It used to be the case that minimills (scrap buyers) and integrated mills (iron ore buyers) had very different cost structures. Integrated steel producers’ costs were relatively fixed because iron ore and coking coal were sold on an annual contract basis and did not change much year to year. Scrap prices on the other hand, moved up and down with steel demand end helped minimills maintain their margins across the cycle. That was then and this is now.
The raw materials used to make steel are in short supply globally, causing much greater volatility in all raw material prices and different purchasing behavior by steel producers. From the few time series which are available to compare the two, scrap and pig iron prices track each other. See the chart below.
So it’s not really fair to fault EAF producers for reacting to iron ore price hikes or integrated producers for reacting to scrap price shifts. Iron is iron and, if priced efficiently, the two commodities will price an iron unit about the same. If you don’t believe iron is iron, check out the recent announcement that Nucor, the largest minimill in the country, plans to build a blast furnace to make the stuff.
And it’s the surcharge, another undoubted frustration for steel buyers (and producers), that has driven steel prices most. There are a number of different flavors of surcharge depending on the product you’re buying and who you’re buying from. But in all cases the surcharge mechanism is relatively transparent, at least enough to show how the supply/demand tensions of the raw material compare with the supply/demand tensions of the finished product.
To make that comparison, just take the calculated surcharge of hot roll sheet or plate from any of the US producers and subtract it from the Purchasing Magazine monthly spot price for those same commodities. You will see that after an initial run up in the base price (i.e. the price excluding the surcharge) in 2003/4, most of the price changes since then have come from the surcharge mechanism alone. It’s only in recent months that the supply/demand dynamics of the finished steel product markets have also started to put upward pressure on prices.
Martin Wolf, as he often does, wrote an interesting column in the Financial Times recently called The market sets high oil prices to tell us what to do. As $1,000/ton steel becomes an accepted fact of life it’s worth asking what the market is telling us to do about high steel prices.
Martin Wolf offers six ‘do’s and ‘do not’s’ as responses to the price of oil. Here they are and how they apply to steel.
1. Do not blame conspiracies or speculators
The steel industry version of conspiracy or speculation theory is ‘insanity’ theory. Current steel prices are regularly called “ridiculous” by some observers. But calling prices ridiculous cuts off any further, more reasoned analysis as to why prices of $1,000/ton or even twice that might not only be rational, but sustainable in the foreseeable future. Avoid calling prices ridiculous. It doesn’t help, especially if they go up again.
2. Do not blame emerging countries for their growing demand
It seems obvious that soaring steel demand in developing countries is a good thing for most industry participants, sellers and buyers. But sometimes these emerging economies are blamed for the few negative aspects to the industry’s current good fortune. China, India and the like have helped drag the industry out of its long term poor performance and we should be thankful at least for that and hope their growth continues.
3. Adjust to high prices by becoming more efficient in the use of oil
Just as with oil, the developed world has been profligate in its use of steel. We thought we could afford to be when it cost only $200/ton. But in Pittsburgh, we still use it to cover potholes in the street. In many manufacturing processes, yield losses of 25% or more are commonplace. We need to be more efficient in our use of steel because it isn’t cheap any more and it’s unlikely to be for some time. Smart manufacturers like Toyota recognize this.
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Severstal recently closed its acquisition of the Sparrow’s Point mill owned by ArcelorMittal. The price paid by Severstal, $810 million, works out to just over $200 per ton of installed steel making capacity. This is well below what assets have been selling for in North America. As can be seen in the graph below, the acquisition cost per ton paid for steel making capacity has risen from around $200 per ton when the consolidation process started, to over $1,000 per ton in the last couple years.
Of course, Sparrows Point was not operating at capacity and generated only $25 million of EBITDA in 2007. So we’ll have to wait and see whether or not this was a good buy by Severstal. On the surface, however, $200 per ton for a fully integrated plant on deep water seems like a bargain.
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).
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Until a few years ago the steel industry was considered mature, and the moniker was accurate. Global steel demand grew more slowly than did the world’s population. In much of the developed world, demand for steel was stagnant after having gone through a long period of decline. Since 1998, however, the steel industry seems to have re-ignited its growth engine and kicked into a new gear. The industry has been growing at 6% annually and most analysts see strong growth continuing for a decade or more. What explains the steel industry’s reemergence and can it continue?
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