ITAC has published a proposed amendment to the PPS. Key issues to note in the proposed amendment are:
- More detailed discounts for specific types of scrap metal.
- The seller must cover the cost of transporting the scrap metal to the buyer. This can no longer be negotiated.
- Scrapping the additional discount of 10%, which the last amendment inserted, for companies selling scrap from coastal provinces. Don’t get too excited though, as the point above simply makes this the seller’s problem no matter where they are situated.
- Scrap metal export permit applications, submitted to ITAC, may not be withdrawn unless a local sale has been made.
- Scrap metal will only be allowed to be exported as breakbulk cargo, with containerised exports being prohibited.
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We will publish the deadline as soon as we have it.
Understanding the price preference system
To understand the PPS, you first need to understand the dynamics of the scrap metal supply chain. We start with Jim. Jim has an old wheelbarrow he wants to get rid of. He places it on the curb at the end of this driveway and later that day Simon walks past Jim’s house with his large flat-bed trolley and spots the old wheelbarrow. He loads it up and is on his way, collecting used beverage cans, an old bicycle frame and various other pieces of scrap metal. When Simon’s cart is full, he heads off to a metal recycler. The recycler receives the metal from Simon, sorts it into the steel, aluminium and so on and depending on the metal, will pay Simon, by weight, for the scrap.
Fred the recycler will have many people bringing him scrap in this way, but while this is happening, Transnet is auctioning off old train wagons, the SA Mint is selling the skeleton left over after they have punched out your coins and Acme Can Co. is selling the scrap left over from their production of beverage cans. Fred is buying all of this up and putting the scrap through a complex process of sorting and processing to convert a waste product into an important raw material.
Fred then sells this raw material to a foundry, mini-mill or exports it. Importantly, the price Fred will pay for the scrap he is buying from Simon or Transnet or Acme Can Co. is determined by how much he can sell it for. The foundries and mini-mills would, of course, like the price of their raw material to be as low as possible and Fred would like his price to be as high as possible. There are a lot of scrap collectors and recyclers and there are a relatively small number of foundries and mini-mills, so the market power sits with the downstream users. The downstream users do not want to compete with export markets for the scrap metal and in fact feel so strongly about this, they convinced the Minister of Trade, Industry and Competition to completely ban the export of scrap metal for 2 months, which got extended to 3 months. This happened on 3 July 2020 and the ban was only lifted on 3 October.
Going back around 7 years, the downstream consumers of scrap approached the Minister of Trade and Industry as it was then known, complaining about their competition with exports. The Minister, with the help of the International Trade Administration Commission (ITAC) implemented the PPS. The PPS forces the scrap recyclers to first offer their scrap to the local users at a discount. They can only get an export permit if they have no local offers and the discount levels of PPS are steep (30% for scrap ferrous metal for example). So did PPS work? That depends on who you ask, but here are the facts of what happened after implementation:
- The value of scrap metal exports fell from R10bn per annum to R3bn.
- The number of mini-mills and foundries roughly doubled in 7 years.
This is seen as an economic success story by government and the downstream industry, except it loses sight of the fact that most of these mini-mills are not a natural development of increased demand in the market for foundry products. No, they exist because they have a subsidised raw material. Yes, the tax payer is not providing the subsidy, but the subsidy is provided by fiat. It is a forced transfer of value from the recycling sector to the mini-mills. Most of these mini-mills also receive (presumably) discounted financing from the IDC, so understandably there is a lot of interest in owning a mini-mill.
But this is not enough of course. The proliferation of mini-mills means greater demand for discounted raw materials, which means even more of the export-destined scrap metal needs to be forced into the local market, bringing us to where we are now; a PPS which makes it ever more difficult to export. No longer is a forced discount enough, the proposed PPS now also seeks to prescribe the discount to global prices for each grade of scrap (recycled metal is sold at a discount to the primary raw material, so copper scrap will sell at a discount to the copper price). This is normally a rough guide and varies according to the amount of the primary material in the scrap metal. For aluminium scrap, the discount is now prescribed for 47 sub-categories of aluminium, 8 of which will have their discount set based on “Analysis/Sample/Recovery Basis”. For copper there are 13 discount categories and 15 for bronze.
