The ferrous complex returned from holiday with a bang on Friday October 8, 2021 as spot rallied, paper jumped and steel climbed:
Do not be fooled. This is a measure only of how crazy markets are right now. Some folks are arguing that the rally is justified by the notion that Chinese power outages will force the closure of more EAF production, supporting BOF and iron ore. There is some evidence for this. Scrap output had already plunged in August:
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However, there are two points to make in response.
Chinese construction – infrastructure and property – is now tracking for a -25% bust over the next year versus the last. This equates to nearly 200mt less steel needed.
That is roughly all of China’s EAF steel production. So, if all of the adjustment is foisted onto EAF then scrap inputs will also collapse in price. The raw scrap and its transport is 75% of the cost of EAF. Power is about 8%. You can see the point. Collapsing scrap prices will completely overwhelm power price rises and make EAF more not less competitive. This is implicit pressure for iron ore.
The second point is that mandated power cuts will still trigger a big drop for EAF output despite the exploding margins for it. But only so far. Other forces, such as decarbonisation and extreme coking coal prices, will hold EAF output up. To date, scrap prices have only eased so the output is still clearly pretty good.
Even if EAF falls by half that still leaves an outlook of 100mt less BOF steel over the next year. Or 160mt less iron ore.
Add 60mt of new supply and even with the total devastation EAF output, iron ore is in an immense surplus above 200mt. As energy comes off and EAF back on, the iron ore surplus heads towards 300-400mt.
Of course, China might stimulate but why would it until it has crashed energy prices?
Being spectacularly kind, this iron ore price rally is technical in nature. It is probably better described as lunatics chasing pennies in front of a runaway locomotive on a downhill slope.