Service Center Cowboys
Shoot Industry in Foot

Though the service center industry is certainly more sophisticated and professionally managed than in days past, it is still populated by too many cowboys who think they can win big by buying low and selling high because steel prices are trending up. Instead, their gamble forces prices down, and they end up shooting themselves, and their peers, in their collective foot.

Few service center executives will ever admit to “stocking up” because prices are low rather than because demand is high. But recent industry data suggests many must be complicit. The distribution channel is just now digging itself out of an inventory glut caused by excessive—and undoubtedly speculative—buying in 2006.

Service center inventory levels rose by 22 percent last year between January and October, on steel imports that topped 45 million tons. Carbon flat-roll inventories rose 47 percent during that period, from roughly 7 million to just under 10.5 million tons. Not surprisingly, the price of hot-rolled sheet declined from about $640 per ton in August 2006 to $510 in February 2007—a 20 percent nosedive caused in large part by the oversupply in the distribution channel.

“Clearly, the demand circumstance did not justify imports or inventories of that magnitude,” said John Nolan of Steel Dynamics Inc., who spoke Feb. 23 at MSCI’s Carbon Conference.

Noting that SDI and other mills have adjusted their output to keep supply more in line with demand, Nolan chided service center executives for letting inventories get so far out of hand. “If I can be gently critical, we are not seeing the same discipline in the channel of distribution. You can certainly point the finger at producers and say that we contributed to the mindset that aroused that kind of inventory growth, but I’m not sure a lot of the blame belongs in our camp.”
Other industry veterans offer similar observations. During the February Toll Processors Conference, economist Glenn Kidd presented ample evidence that the service center industry is at fault for oversupplying the market and putting pressure on prices. “Service centers have gone so far they have created inventory cycles that just don’t exist in other industries,” he asserted.

“This shows a real lack of professionalism,” he added, pointing to a chart showing the large first-quarter gap between supply and demand. “Inventory shouldn’t see such wild swings; it should be appropriate for business needs. This is speculation, which is very unfortunate because it aggravates the steel industry’s instability.”

Even some service center execs acknowledge their industry’s shortsightedness. “The mills, through consolidation, have done a pretty good job in most cases to match production with demand. Service centers don’t seem to have that same discipline,” said Chatham Steel’s Bert Tenenbaum during last month’s NASA roundtable. “A lot of the margin pressure is coming from too much inventory in the pipeline at service centers. Until we as an industry can begin to get our arms around that, we are doomed to keep repeating this boom-and-bust cycle with inventory and profitability.”

Industry cowboys would do well to heed his advice and rein in the impulse to gamble on steel prices. It’s a game where everyone loses. As Tenenbaum says: “Buy for need, not for greed.”