Backward physical integration comes to the aluminum rolling industry
SDI’s decision to “jump the fence” and enter the aluminum rolling sector was, in and of itself, blockbuster news. However, the repercussions on the aluminum scrap market may be even more profound. CRU has argued for some time that the big aluminum rolling mills would eventually borrow from the SDI and Nucor business model and embrace backward physical integration. These companies’ purchases of Omnisource and The David Joseph Company, respectively, in 2008 enabled both steel companies to gain more direct physical control of their scrap feedstock. These companies’ footprint in auto shredding and other steel origination “across the scale” have been major contributors to their bottom-line success. SDI, for example, reported that Omnisource secured 42% of their ferrous supply during fiscal year 2021. That surety of supply is a big plus.
The aluminum industry has historically had uneven commitment to backward, physical integration.
Years ago, Alcoa and Reynolds operated large, retail recycling centers for purchasing used aluminum beverage containers (UBCs). These centers exposed the risks of corporate America getting into the scrap business. They were beautiful facilities, but high cost and never realized their potential of delivering high-volume, lower cost metal units. Alcoa shut their system down in the 1990s, and Reynolds sold their last 29 centers to Wise Metals in 1999. Wise (now Constellium) has rationalized those centers down over the years to a handful of sites.
Anheuser-Busch, Coors, and Coca-Cola all took turns building and then dismantling UBC recycling sourcing organizations. All are gone today.
Alcoa and Novelis had ambitious plans to source UBC through their Evermore Recycling formed in 2009. While this did not entail operating scrap yards, it proposed to aggregate their large, combined volumes in economies of scale on freight and a coordinated approach to the market. Novelis asked to dissolve the joint venture in 2011 due to conflicts with a major can sheet customer. Alcoa took sole control of the company in 2012 and in September 2013, Alcoa folded the Evermore business back into its third-party buying arm.
Today, the only semblance of backward physical integration in the market are the successful closed-loop tolling arrangements that exist for aluminum beverage can scrap (“class scraps”) and automotive stamping scrap. Can scrap represents about 16-18% of the volume of can sheet shipped from the mills. Automotive scrap represents 45-50% of the volume of auto body sheet shipped in.
Aside from those scrap streams, the mills use the vast network of third-party scrap dealers and processors to buy what they need. This does not give the mills either supply or cost surety beyond one year – and in some cases, only quarter to quarter.
Now, SDI intends to adapt its integrated ferrous model to the aluminum world, leveraging Omnisource. This could be a notable change.
The SDI mill will change Omnisource’s role in the market and overall scrap flows
Omnisource is considering the largest US nonferrous process operating auto shredding capacity, with 60 facilities stretching from Indiana to Mexico, plus major regional trading offices sourcing from third-party feeder yards. SDI reported handling 3.1 billion pounds of nonferrous scrap between 2019-2021, with 1.1 billion pounds during 2021. They trade the full gamut of aluminum scraps from obsolete, secondary grades to new production mill grades. Omnisource’ s large auto-shredding footprint makes them a natural producer of zorba and twitch, the principal feedstock of the aluminum secondary diecasting industry. They also trade substantial volumes of OEM new production scrap, sourced from turnkey arrangements with OEMs to collect, process and ship their material.
Their overage of the market is undisputed, and, in the past, their prowess in sourcing scrap enabled them to own the exclusive franchise of supplying aluminum scrap into the old Nichols-Home Shield aluminum mill in Davenport, Iowa. They have prominent commercial supply positions with most of the leading mills today. Those relationships may change with SDI entering the fray as a competitor to Omnisource’ s customer base.
It is likely that Omnisource’ s supply of mill grade scraps to third-party rolling mills will be restricted once the SDI mill comes on-stream. SDI will clearly be looking to copy their ferrous model of internal sourcing over to the aluminum mill.
Aluminum scrap deficit and flows will again be altered
We have previously discussed how the new Novelis, Bay Minette (Ala.) and Manna/Ball Corporation, Los Lunas (N.M.) mills would impact aluminum scrap demand and flows. Those mills raised scrap demand by 1 million to 1.1 million tons.
SDI’s mill will further boost demand by another 525,000 tons, bringing aggregate new demand to about 1.625 million tons by 2026.
SDI will have the unique advantage of being able to leverage Omnisource’ s sourcing network.
It is not a coincidence that SDI’s press release about the mill alluded to plans for a major secondary aluminum slab-casting facility in Mexico. In May, they acquired the major Mexican recycler Roca Acero SA de CV, with scrap processing capacity of over 850,000 tons (ferrous and nonferrous).
This acquisition was undoubtedly aimed at supporting their new 3 million ton/year flat-roll steel mill in Sinton, Texas. Roca also affords SDI the ability to capture the large amount of UBC and class scrap that comes into the US from Mexico.
Prior to the SDI announcement, we assumed that Los Luna’s locale would be in ideal position to capture the Mexican scrap. Now SDI’s new secondary slab casthouse will intercept that metal before it even crosses the border. It will also jeopardize other flows into the Ta Chen industrial alloys rolling mill at Texarkana, Texas, and the big mills in the lower Ohio Valley.
Assumptions about Novelis’ ability to capture UBC and can scrap from the Gulf Region, including Florida, will depend on where SDI decides to site the second announced standalone slab casthouse in the “Southeast.”
Stakes become even higher for a radical move on UBC recycling
Bay Minette and Los Lunas were already a call to action for the supply chain to address raising UBC recycling rates. SDI now makes it imperative. If we assume that 75% of the1.625 million tons of new scrap demand is UBC, that represents 1.2 million tons. That is 16% more than the total number of UBCs consumed by the entire industry in 2021. We will have nine mills chasing the available supply in 2026 versus six in 2022. Something must give.
In the absence of a structural change in the recycling rate for UBCs, we are going to witness UBC discounts to primary aluminum narrow sharply as the market goes into a feeding frenzy to ration the available supply.
The removal of Omnisource’ s supply from the non-SDI mills will aggravate this situation.
Apart from structural change in the UBC collection process, the SDI mill may jar other mills into thinking about backward integration. That could be a tough and expensive process. The scrap industry has been very lucrative for the past few years. Anyone considering buying either public or privately held assets will face some eye-watering P/E multiples.
We are not going to speculate on what companies might be in play. But undoubtedly SDI’s actions will prompt their new competitors in aluminum to explore all options to stay competitive in the scramble for scrap units.
By Greg Wittbecker, Advisor, CRU Group, Gregory.Wittbecker@CRUGroup.com
Learn more about CRU’s services at www.crugroup.com.
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