THE
CHANGING FACE OF STEEL by
MEPS (International) Ltd.
The global steel industry has been subject
to a number of significant changes since the start of the
millennium. It started with China's emergence as the major force.
Steel prices suddenly came to life with
unprecedented increases through 2004 followed by substantial
decreases in 2005. Moreover, e-business portals came and went. The
LME steel contract was postponed in favour of plastics. The MEPS
on-line price service was put in place to provide benchmark steel
product prices to meet the needs of steel customers. Consolidation
within the steel sector is now high on the agenda and the once,
impossible is now becoming a practical necessity.
CONSUMPTION AND PRODUCTION
The rapid rise in world steel output and
demand is mainly the result of higher economic activity in China and
the resultant expansion of steelmaking by the domestic producers.
Approximately 80 percent of global steel production and 72 percent
of consumption over the five years from 2000 to 2006 can be
attributable to China.
Over the period, Chinese steel production
will have increased by 220 million tonnes (170 percent) whilst in
the rest of the world, the estimated equivalent figures are 54
million tonnes (7.5 percent). A similar picture can be seen for
finished steel consumption - with Chinese demand growing by 180
million tonnes against the rest of the world's 70 million tonnes.
Chinese steel production in 2005 is
expected to be 347 million tonnes: equating to 31 percent of global
output. By 2008 China's share of steel production and consumption
are likely to have reached 32.7 and 32 percent, respectively.
With such dominance, the Chinese steel
enterprises must exercise a degree of responsibility to the rest of
the global steel industry and to their own shareholders. If supply
continues to exceed internal demand then global prices will
inevitably decline to unprofitable levels. The first stage of
retaliation will be a spate of anti-dumping actions brought against
any country which seeks to export its oversupply problem. This
situation may not be far into the future.
We do believe that the Chinese government
will act to cut the rate of capacity increases in the steel sector
in the medium term. The current plans of most of the major steel
manufacturers will probably be not allowed to come to fruition.
However, many big projects are already in place and cannot be
stopped. Consequently, we expect substantial growth in Chinese
output to continue up to 2007 at least. It is probable that all
export incentives for the steel sector will be eliminated in the
near term to regulate the anticipated flood which may take place
soon.
China is not the only future growth area
for the steel sector. Indian steel mills have also big plans to
expand capacity to meet the expected growth in internal demand. Many
of the projects will go ahead over the next two or three years. In
the longer term, foreign steel companies are making investments for
steel manufacturing in India to build plants using the readily
available local sources of raw material. We believe that many of
these may not meet their full design capacity in the time frame
originally planned.
The high price of oil in recent times has
radically changed the trade flows around the world. The middle
Eastern countries and Russia have been winners. In contrast, steel
consumption in the oil importing regions, including, North America,
most of Western Europe, Japan and South Korea, is likely to be
stifled somewhat as economic growth is held in check.
Raw material costs for steelmakers (iron
ore and coking coal) moved up quite steadily for many years up to
the start of 2004. Consistently higher demand from China raised
fears of shortages as the local producers of steel racked up output
in 2003. The increase was equivalent to almost the total output of
the German steel industry.
Negotiations for 2004 contracts showed
rises of 71 percent for seaborne iron ore and 120 percent for coking
coal. On top of this, freight rates more than doubled. These massive
hikes were possible because it was thought that the raw material
suppliers would be unable to meet demand. In the event, global steel
production rose by 87 million tonnes and shortages were only notable
for two or three months in the second quarter.
The raw material and freight cost
escalations at that time pushed up mill costs by around $US100/120
per tonne of finished product. However, the steel makers were able
to lift prices by much more than the cost increases as customers
feared being without material for their production lines.
Pig iron production costs in Brazil are now
reported to be near to $US230 per tonne.
STEEL PRICE TRENDS
Over the past two years carbon steel prices
have been extremely volatile. In the final quarter of 2003, MEPS
domestic average hot rolled prices in Asia, North America and EU
were at similar levels at $US340/350 per tonne. By September 2004,
North American values peaked at almost $US800 per tonne before
declining rapidly to around $US550 per tonne in July this year. In
the EU, domestic hot rolled coil values rose to near $US700 by the
end of 2004 but slipped back to $US530 per tonne in July 2005. Asian
prices never reached the dizzy heights applicable in the other two
regions - rising to below $US600 per tonne in May this year. A
steady decline then set in.
The fear of shortages generated the
backdrop for the massive price hikes around the world. Customers
placed orders well in excess of real demand. The mills took
advantage of the panic mode. When it became apparent that orders
could be met by the steel producers, customers reduced their order
patterns and prices fell.
Steel is a heavily traded material across
the world. The US dollar is the currency for trade in raw materials
and steel products. Currency exchange rates therefore play a key
role in determining the trade flows. Freight rates are also an
important factor; particularly since their substantial upturn in
recent years. High freight rates inhibit exports unless substantial
regional domestic price discrepancies exist.
Political decisions, also play their part.
The US government's unilateral decision to impose section 201
safeguard tariffs' in 2002 had the effect of lifting steel prices
around the world. We expect more anti-dumping cases in the future,
now that China is a net exporting nation.
Steel prices for a given product usually
follow a similar pattern but the size of increase and timing of
implementation can differ widely. These price discrepancies generate
rapid rises and declines in traded volumes over short periods of
time as imports and exports become more attractive in different
markets.