Perhaps the most concerning part of the new proposed amendment (the 2nd in 6 weeks), is the requirement that “Scrap metal, which is authorised by ITAC for exportation by virtue of an export permit, must be exported as breakbulk cargo and not as containerised scrap”.
This paragraph will have profound implications for the state of competition in the scrap industry. Here is why.
Competition in the scrap metal industry
Scrap metal is a voluminous product, so when you are stuffing a container, you are maybe getting somewhere between 20 and 25 tons into the container. If you are a small recycler it can take a while to get to enough to fill a container (think of how many Simon’s you need to get to 20 tons). Fred, our recycler, goes about his collecting and when he has enough he makes an offer into the local market. Let’s assume for a moment, it is steel. Fred puts his offer of 20 tons of steel into the market, through ITAC, who then distributes his offer to the scrap consumers. If there is interest, a buyer will make an offer and a deal will either be struck or not. If Fred does not conclude a deal with a local buyer, ITAC will issue him with a permit and he will export his 20 tons of scrap steel.
Now let’s see what happens when Fred has to export break-bulk (meaning the product is dumped into the hold of the ship and not any longer in discrete 20 ton containers). A break bulk ship is usually divided into a small number of large compartments, to allow it to carry different types of cargo on the same ship. There are considerably fewer break bulk vessels than container ships and it is not clear how many of these ships are currently sailing the shipping lanes most important for scrap metal. If there is no other cargo of interest to India (the biggest scrap export market), then the exporter would have to charter the full vessel for the trip. A small bulk cargo ship would be transporting 15 000 tons of product, compared to the 20 tons container noted above.
Very few companies have either the capital or physical space to collect enough scrap to fill even a small break-bulk vessel. This means a new player will enter the market, which I am going to call a scrap aggregator. The aggregator will buy up loads of scrap from small competitors and then aggregate the load on their (very large) premises close to the port. And it has to be very close to the port, because if we assume each truck carrying the scrap from the aggregator to ship carries 20 tons and the export ship will be loading 20 000 tons, this means there needs to be 1 000 trips to fill the ship. If we generously assume it takes 30 minutes to load a truck and 30 minutes to get to the ship, 30 minutes to unload and 30 minutes to get back to the aggregator’s yard, it means a single load takes 2 hours. If we assume the trucks are lining up and running 24 hours a day and we are loading 10 trucks at a time it will still take 9 days to load the ship.
They will need (lots of) capital and land, both of which are expensive. They also need to make a profit, which means the price paid for the scrap from their smaller competitors will be lower. This will ultimately make it less attractive to export, forcing more product into the local market. For those products which can’t be sold locally, which by variety is significant, scrap recyclers will be forced to sell to the aggregators. We are not going to see hundreds of aggregators, which means we will almost certainly end up with an oligopsony (a small number of buyers purchasing from a large number of sellers).
Fred will get a much lower price for his scrap metal, he will pay Simon less for his scrap forcing Simon to decide if it worth his while collecting certain types of scrap. If Simon stops collecting, then the scrap truly becomes just rubbish and will end up in a land fill. According to the Department of Trade, Industry and Competition, there are 300 000 waste collectors, so the impact of further reduced scrap prices on the most vulnerable people in South Africa is quite profound.
If the aggregator has a strong relationship with a local buyer, either through equity or even just by agreement, we can very quickly find ourselves in a position where a very small number of companies control all the purchasing of scrap, whether for local or export sale. Whatever could go wrong!
In 2008 Reclamation Group settled on a R145m fine with the Competition Commission for collusion. More recently, in 2016, a scrap buyers cartel, was fined by the Competition Commission for price fixing.
If the legislation is amended to force all exports to be made as breakbulk, we will almost certainly see a very rapid concentration of the industry, with all of the challenges it brings.
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