Formula pricing does not work for scrap if there is a shortage of raw materials

An article by the chairman of the supervisory board of the Ukrmet group of companies Konstantin Bass on the GMK-center portal:

In response to the offer of metallurgists to switch to formula pricing (price in Turkish ports minus supplier expenses) on the scrap market, UAVtormet Association pointed out the incorrectness of this formula.

The proposed pricing formula is generally understandable and transparent, but does not fit all market conditions. Under the conditions of the supply surplus of scrap, the formula is quite acceptable, but completely non-working when there is a shortage of this raw material on the market.

In January-March, when there was a shortage of scrap, metallurgists could not agree on a price and were forced to import. They tried to negotiate with large scrap-traders, offering them attractive pricing conditions to fill their needs for scrap metal. Now, when the deficit is partially overcome, the metallurgists want to consolidate the formula, taking advantage of their monopolistic right of buyers (where does the Antimonopoly Committee look?).

In addition, the formula has one incorrect component - an artificially high export duty of € 58 / t. In our opinion, the formula should take into account “export parity” and may be as follows:

Export duty + exporter costs + exporter margin = domestic market price.

As a result, the internal price, taking into account export parity, can be at the level of $ 195-200 / t. But the export duty should be adequate, and not the one that is today. In our opinion, the export duty should be no higher than € 10 / t.

You must also consider reducing scrap collection. After the May scrap collection of 300 thousand tons, in June-July there will be no such indicator. According to our forecasts, scrap harvesting in July will be only 100-130 thousand tons (with an average monthly harvest of 270-280 thousand tons in 2018). This will be the result, above all, low purchase prices that are established on the market. Since the beginning of the month, they have decreased by UAH 800-900 per ton.

It is precisely the low price factor that can lead not only to a reduction in scrap collection, but also to the fact that suppliers will have to freeze work on dismantling projects and cut staff or send it on unpaid leave. This will occur before the establishment of higher prices in the market. Small companies can close altogether, especially since today there is a high receivables from metallurgists for the supplied scrap of ferrous metals. At the same time, scrap collectors do not have sufficient own reserves to reduce costs due to high fixed costs (rent, staff, etc.).

Under the conditions of a shortage of raw materials, metallurgists have only two options: to increase purchase prices (breaking the “export parity”) or to import. The most realistic way to purchase scrap is Russia. But there may be other markets.

It should be borne in mind that when there is a shortage of scrap, large consumers (metallurgists) will not adhere to price agreements even if they are adopted. They may offer scrap collectors hidden surcharges to compensate for the shortage of raw materials.

I believe that a price compromise with metallurgists is absolutely possible. We have an interconnected business. Lomozagotoviteli always try to find a point where the interests of the parties converge (as it was already more than once), and get the pricing that will allow you to work with an acceptable level of profitability. But the main stumbling block is the current duty of € 58 / t.

On the other hand, in the fall, we expect a rise in scrap prices on the world market. This will not allow metallurgists to keep low domestic prices (even if formulaic pricing is adopted). For its part, Ukrmet is studying and considering the possibility of working with European and other sales markets.