Long and flat product values move in
similar directions. However, the variation in price can be quite
small - rising to $US170 per tonne at times. The fortunes of the
construction sector play a large part in demand for long products.
In contrast, consumption of consumer goods is a key driver for the
flat products segment.
The main element in steel price movement is
still the balance between supply and demand. However, in the past
two years, the cost of raw materials is playing an ever increasing
role in the determinant of the floor prices. It is now clear that
the $US200 per tonne hot rolled coil selling price is a thing of the
past.
In recent years MEPS had seen the need for
developing benchmark prices for individual products across regions.
It was clear to us that a physical contract as proposed by the LME
would be difficult to achieve - partly because the material is
subject to corrosion, therefore keeping stocks is an impossible
task. Moreover, the industry has a large number of product
categories and dimensions that finding a suitable product to monitor
was and is very difficult.
We should remember that the steel industry
is not like the metal's business. Their structures are completely
different. The major metals producers usually operate from raw
material extraction to production of a semi finished product used
for further processing. In the steel business, raw material supply
is undertaken by separate mining companies. The mills are integrated
from melting to the production of finished products. This means that
there are substantially more buyers. Many of them are also
suspicious of any initiative promoted by the mills or financial
institutions - hence the failure of e-business and the initial
apathy for the LME contract from the majority of buyers.
Whilst discussions were taking place on the
LME steel contract, MEPS was developing a range of steel price
indices relating to the key finished products sold in the industry.
Steel customers indicated a need for benchmarking price movements
for individual or a group of products within a region. Using
existing data obtained in research already undertaken in twenty
countries worldwide, we developed monthly indices in three regions -
EU, Asian and North America for seven rolled carbon steel products.
These were then grouped into flat and long products prices, plus a
composite all products price for each region. Finally, a composite
global price/index was generated covering the seven products across
the three regions. One year forecasts were then produced for most of
the indices available and the service was launched in March 2002.
Similar indices are being provided by
others. The big advantage that MEPS possesses is that historical
date is available from 1997 for all regions. The information is
posted monthly on our website and is accessed on subscription. The
service is being taken up by government and commercial organisations
with responsibility for commissioning major projects. Main
contractors, subcontractors and equipment manufacturers all utilise
the service. More and more enterprises are finding a use for
benchmarking their main steel requirements. The complexities of the
steel sector are reinforced by requests to us for indices relating
to electrical sheets, tinplate, ships plate and offshore special
grades. To meet some of these requirements MEPS will be launching
its range of stainless steel indices and forecasts early in the New
Year.
The indices were not specifically designed
as a financial instrument for forward contracts. The data is not
built up on physical transactions but from researched data in the
market place. This means of collecting information does not,
however, invalidate the pricing trends. The need for benchmarking in
the steel sector is reinforced by the 2500 subscriptions taken up
for the service in the first eighteen months of its operation.
STEEL INDUSTRY CONSOLIDATION
Many mergers and acquisitions have taken
place in the steel sector in recent years. The catalyst for this
activity was the privatisation of British Steel in the late 1980's.
Rationalisation within the industry was almost impossible because
the majority of steel companies outside Japan and North America were
state owned. Restructuring in Japan was unlikely because of
complicated cross shareholding and the implications of lifetime
employment. Consolidation in the United States was not possible due
to legacy costs from worker pensions and medical costs. Much of the
West European steel industry was state owned. A stalemate prevailed
for many years. Furthermore, many governments saw the steel as a
strategic industry.
The picture changed with the privatisation
of British Steel. The success of the company in its early years
prompted many other governments to sell or substantially reduce
their stakes in their steel enterprises - particularly in the
European Union. This was then followed by the big merger in Japan
between NKK and Kawasaki to form JFE. The opening of the Iron
Curtain provided opportunities for many of the East and Central
European states to divest their steel industries. Government
assistance in the US helped to unlock the problems of legacy costs
to facilitate acquisitions. The fashion of privately owned steel
enterprises is spreading around the world into South America and
several parts of Asia and the former USSR.
Consolidation started with inter-regional
transactions. This was quickly followed by inter-continental mergers
and acquisitions. This latest form was pioneered by the Mittal Steel
Group but others are now taking this route.
Inter-regional rationalisation has proved
very successful for the steel makers. Larger groupings have led to
opportunities for restructuring and improvements in operational
efficiency. This, however, has not been the only benefit. Reduced
competition in the market place has given the mills more
opportunities to respond to changing situations. They are now more
nimble in their actions, resulting in more rapid price adjustments
and output control. Without consolidation it is unlikely that recent
price levels would have been achieved. Moreover, it would have taken
much longer to establish the significant production cuts that have
taken place in the major markets. The emergence of a market leader
with a substantial share of the supply also gives a degree of
discipline by taking decisive actions which the smaller enterprises
often follow.
The success of past consolidation in the
steel sector is a guarantee that more will follow. Inter regional
rationalisation will take place as the smaller mills link up to
leave, perhaps, four or five groupings. Competition regulators will
not allow the major steelmakers to expand much further within a
region or country. International mergers and acquisitions are likely
to extend as the current leading steel producers try to build up
their influence across the world.
Article written for Commodities
Now by Peter M Fish, Managing Director
MEPS (International) Ltd.
Sheffield, UK
