By John Hall
It is an industry whose fate has long been shaped by the building of cars, highways, office buildings and factories, so it’s no secret that steel prices remain relatively low as the U.S. continues to slowly recover from the recession. Prices are expected to remain calm until the fourth quarter and early first quarter next year, when they are projected to rise slightly from an expected production slowdown in China, only to fall back down again in the closing weeks of 2013.
Meanwhile, domestic steel demand could get an unexpected boost in the next 2½ years as a result of a key infrastructure bill approved by Congress in late June.
Exit One Powerhouse, Enter China
Virtually none of steel’s recent history excludes China. Japan and the U.S. long held dominant steel production positions following World War II. Thirty years ago, U.S. factories began shutting down as capacity shifted to thrifty labor-rich China. Today, North America, the U.S. in particular, is one of China’s biggest customers.
“The U.S. has been an importer since the 1980s when much of the capacity shut down and stayed shut down,” John Anton, Manager, IHS Steel Service tells My Purchasing Center. Before the recession began in 2007, the country imported 20-25% of all its finished steel needs. But as demand tanked, so did imports because the U.S. had plenty of online capacity to meet its needs, anemic as they were and continue to be.
“We still have not recovered from the recession in steel manufacturing so the need for imports now is supplemental in nature, and to keep a check on prices if they rise too much in the U.S.,” Anton says.
Meanwhile, even as global demand for steel dropped, China has been on an unprecedented production binge, fueled in part by its need to protect multibillion-dollar investments it made in new steel mills over the past decade. Today, the country produces nearly half of the world’s steel. To put things in perspective, Anton says to consider: As recently as 1999, China was producing about 110 million metric tons per year, slightly more than the U.S. By 2004, the number rose to 250 million. Today, China cranks out nearly 800 million metric tons of steel a year. The next biggest producers are Europe (200 million), North America (150 million), Japan and the former Soviet Union (each about 120 million).
“When people talk about China and steel, it’s really that important,” Anton says. “China has a huge incentive to run its mills flat out and many are following the U.S. auto industry’s former strategy that made it acceptable to lose $1,000 on every car they made by hoping to recoup it in volume. That’s no way to run a business. Most Chinese mills are losing money on every ton of steel they make. But they won’t cut back on tonnage. Part of that volume is going to export, but most of it is stacking up internally into inventory.”
The result: China has been selling steel at “fire sale prices,” he adds.
Current Market Conditions
Ask most observers of the steel market for an assessment, and you’re likely to hear the same thing, in so many words: “The general market conditions are poor. The economy is poor. Europe is in the tank. China’s markets are softening. We have high unemployment domestically. All of that contributes. We’re still trying to recover from the Great Recession,” says Lawrence Kavanagh, President of the Washington DC-based Steel Market Development Institute, whose mission is to promote the use of steel in traditional markets and identify new ones.
Given that scenario, and even in light of soft demand, U.S. buyers are paying among the highest prices in the world, according to Anton at IHS Steel Service. Why? For one thing, it’s hard to break old habits, he says. But the answer is far more complex. Part of it lies in the world of service centers, the intermediaries between steel mills and end users. Today, those entities continue to provide a valuable service by holding large steel inventories and breaking it down and selling it in smaller quantities to various industries. But before the recession, there were more of them. As the credit markets crumbled in 2007 through much of 2009, some went under. Complicating matters is the volatility in global markets fueled by uncertainty in the euro zone.
“Service centers are best when they make their money off taking a 20-ton coil of steel and selling it in pieces,” Anton says. “If they hold inventory and the price goes up, they get a bonus because they bought it at $800 a ton and now they’re selling it for $1,000.”
But inventory isn’t moving as fast or predictably as it once was, making it extremely difficult for many service centers to turn it efficiently. “Service centers use to do four turns a year before the recession,” he says. “Now they’re doing their darndest to do five turns a year. If you import steel it takes about four months to get here from the time you place the order. That works against them.”
Bad News: Construction
First, the bad news: Even though steel is a major part of appliances, weapons, tools, machines and cars, nothing consumes more of it than construction, an industry that continues to be anemic. Overall, the construction industry was one of the hardest hit by the recession, and today, remains the second worst industry in terms of employment among the top 10 private sector industries, according to Jobenomics, an industry blog.
And within that industry, the bulk of steel is used in nonresidential construction, an area that once represented as much as 5% of the U.S. economy. Today, nonresidential construction is at its lowest level in almost two decades, according to a recent Sage Policy Group report. Since reaching a high of over $700 billion on a seasonally-adjusted annualized basis in October 2008, nonresidential construction spending was down as much as 27% as recently as February 2011, “even as the broader economy has begun to experience more meaningful recovery,” the report states.
