Despite indisputable evidence that the economy is slowing, steel and aluminum executives remain optimistic about demand in such sectors as energy, construction and capital equipment next year. Following are reports from a sampling of sessions at the Metals Service Center Institute’s annual Economic Summit: Forecast 2007 conference Sept. 11-12 in Chicago-suburban Schaumburg, Ill.

By Myra Pinkham,
Contributing Editor

Carbon Flat-Roll
Economic Foundation
Positive for Steel
Roy Platz, director of marketing, sales and manufacturing for Mittal Steel USA, put gloomy forecasts in perspective during the carbon flat-rolled breakout session at MSCI’s Forecast conference.

“Take a look back to 2000. Since then we’ve had the equity collapse, followed up by the 9/11 tragedy, corporate governance scandals, Afghanistan, Iraq, devastating hurricanes and soaring energy prices,” Platz said. “If you were sitting here back in 2000 and that was laid in front of you, the television pundits would have predicted the economic collapse of the United States. But we’re in 2006-07 with the Fed trying to cool off the economy.”

That kind of resiliency, coupled with positive trends in several significant sectors, have kept Platz optimistic about the future for the carbon flat-rolled market. Chief among those trends is the United States’ continued strength in manufacturing.

“I happen to be very bullish on the U.S. manufacturing economy. We’re manufacturing more today than we ever have,” he said.

Platz presented data showing that while manufacturing jobs have remained flat for more than 60 years, productivity has improved more than 700 percent. And that productivity edge shows no signs of slowing.

“Although the economy didn’t grow as fast in the second quarter as it did in the first, manufacturing did,” Platz said. “As we see productivity continue to improve in the U.S., we’re going to be more competitive going forward.”

Another positive sign on the manufacturing front is capacity utilization, which has improved from near 71 percent in 2003 to above 81 percent this summer. This is resulting in increases in construction and capital equipment spending.

Though nonresidential construction is promising, the same isn’t true for residential building. Housing starts and building permit applications have fallen dramatically. While the appliance market so far has resisted following suit, Platz said he expects that to taper off eventually.

The automotive market has also slowed with sales in the 16.5-million-vehicle range this year. But, Platz said, “the steel industry cares mostly about where the vehicles are built, not how many are sold.”

Though only a modest bump in the build rate is anticipated in 2007, the longer forecast is more promising. New Domestic plants coming on stream from foreign automakers Toyota, Honda, BMW and Kia boost hopes for future steel consumption. “The New Domestics have gained market share faster than they can build plants in North America,” Platz said.

One of Platz’s co-panelists, Joseph Scherrbaum, vice president of sales at U.S. Steel Corp., said the U.S. economy is influenced by three major factors—China, energy prices and inflation.

China’s rapid growth has affected the U.S. on numerous fronts, including its appetite for raw materials and its transformation from net importer to net exporter as its steelmaking capacity has grown. “As China’s demands for steel declined, countries that previously saw China as a market are looking elsewhere, and many are finding the United States an attractive option,” he said.
Imports have spiked in 2006, with foreign steel likely enjoying its greatest penetration in the U.S. market since 1998.

China has also had a major impact on the second factor, energy, becoming the second largest consumer of oil. Restrictions on refining capacity and supply shocks have also contributed to the price-inflating effects of world demand increasing faster than the discovery of new supply.

On the inflation front, Scherrbaum said, consumer prices have been increasing above the targeted 2 percent. Essential, non-discretionary purchases comprise 55 percent of all spending—an all-time record, he said.

Like Platz, Scherrbaum said more favorable conditions exist in the nonresidential and industrial construction markets than segments involving consumer spending.

“Even with the most pessimistic outlook, growth will still continue, although below the 3 percent trend line,” Scherrbaum said. “It’s not too bad considering all the challenges.”

Carbon Plate
2007 Stacking Up
as a Strong Year
Consumption of carbon and alloy plate products in North America and around the world continues to be so strong that producers are planning capacity additions to meet the demand.

“2007 will represent an active growth period for our economy,” said Mark Breckheimer, president of Primary Steel LLC. Industrial production next year may not attain 2006 levels, “but I think we can expect a robust environment for the products we are looking to sell in the carbon and alloy plate business.”

Breckheimer served as moderator of the plate panel at MSCI’s Forecast conference and presented the group’s data. Other panelists included: Patrick McFadden, sales manager, plate group, Nucor Steel Hertford; Shelby Pixley, director, plate sales, Mittal Steel USA; Daniel Miksta, vice president, general sales manager, steel products, IPSCO Inc.; and R.K Theis, national marketing manager, Oregon Steel Mills.

