, namely recyclers and steel mills, has been slow to adopt them. Although LME futures trading volume is slowly expanding, the recent natural disasters serve as a call for the market to reconsider them as hedging tools. Futures contracts are most useful when there’s sufficient liquidity. In order for these contracts to see increased liquidity, the top three or four recyclers and steel mills in major scrap-trading nations -- not only Turkey, but South Korea, Mexico, India and the Gulf states -- need to begin trading them to encourage others in the market to follow suit. Speculators serve an important role as well and should not be seen as market manipulators but rather as market liquidity providers.
Surely there will be additional unforeseen and destructive acts of Mother Nature that will influence scrap metal and many other raw materials. And industry, both producers and consumers, should take this into account in their risk-management practices by hedging. It’s in the best interest of their businesses, their bottom lines, and for the affected communities to more quickly resurface.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shelley Goldberg is an investment adviser and environmental sustainability consultant. She has worked as a commodities strategist for Brevan Howard Asset Management and Roubini Global Economics.
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