“ITAC is proposing to reduce the Price Preference System (PPS) discount on scrap steel from 30% to 25%., but…. always the but…. keep reading…,” says Donald MacKay in his blog on his Global Traders Advisors web page.
“PPS provides a raw material subsidy to scrap consumers such as mini-mills by forcing factories, mines, construction companies and SOE’s to accept less for their scrap metal. This value transfer amounts to about R8.5 billion per annum at present. But PPS is about more than just the discount on the face value. It is a deliberate shift in market power to the scrap consumers, so in addition to the discount, the sellers have to cover the cost of transport to the buyers and the buyers can block exports without ever actually taking delivery of the product,” MacKay continued.
“Let’s take a moment to understand the unusual economics of scrap metal first through the eyes of a manufacturer. Our manufacturer buys steel from a supplier. They cut it up to make their widgets and then sell the waste bits of scrap to a recycler. The price they are paid is directly linked to how much the recycler believes they can sell the scrap for and what PPS does is force down that price by any competition to the consumers of scrap metal, by foreign buyers. Although the primary mechanism of PPS is the forced discount, it is ‘complemented’ by export duties so that when no one wants to buy the product locally, an export duty is still payable.”
“There is an important cash flow issue to consider. For most scrap purchases, the recycler needs to pay cash from the scrap metal and given that banks are reluctant to fund the industry, the buyer often turn to a less formal and more expensive forms of lending from people in the industry who better understand the risks.”
“When the recycler owns the scrap, they take it to their yards, sort it and sometimes partly process it before selling it on. All of these are costs they need to cover, still with no certainty on the exit price they will receive. You will notice that scrap yards tend to be large (scrap takes up a lot of space) and well secured (people steal scrap all the time), so a scrap yard is expensive even without counting the value of cash tied up in stock.”
“When everything is ready for sale, the scrap recycler approaches ITAC and tells them how much they have for sale of each type and grade of metal. ITAC then circulates these notices to potential local buyers who make offers, or not, as the case might be. There are a few characteristics of these offers that are worth noting. Firstly, the seller has to always cover the cost of transport to the buyer. Most of the scrap consumers are in Gauteng, but scrap metal is generated all over the country. This means that companies further away from Gauteng end up recovering less for their scrap.”
“The gazette proposes to reduce the PPS discount for scrap steel (good), but still ensures the sellers need to cover transport costs. In the past buyers had 15 days to finalise their negotiations after which ITAC was supposed to make a decision. In reality the deadline was never respected but now the deadline has been removed. This will have very serious consequences. There is huge incentive to submit ‘blocking’ offers, where an offer is made but is not fulfilled on time forces down prices for recyclers, further increasing the effective discount.”
“The refusal to review seller-funded transport obligation allows mills to continue issuing uniform purchase offers across provinces at PPS-discounted rates (e.g., 25 – 30% below international benchmarks). Since sellers absorb transport expenses – which rise with distance – suppliers in remote provinces such as KwaZulu-Natal get blocking offers from Gqeberha, for example and cannot viably compete or sell inter-provincially, allowing local mills to maintain low prices without upward pressure from broader market dynamics. This risks underestimating economic distortions, as no explicit analysis of transport impacts on pricing is provided.”
Too much steel in South Africa
“There is too much steel in South Africa which is one of the reasons Mittal closed its Newcastle operation. There are around 10 mini mills in South Africa, with a new Chinese-owned mill opening in Nigel adding another 600 000 tons of long steel to the market. PPS forces down the price of scrap metal and friendly finance from the IDC (R14 billion into mini mills, according to then Minister Patel) is creating a scrap consumption bubble. Because no one sets up a factory to produce scrap metal, and because PPS artificially suppresses the prices of scrap, we are very likely to see shortages.”
Steel billets exported
“When there is no local demand, scrap steel is melted into billets or ingots and mainly exported. These semi-finished products are a combination of scrap steel and electricity (a scarce resource). They also don’t attract an export duty, so although there is nothing inherently wrong producing semi-finished products, these exports are artificially high because of the arbitrage created by PPS, export duties on unprocessed scrap steel, and friendly IDC finance.”
“These exports represent the PPS discount, forced on local generators of scrap, transferred to foreign buyers of steel. Some of that discount returns to South Africa as cheap steel which competes with our own local steel industry. In the last 12 months, just shy of R4.2 billion was exported like this.”
What happened to the last PPS review?
“A 13-month review of PPS was undertaken by ITAC, but no report has yet been released, an important pre-condition before a decision is taken on this new proposal.”
“According to ITAC’s Chief Commissioner, “ITAC had made a determination based on the balance of evidence that had been placed before it and the economic modelling it had conducted.” This determination is an administrative decision and should be made available once that decision is implemented, which presumably will happen after all comments have been received on the current proposal.”