The main drivers of global growth continue to be China, India, the CIS and Eastern European countries, and South America. Producers will add significant new capacity—much of it in China and India in 2007 and 2008—in response to the continued strong demand for carbon plate. “We can assume going forward that there will be a fairly good balance of supply vs. demand,” Breckheimer said.
The top six global plate producers—Arcelor Mittal, JFE, Nippon, IPSCO, Baosteel and POSCO—command 26 percent of global production capacity.

In North America, capacity for cut plate and plate in coil totals about 12.5 million tons. Production for 2006 is forecast to reach about 9.1 million tons (for Steckel and reversing mill product). Of that, Mittal USA, IPSCO and Nucor will combine to produce 73 percent.

Carbon plate shipments continue to trend upward, in terms of average tons per day. The strong market is attracting more imports, however. “We are on a trend to see 1.5 million tons of imports in plate. This is something we have to address as we look at our business models. Inventory levels are up due to a large arrival of imports,” Breckheimer said.

Korea, Thailand, Malaysia and Taiwan are the most aggressive importers. “These are the countries that are starting up mills, have access to Chinese slabs and are interested in importing to the United States no matter how weak the dollar. On an adjusted basis, we can probably expect more of the same from them in 2007, depending upon their economic outlook. The United States continues to be a market of interest to the Asian mills.”
Like imports, service center inventory levels have risen significantly as well. July MSCI data showed service centers averaging 3.9 months supply on hand, up 26 percent in one month, which is potentially cause for concern, Breckheimer said.

Strong demand this year in such segments as industrial equipment, pipe, oil, gas, heavy machinery, railcars, barges and wind towers has sucked up much of the imported product, however. Domestic mill production and capacity utilization remain high.

The group’s forecast for 2007 includes continued strength in machinery and equipment, though the agricultural equipment segment will be weak. Truck-trailer demand continues strong due to the overall economy’s need for transportation. Railcar makers are booking steel into 2008 and even 2009 to catch up with demand for their product.

With a new manufacturer in the barge market, steel orders are accelerating. Shipbuilding is still off by historical standards, but it’s staging a comeback. “General Dynamics has let a nine-vessel, double-hulled tanker contract. There hasn’t been one of those let in this country in 10 years. That will represent a significant amount of plate.”

Fabricators of poles for wind towers are booking steel orders into 2008 and making inquiries to lock in prices for 2009. “The future of the power tax credit is a question, but it does not appear to be slowing activity,” Breckheimer noted. “Some think that because of the high cost of energy, that tax credit will be passed.”

Anticipated demand from bridge fabricators due to the federal highway bill hasn’t materialized yet in 2006, thus the current expectation is that it will happen in 2007.

Tank manufacturers are experiencing their best business levels in years, even though elevated water tank projects are easing due to the slowdown in residential construction activity.

North American line pipe demand is expected to exceed available supply for the next couple of years.

Current North American line pipe capacity is estimated at 1.8 million tons, excluding ERW pipe. New pipeline projects on the drawing board dwarf that annual capacity. In response, mills have planned capacity additions. IPSCO, for one, will add a total of 400,000 to 500,000 tons of liquid steel capacity at its three mills by 2008.

“It’s pretty easy to forecast that 2007 will be a solid year for plate, absent one concern,” Breckheimer said, namely excessive imports that create an inventory oversupply. “Inventories are high and rising. If they get up to 4.3 months on hand, that usually signals a correction. But as long as demand remains strong and there isn’t a lot of panic, 2007 should be in the bank.”

Capital Equipment
Easing into Slower Mid-Cycle
Metals demand from the industrial equipment sector will remain relatively healthy into 2007, though top-line growth will slow from above-normal double digits to mid-level single digits, forecast Eli Lustgarten, senior vice president of Longbow Securities and president of ESL Consultants LLC.

“We are transitioning this economy from a mid-decade boom to a normal mid-cycle recovery,” Lustgarten told executives at MSCI’s Forecast conference.

2004 was the first, and most surprising, of a three-year recovery for capital spending. Most companies expected 8 to 10 percent growth, and experienced 20 to 30 percent gains in many markets. Industrial markets were driven by strengthening corporate profitability and capital investment, improved U.S. competitiveness aided by a weakening dollar and rising capacity utilization and industrial production.