Kavanagh at the Steel Market Development Institute remains optimistic about the industry. “Construction is composed of many sub-markets and it’s coming back slowly,” he says. “I’m seeing a slow rally.”
At IHS Steel Service, Anton sees glimmers of hope as well, but throttles that optimism when he considers how painfully slow the recovery has been. Look no further than the residential construction market, which is experiencing a slight uptick in housing permits.
“Residential housing may be improving, but it’s nowhere near what it was before 2008,” he says. “The U.S. construction industry should be making about 1.6 million single-family houses a year and in the earlier part of this decade, we hit over 2 million. It may be up by about 20% from a low of 500,000, but it’s still 1 million less than what it should be."
Similarly, nonresidential construction has undergone some volatility. According to Anton, factory construction fell from about $70 billion to $10 billion a year in late 2001. The next year, it went up to $13 billion. “That was a 30% increase but still, one-fifth of what it should have been,” he says. “Percentages are dangerous when you’re looking at construction. It’s so depressed on the residential and industrial sides that even though it’s coming back, it’s really coming back from an abysmal level. It needs to triple to even keep pace to where it was before the recession.”
Using inflation-adjusted numbers, nonresidential construction has gone from a $470 billion annualized rate in 2007 to roughly $300 billion today, Anton says. “That’s the primary reason why it’s hurting the U.S. steel industry.”
Good News: Autos
Even though it is dwarfed by construction, the U.S. auto industry’s comeback has been a bright spot on the horizon for the steel business, according to Kavanagh at the Steel Market Development Institute.
It doesn’t hurt that the industry is a favored user of domestic steel. In fact, most foreign car makers are moving away from imported steel, according to Anton. Around 2000, North America production levels for light-duty vehicles was at about 16 million per year. It slowly declined to about 15 million. By 2009, it plunged to about 8.6 million. In 2012, the domestic auto industry is projected to produce about 14 million light duty vehicles.
Unfortunately, other steel-hungry industries aren’t rebounding as well. “Today, appliances are only being bought when the old ones break,” Anton says. “The appliances won’t come back until people have enough disposable income to do remodeling, etc.” That could change in the next few years as aging appliances reach their useful lifetimes.
Short-Term Opportunity to Negotiate Price
Meanwhile, savvy steel buyers could seize a rare opportunity to gain price concessions if they know where to look, according to Elizabeth Baatz, an economist for Alertdata.com.
“Here’s where the most interesting stories lie,” she says. “Buyers have an opportunity right now to argue effectively for price cuts with iron and steel foundries,” where raw materials costs have been declining since December 2011 (each down 9.47% from a year ago). According to Alertdata.com, the current growth rate in earnings potential in both sectors is significantly high enough to support discounting.
Since June 2011 in the iron foundries sector, industry prices have gone up 3.88%, or 0.57% for each 1% fall in manufacturing costs, according to Alertdata.com. After adjusting for price/cost changes and other economic factors, estimates show supplier margins gaining $6.75 per $100 of market-valued output. Passing this gain on to customers means cutting prices by 11.33%. Similarly, industry prices have gone up 2.82%, or 0.45% for each 1% fall in manufacturing costs in the steel foundries sector. After adjusting for price/cost changes and other economic factors, estimates show supplier margins gaining $6.38 per $100 of market-valued output. Passing this gain on to customers means cutting prices by 10.05%.
Steel Prices to Rise
The Steel Market Development Institute’s Kavanagh echoes the projections of many expert observers: Steel prices should rise slightly in early 2013, only to dip again later in the year.
“There are some positive signs out there as far as demand, but it’s a very slow recovery and much slower than anticipated,” he says, adding he sees “the benefits of continued positive growth” by early 2014. “When you start seeing GDP numbers in the 3-4% range, I think we’ll see a pull through in construction markets.”
To analysts like Anton, the steel industry is not likely to sway from the model it’s traditionally followed for decades. “When people talk about cyclical industries, the ones they usually reference are autos and steel,” he says. “Some would say 20% volatility in prices is pretty high, but not necessarily for steel.”
Anton expects China will cut production later this year just like it did in 2010 and 2011. “When that happens, supply will finally tighten up a bit and they will have an expectation of about $100 to $120 per metric ton increases,” he says. This is what we see in the U.S. The problem is as soon as they get any price increase at all, we’ll see what any industry does when it has dangerous over-capacity and cuts production – as soon as price increases are announced, they start rushing that capacity right back online to take advantage of those higher prices. The steel business really is a classic production-price cycle.”
