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China steel mills cutting scrap use favors iron ore prices: Morgan Stanley

London — China is using less ferrous scrap in steelmaking due to low steel margins, supporting demand and prices for iron ore, Morgan Stanley analysts said in a recent report.

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"The iron ore price remains elevated, as China's steel makers consume less scrap," the analysts said.

"Steel mills' profit margins have come down, and steel scrap is more expensive compared with the variable cost of producing hot metal in a blast furnace."

Platts China HRC and rebar export spreads with iron ore and coking coal, which weakened sharply over October and November, have started to stabilize this month as steel prices stabilize.

Morgan Stanley estimates China's scrap rate in the oxygen converter, or BOF steelmaking process, fell during the course of 2018 to 15% in November, from 24% in March.

"Given the current price differential, there is a chance that China's steel industry will consume less scrap for longer, if steel margins do not improve on policy easing."

China's iron ore demand may increase 40 million mt should scrap consumption rates at integrated mills remain lower, and EAF production in China stays at 9% of overall crude steel, the bank said.

The assumptions were based on Chinese steel production in 2019 falling to 897 million mt, down 2.6% from 2018.

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Additional demand of 40 million mt of iron ore would result in a balanced iron ore market in 2019, more than covering a global iron ore supply surplus of 37 million mt in the bank's base case scenario.

"Despite low steel margins and falling production, we could see higher than expected iron ore prices this year," the analysts said.

"However, we do not believe such a scenario would extend beyond 2019, as lower scrap consumption will start to lower the scrap price, rebalancing the equation vs iron ore."

Morgan Stanley said China's domestic scrap supply was expected to grow over time and scrap consumption will increase in the longer term, with market factors making it difficult to know how the expected trend would play out.

--Hector Forster, hector.forster@spglobal.com

--Edited by Daniel Lalor, newsdesk@spglobal.com