2005 was also a strong year for the industrial economy despite various shocks to the sector, such as rising interest rates, overproduction by auto companies, the hurricane disruptions and the waning of tax and investment incentives. Most companies scrambled to meet increased demand despite supply chain shortages, with prices rising rapidly to offset higher input costs, Lustgarten said.
So far through 2006, the industrial sector has stayed on a roll, he continued. Business conditions in most markets remain solid, particularly in the construction equipment and fluid power sectors. Only the agricultural equipment sector looks weak.

A slowing of the domestic economy was inevitable, as the 5.6 percent growth rate in first-quarter 2006 was unsustainable, Lustgarten said. GDP dipped to 2.5 percent in the second quarter, a pace the economy is likely to maintain for the balance of the year.

Corporate spending should counter slowing consumer spending going forward. Improving industrial production has raised overall capacity utilization to well over 80 percent, which is the trigger for major capital investment. Capital spending should continue to strengthen well into 2007, fueled by healthy corporate cash flow and pent-up demand for plant and equipment upgrades.

Growth markets in 2007 will include commercial aerospace, heavy construction, nonresidential construction, material handling, energy and fluid power. Likely weakening markets include trucks, housing and light construction. Uncertain is the 2007 outlook for automotive, defense, agriculture, mining, railcars, appliances, power generation and packaging, Lustgarten said.

The farm outlook is uncertain because bumper crops have driven grain prices and farm profits down. Commodity prices will gradually increase to more normal levels, depending on weather conditions, Bush administration policy decisions and the next farm bill from Congress. Farm equipment production in North America is likely to increase, but only modestly, he predicted.

Much talked about is the potential for ethanol production to boost corn demand. Many new ethanol plants are on the drawing board and will increase production of the gasoline additive/substitute to 7.5 billion gallons by 2008. Little is being done about boosting the infrastructure to move the ethanol to market, however, such as increasing production of stainless steel tanker trucks. So the jury is still out on how ethanol will impact the market, Lustgarten said.

The boom in sales of on-highway trucks is slowing. Truck owners are reducing the average age of their fleets by the end of this year to buy ahead of the 2007 emissions standards. (2007 engines are basically 2002 engines with added filtration, at added cost). “The engines that fleets hate in 2007 will be loved in 2008 and 2009, because even more stringent emissions standards take effect in 2010, calling for major engine and truck redesigns,” Lustgarten said.

The automotive market has passed its peak. “Fourth quarter GDP will be materially affected by the slowdown in automotive,” he said, predicting a soft landing. Vehicle inventories are on the rise, as domestic auto production softens modestly to a projected 15.4 million units this year, recovering to around 16 million in 2007.

Construction activity will slow in the second half and into 2007, particularly in the housing sector, due to higher interest rates and an inventory of existing homes that hasn’t been this high since 1995. While residential construction has peaked, nonresidential remains robust. About 1.85 million housing starts are forecast for 2006, falling to about 1.72 million in 2007. Meanwhile, commercial and office construction will move ahead at an 8 to 10 percent growth pace. Public works construction will remain strong as long as states have funding to support federal programs.

Despite weak new-home construction, appliance sales are forecast for 1 to 2 percent growth, driven by consumer demand for stainless-steel-heavy new-product designs, despite higher price points.

The U.S. economy faces little risk of recession. “Excess inventory is the big cause of recession,” Lustgarten said. “Money is tighter and inventory is building, but we’re not seeing recessionary conditions—at least not yet. But we need to be watchful.”

Construction
Strength in Nonresidential
Compensates for Housing Dip
For the better part of five years, the construction market was driven by residential development. But the dip that’s been projected is finally setting in, just in time for a spike in nonresidential construction.

That was the conclusion of panelists Edward Sullivan and James Haughey during the construction market session at MSCI Forecast—though they weren’t in complete agreement on the extent of the dip in residential building or the increase in nonresidential.

Sullivan, the president of the Portland Cement Association, noted significant warning signs for residential development. Slower economic growth, higher interest rates, slower job growth than anticipated and a change in the credit landscape will all contribute to the slowdown in housing starts and demand for construction materials.

Low interest rates and exotic mortgages allowing first-time buyers to enter the housing market helped fuel and extend the residential construction boom, Sullivan said. But rising interest rates and expiration of the early terms of those exotic mortgages have led to an increasing number of defaults, resulting in a tightening of the credit market.

Unconventional mortgages, such as interest-only loans, allowed more, sometimes lower income, buyers to get into the market. “They have to be adjusted, and we’re going to see [the impact] of that in the second half of this year,” he said.