Domestically, Anton doesn’t expect any dramatic swings in U.S. prices because they already are high. He sees “very strong growth” in the markets in 2014 and 2015, and even the possibility of a turnaround in residential construction by 2016.
A sovereign debt meltdown in Europe and climatic calamities are the wild cards for steel, just as they are for virtually every industry today. While Anton cannot foresee the latter, he says expectations of the former are feared but not anticipated.
“Of course, the euro zone could change everything radically, he says. “The biggest possible risk is we expect Greece to leave the euro next year, but once that happens, things will likely improve. But if the markets panic and Spain gets caught up in it, that’s the biggest downside risk. This would plunge demand in Europe and with China ramping up capacity, there will be no market for their steel there and Europe is China’s biggest export market.” Such a “negative scenario” could shock the Chinese system and lead to a possible mild recession in the U.S., he adds.
In China, a benchmark product – hot-rolled carbon sheets – is already selling for “too low a price,” according to Anton. “It’s at about $520-$530/metric ton and should be selling for at least $600 just to cover their costs and give a tiny profit.” For those reasons, Anton predicts prices will go back to those levels in the near term. The worst-case European scenario, “which we fear but do not expect,” could send prices down around $420, he adds.
Other factors that could change projections involve oil, but only if they stay high for a long period of time. Short-term spikes in oil actually keep steel prices down because demand dips. The exceptions, however, involve prices for copper and aluminum, which often parallel oil price increases because of speculators, he added.
Bright Spots: Infrastructure, Cars, Energy
While the industry waits out a low tide in the depressed construction business, there are bright spots fueling both demand and innovation in the near term.
One very promising development came earlier this year, when the House offered up its proposed American Energy & Infrastructure Jobs Act. The legislation aims to reform transportation programs while promoting increased domestic energy production and is reportedly the largest transportation reform bill since the creation of the Interstate Highway System in 1956. The five-year bill would clear regulatory hurdles and give states more flexibility to move their most critical infrastructure needs forward.
In early July, Congress approved a 27-month transportation initiative to ensure states can carry out important infrastructure projects and ensure long-term jobs in the construction industry, according to House Transportation and Infrastructure Committee Chairman John L. Mica. The bill was signed into law on July 6, 2012.
Kavanagh at the Steel Market Development Institute tells My Purchasing Center that while the move is good news for the steel industry, it’s unclear whether two years of spending will be enough to make a significant impact. “It’s certainly a step in the right direction and could lead to a bump in commercial building,” he adds.
“Infrastructure is a big steel consumer. By itself, [the transportation bill] would not change the whole calculus but it certainly would help,” Anton says.
Another bright spot is energy, according to Kavanagh, who sees the big upswing in domestic oil and gas drilling creating strong demand for assorted flat and tubular steel products. In addition, such clean energy alternatives like wind turbines could further spur demand for steel.
Meanwhile, a bump in domestic energy production is unlikely to affect the way steel is made, according to Anton. Improvements that have opened up natural gas markets, for example, have had some industry observers buzzing about using it as an alternative fuel source for mills. “It’s easy to overstate that trend, but I think natural gas will be a marginal player at best,” he says. That’s because coal is not only cheaper, but the costs of retrofitting mills is too prohibitive. “You’re not going to discard a $2 billion mill to save $10 million a year by using natural gas,” he says. “If you build new mills, however, then the economics may make sense.”
The Steel Market Development Institute is currently engaged in promoting new uses for steel, including utility poles, as well as important innovations that are providing lighter, fuel-efficient and safer construction in cars, according to Kavanagh. But one of the efforts he’s most excited about is short-span bridges.
According to an Institute report, the U.S. Department of Transportation declared that more than 12% of the more than 600,000 bridges across the country were categorized as structurally deficient and more than 14% were categorized as functionally obsolete as of the beginning of 2009. And it’s only getting worse.
“We just came out with new designs for short-span bridges that are very cost effective and easy to install,” Kavanagh says. “We believe the initiative will help communities repair many of their defective short bridges.”
The Institute provides a web-based design tool that shows how to replace short bridges with durable, sustainable, economical newly developed steel grades with higher yield strength, better toughness and improved weldability. By utilizing new modular systems, a steel bridge can now be installed in less than 48 hours, according to the Institute.
Also see the My Purchasing Center article, Steel Hungry for a Price Rebound
John Hall is a freelance writer who reports on commodities markets and procurement and supply management topics for My Purchasing Center. His website is jhallmedia.com.
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