Is R for recession or resilience?
Goldman Sachs reported today that it believes the US economy will suffer a recession in 2008, and Goldman is not alone. It seems everyone is worried about the impact of the credit crunch and high energy costs on US consumers. So, what might a recession mean for shipments by steel producers in the US in 2008?
There is clearly a correlation between GDP growth and steel demand. In developed economies, such as the US, the rule of thumb is that GDP has to grow at a base line level or steel demand contracts. In the US, the rule is pretty simple: If GDP grows by more than 2.5%, steel demand tends to rise. Conversely, steel demand falls when GDP grows by less than 2.5%. You can see this in the graph below. (If the graph is hard to read, click on it and it will enlarge).
As a thought experiment, let’s assume US GDP grows by 0.8% in 2008, as Goldman predicts. Based on the historical relationship between US GDP growth and steel demand, 0.8% growth in GDP would result in a 5% decline in steel demand this year. But be careful. A 5% reduction in demand doesn’t translate directly into a 5% decline in shipments by US mills because there are other factors at work. The most important are exports, imports, and inventory levels. Let’s take a quick look at each of these to see how they might impact 2008 mill shipments.
When all data are in for 2007, US exports of steel mill products will likely set a record - over 10 million tons of finished steel products. This will be the third record year in a row for US exports. Strong export performance can be attributed to a weaker US dollar, strong global demand for steel products, and low US prices relative to much of the rest of the world. With the dollar likely to remain weak, it is reasonable to assume that US exports will remain close to 10 million tons, where they have been for the last few years. Exports will help mills maintain shipment levels even in the face of weak demand.
On the other side of the trade ledger, imports in 2007 are likely to have fallen by 25% from the record levels of 2006 (27 million tons in 2007 vs. 36 million tons in 2006). With steel prices rising in the US and steel service centers replenishing inventories (explained below), it is reasonable to assume a modest increase in steel imports in 2008, but not a deluge. A reasonable assumption is that imports will rise by 2-3 million tons in 2008 to 29 or 30 million tons for the year.
Inventories of steel products at service centers, as reported by the MSCI, will finish 2007 at around 12 million tons, the lowest level in ten years. Most industry observers expect service centers will build inventories to recent historical levels over the course of 2008, especially in the face of rising US prices. This inventory build, which would need to be two million tons to bring inventory levels back to their five year average, also will help cushion the impact of declining demand on mill shipments.
The net result of all this give and take is expected to be a modest decline in mill shipments in 2008, to just over 100 million tons. See forecast below. Not a boom year, but not a disaster either. And certainly no reason to assume the only R word we can apply to the steel industry is Recession. Given the industry’s recent performance, R may be for the steel industry’s Resilience in the face of challenging economic conditions.