The dip has already started. Homes for sale are already spending longer on the market than any time since 1995.

After peaking at 17,000,000 new-home starts in 2005, a 10 percent dip is projected for 2006, another 7.8 percent for 2007 and 4.2 percent for 2008. Sullivan’s forecast suggests the market won’t climb again until 2010. Moreover, Sullivan said he fears that his forecasts aren’t low enough, and that more downside risk exists.

Though Haughey, an economist with Reed Construction Data, also projected a dip in the residential market, he doesn’t envision the drop to be quite as steep. Real shortages of homes in several markets, persistence of speculation, a still-solid second-home market and greater gains in jobs and consumer income will slow the decline in building activity, he said. He also projected a better outlook for the multifamily market.

Unlike residential building, there are positive signs for virtually every sector of nonresidential spending.

Vacancy rates in office buildings have decreased while office employment has increased; lodging room rates and sales are up 4 percent; health care needs are increasing with aging baby boomers; and manufacturing capacity utilization is near 82 percent—“above the usual threshold for a surge in capacity investment,” Haughey said.

Additionally, public spending is also likely to increase in the coming years. “Public construction funding availability is going to improve,” Sullivan said. “Those projects that were postponed during the tough times are going to get pushed forward. It’s a release of pent-up demand.”

Sullivan predicted an 8 percent increase in nonresidential spending in both 2006 and 2007, while government spending will improve 5.5 percent this year and a little bit more the following year.

Haughey’s numbers differ slightly, but he agreed that the overall market, including both residential and nonresidential, would be relatively flat—which isn’t all bad.

“In some ways I think we’re a little greedy,” Sullivan concluded. “Imagine if I had asked you back in 1990 if would you be happy with a $750 billion market year after year.”

Aerospace
‘Firing on Both Cylinders’
The aerospace market has been one of the metals industry’s most profitable segments in recent years, and the forecast is for more of the same in the near future.

“We have the privilege to witness an industry that’s firing on both the civil and military cylinders,” said Richard Aboulafia, vice president-analysis with Teal Group Corp. “We haven’t seen the likes of this since the early 1980s.”
Jetliners and regional aircraft dominate the aerospace market with more than 50 percent of production. Aboulafia said he anticipates continued growth in the market through 2008, and no dip until 2010.

To some observers, the market slowdown in 2004 may look like another example of the industry’s typical cyclicality. But Aboulafia said that changes in market drivers might lessen any fall. Traditionally, the airline industry followed the same economic cycles driving the worldwide economy. Different cycles are affecting the major purchasers now.

“This market is benefiting from fragmentation. Players are growing more distinct from each other in terms of their timing and requirements,” Aboulafia said. “In theory, this should become a slightly more gentle market from the standpoint of deliveries.”

Aboulafia forecast a slight drop in deliveries from 2010 through 2013, though that’s based primarily on a shift to the new generation of narrow Boeing and Airbus models. But it’s the transformation more than the dip that should concern metals producer and distributors.

“I can virtually guarantee that the A320 replacement from Airbus and the 737 replacement from Boeing will not be the 95 percent metal plane being built today,” he said. “There’s a good chance they will have a majority of composite configurations.”

Drew Magill, director of market analysis at Boeing, tried to assure visitors that his company will still be purchasing plenty of metal in the coming years despite the change in composition.

“Over the last three years Boeing has tripled its consumption of aluminum plate,” Magill said. “We’re building a lot of different parts that require the properties of metal. We’re just looking for the best materials. In many cases, metals work better.”

One other trend that has emerged in the past 18 months is the domination by Magill’s company. Boeing reversed recent history by pulling in 58 percent of the orders over Airbus in 2005. The victory over Airbus is even greater this year, with Boeing now owning 75 percent of the orders over the past 18 months.

“This is one of the most significant sea changes in any legacy manufacturing industry. If anyone can save Ford from itself, it’s someone who did this,” said Aboulafia, referring to Boeing’s former executive Alan Mulally being tabbed to run Ford Motor Co.

Besides commercial jets, the market for regional jets has flattened somewhat, with economic struggles at some of the major users of regional jets leaving a glut in the market.

Aboulafia said business jets remain difficult to predict, as there are no readily definable drivers of demand. But with barriers to entry in the market being lowered, the business jet business is promising, he said

Automotive
Uncertainty’s Daunting for Detroit
“Detroit is not a very happy town right now,” said Michael Robinet, vice president of global forecast services at CSM Worldwide.
North American vehicle production is forecast to hit 15.6 million units this year, down 1.4 percent from 2005.

