Scrap Prices, and the Cost of Doing Business

Oct. 27, 2004
What looks like a commodity shortage turns out to be a monetary problem.

Earlier this year we reported on the Emergency Steel Scrap Coalition formed by manufacturers to argue for federal action to address the crisis-level shortage of scrap for basic manufacturing. Their primary aim was an embargo on scrap exports, mainly to China.

The demand for an export cap did not get much serious attention in Washington, but now, unfortunately, the ESSC argument is a bit more persuasive. Citation Corp., a forging and casting producer filed for Chapter 11 bankruptcy in September. It's competitor, Intermet Corp. followed suit just a few days later.

This resort to bankruptcy is a startling indication of how difficult it is now to maintain a successful organization in a market defined by demand and shaped by regulation — but distorted by external factors that sever any sensible relation between those two forces.

Citation and Intermet will be reorganized, but given the scope of manufacturers' raw-materials problems and the availability of bankruptcy law it's possible these two will not be the last to seek protection. Intermet warned of its troubles in September when it cited the rise of scrap costs from roughly $160/ton at the start of 2003, to about $395/ton at the end of August. Citation president and CEO Ed Buker explained his firm was met with steel scrap prices up to $420/ton.

Steel scrap is a commodity, so manufacturers know they must manage the risk in order to maintain their organizations effectively. In fact, steel scrap responds well to market forces, because the supply is fed by old capital goods and construction materials that are being replaced with new steel products.

The problem now is that the scrap market is not following any such pattern. Domestic demand is being defined by buyers overseas, principally in China, where there is no domestic scrap market of any scale. Steel scrap is heading there to feed demand, but no "new scrap" is returning.

Solutions like surcharges and export limits are remedial, at best, and steel scrap is just one commodity market that's being distorted by Chinese demand: in oil, natural gas, and all sorts of ores, the pattern is the same. What looks like a commodity problem actually is a monetary problem.

China pegs its currency value to the U.S. dollar, meaning Chinese consumers can acquire whatever raw materials they need without any fear of serious inflation. They are serving domestic demand, but they're exporting part of the cost. That's the distortion of market principles.

So what's to be done? The Bush Administration immediately rejected a September petition for a Section 301 investigation. That won't end the effort to force the feds into action on this , but it should be plain to all that if China will not normalize its currency for its own good, U.S. trade laws will not get it done.

And so, another set of laws is called into use. The standard criticism of the corporate bankruptcy routine is that it challenges our sense of fairness. When all is settled, someone — suppliers, contractors, employees, communities — is left poorer than they had reason or right to expect to be. Citation and Intermet chose a reasonable solution to their problem, and the companies will recover. But, their creditors may well wonder where the money went.