Nerds of Steel

Data just released by the AISI shows raw steel capacity utilization at 67.3% during the last week of October, down from close to 90% a couple months ago.  How does utilization below 70% compare to previous recessions?  And how long might it last?  A review of historical data is always a good place to start when pondering such questions.

The graph below shows annual capacity utilization for the US industry back to 1915. Utilization dropped below 70% only four times: During the depression of the early 1920s, in the great depression of the 1930s, in the period of global economic slowdown between 1958 and 1962, and finally during the severe recession of 1982 and its aftermath. In other words, history suggests that sustained periods of steel industry capacity utilization below 70% are rare, but not unheard of, and occur only when the US and global economies are in severe recession.

Though we do think we’re in a recession in the US, we don’t believe we’ll see a prolonged period of utilization below 70%. There are two reasons for our relative optimism.

First, this global downturn is not expected to be as severe as some we have experienced in the recent past, for the reasons cited in this post by fellow nerd, James Moss.

Second, supply and demand are much better balanced in the US now than in the early 1980s. The recession of 1982 exposed the fact that the US economy was in a period of de-industrialization. Manufacturing activity was moving off-shore and the steel intensity of the US economy was in decline. Steel intensity (measured by thousands of tons of steel consumed per billion dollars of GDP) fell by half, from 23 in the late 1970s to under 12 by the early 1990s.

Rapidly declining steel intensity led to severe overcapacity in the US industry, as it did elsewhere in the developed world. Mills ran at low levels of utilization while the industry gradually closed excess capacity. Between the late 1970s and the early 1990s there was a net reduction of roughly 50 million tons of steel making capacity in the US, a decline of over 30%. This restructuring, while brutal for the industry and its employees, eventually brought supply and demand into better balance.

It really is different this time. Steel intensity has stabilized, so steel demand grows slowly along with GDP. This growth, combined with careful investment in new capacity, means that raw steel capability remains below the level required to meet peak steel demand in the US. As a result, the US is a substantial net importer of both finished and semi-finished steel products. This structural undersupply has helped the industry maintain relatively strong operating rates since the late 1980s. As can be seen in the graph below, monthly raw steel capacity utilization has dipped below 70% only twice since the late 1980s, once during the 2001 recession and now.

It is certainly conceivable that utilization could remain below 70% into the first quarter of next year as mills work to keep production in line with demand. But a protracted period of 70% utilization could only occur if demand remains severely depressed for an extended period of time. With low inventory levels and limited import offers, any uptick in economic activity will push the US utilization rate up quickly.

In the meantime, we do not expect an industry restructuring like we experienced in the 1980s or the opening years of this century. The US industry is in much better shape now. Not only are supply and demand better aligned, but balance sheets are much improved and cost structures are more variable.