Most of the loss has been at the expense of the Big Three automakers, he said. The Big Three are vulnerable due to their overcapacity and overdependency on sales of full-framed trucks. Full-framed sport utility vehicles (SUVs) are seeing an accelerating decline in demand, replaced by smaller, more fuel-efficient multi-activity vehicles (MAVs) and compact activity vehicles (CAVs).

The auto market will be weak for the remainder of this year due to uncertainty over closings and production cutbacks at various GM, Ford and DaimlerChrysler plants. Four plants were idled in 2005 and six more in 2006, representing a 700,000-unit production reduction in a single year.

Robinet reported a growing emphasis on “product cadence” among automakers—how often and how quickly they can replace vehicle designs. This flexibility significantly favors the New Domestics, which have done a much better job of attracting consumers with a steady stream of new products. The Asian 4—Toyota, Honda, Renault/Nissan and Hyundai—will continue to lead the charge for the New Domestics in North America, he said.

In 2007-2008, the auto market as a whole is projected to grow only slightly, fueled largely by transplants opening new facilities and expanding production here rather than importing vehicles and parts—which is good news for domestic metals suppliers.

CSM forecasts that North American vehicle production will grow 8 percent by 2011, a volume gain of 1.3 million vehicles. Annual production will level off around 16.9 million vehicles.

Tubular
Energy Strong, Imports Troubling
Tube makers are optimistic about energy market demand, but concerned that it might prompt an increase in imports.

“We still see the energy market being strong through 2010,” said Patrick Tobin, distribution sales manager for Dofasco Copperweld, during the tubular products session at the Forecast conference. “With drilling, pipeline and refining projects, that’s going to drive the tight supply of specialty steels, plate and oil country goods.”

Much of the demand will come from Western Canada, second to Saudi Arabia in proven oil reserves with 175 billion barrels untapped. Production there is expected to quadruple to four million barrels per day by 2010, he said.

“We expect 2007 to be another big year on the OCTG side, although supply and demand are much more balanced than they were before,” said Scott Barnes, general manager of U.S. Tubular Sales for IPSCO. “We’ve had some capacity increase among domestic mills.”

Even producers that don’t participate as heavily in the energy sector, such as makers of drawn-over-mandrel and aluminum tubing, expect to benefit from the robust market.

The oil rush in Western Canada has had additional benefits, said Robert “Butch” Mandel, executive vice president of Welded Tube of Canada. “Western Canada is going crazy with oil, and we’re starting to see manufacturing follow.”
But, like others on the panel, Mandel said the influx of imports is a troubling sign. “There’s been a 30 percent bump (of welded tube into Canada) over 2005. It’s a disturbing trend.”

Import penetration varies wildly by segment, with some feeling little impact while foreign-made metals dominate others. Data presented by Tobin showed little import impact on seamless OCTG products and standard pipe, while imports dominated line pipe and pressure tube.

Yet IPSCO’s Barnes said import penetration had risen from 38 percent of the OCTG market to 50 percent during the first six months of 2006. He projected further increases for standard-, large- and small-diameter pipe.

Increasing imports may be having an effect on service center inventories, Mandel said. “Inventories are trending up and shipments are trending down. That’s a divergence nobody wants to see.”

Among other end-use markets for tubular products, the most promising include heavy equipment and manufacturing. Weakening markets include consumer durables and heavy truck.

The automotive market remains a mixed bag, executives said. The move toward smaller, more fuel-efficient cars reduces the demand for steel, though that’s offset somewhat by the New Domestic automakers sourcing more of their material from North American suppliers.

One key issue that will play out in the coming year is the rapid consolidation among tubing producers, Barnes said. Deals in 2006 included the Tenaris-Maverick and Arcelor-Mittal mergers, and his company’s purchase of NS Group just the day before the conference.

“Consolidation is going to be an important factor going forward, on both the customer side and the supply side,” Barnes said.

Though their companies served different segments, the five panelists all had similar projections for their portion of the tubular market in 2007. Production forecasts ranged from flat to a 5 percent increase for the coming year.

“We see things slowing through the second half of 2007, but a good year overall with 1 to 2 percent growth,” said Jay Grissom, director of industrial markets for Alcoa Global Engineered Products.

“We had three great years. My best guess on DOM shipments is we’re looking at what might be a flat year,” said Warren McKenzie, corporate vice president of sales and marketing at PTC Alliance.