“Next year has to be better. I can’t see another 12 months of this,” says Jeffrey Diener, general manager of Lee Steel Corp., Southfield, Mich. A disappointing first half points to the likelihood of a similarly dismal third quarter for the whole automotive food chain, including parts suppliers as well as the automakers, he adds.

“Demand is quite weak,” admits George Pipas, sales analysis manager for Ford Motor Co. in Dearborn, Mich. “That is to be expected given the concerns about an economic contraction, which is a nice word for recession. Whether it is or isn’t a recession isn’t important. What is important is the breadth and severity of this period of weak economic growth.”

Consumer confidence has hit its second lowest level in 15 years due to all the economic uncertainty, leading to predictions that overall U.S. sales of cars and light trucks in 2008 will be down about 1 million units from last year, says Cindy Knight, a Toyota spokesperson.

“The good news is that the Federal Reserve is acting quickly to reduce interest rates and putting money into the banking system,” adds Pipas. “Congress has passed the economic stimulus package, which should help consumers. So there is reason to be optimistic that economic growth will resume soon.”

But perhaps not soon enough, says Mark Cornelius, president of Morgan & Co., West Olive, Mich. “The lower federal funds rate will help those consumers with adjustable rate mortgages and equity lines of credit, but will not free up a significant amount of discretionary spending as people have to deal with higher fuel and food prices and falling home values. Recent information indicates a deepening of the housing contraction as well as some softening in the labor market.”

Morgan & Co. projects that U.S. auto sales will fall from 16.14 million vehicles in 2007 to 15.65 million in 2008, when North American light vehicle production declines to 14.43 million units, down 4.4 percent from 2007, the lowest level since 1993.

Vehicle sales have been declining for several years, but that decline is accelerating as people delay new-car purchases due to fears about the economy and their own job prospects, adds Erich Merkle, vice president of forecasting for IRN Inc., Grand Rapids, Mich.

North American auto production has been declining since 2002, even as the New Domestic automakers—European- as well as Asian-owned companies—have added new facilities, notes Ronald P. Krupitzer, vice president of automotive applications for the American Iron and Steel Institute in Washington, D.C. Much of this decline has resulted from efforts by the Detroit Three—Chrysler, Ford and GM—to streamline operations and return to profitability (as evidenced by Ford’s recent agreement to sell its unprofitable Jaguar Land Rover luxury car unit to India’s Tata Motors).

New Domestic production is also expected to decline slightly this year, largely on the light truck side. Both Toyota and Nissan have cut back production of their large pickup trucks, a light-truck segment that has been hit by the homebuilding slump as contractors and other tradesmen seek to economize.

“You can’t go a day without reading something bad about the economy and the credit crunch. People are conditioned. It is keeping them from spending,” Diener says. “They are hesitant to buy new cars, and even when they do, they spend on smaller cars with less steel in them,” which is not good for metals suppliers.

Sales of smaller vehicles generate less profit for the automakers, as well. “That will be the way of the future whether we like it or not,” says Ted DiGuiseppe, vice president and general manager for automotive and industrial products at Kaiser Aluminum Corp., Foothill Ranch, Calif.

Bob DiCianni, manager of marketing for ArcelorMittal USA in Chicago, remains surprisingly upbeat about the auto market. While he admits that demand has been below expectations so far this year, he maintains that automotive consumers remain relatively resilient. “When you look at sales through the first two months of this year, retail sales were only down 2.8 percent vs. last year, which isn’t really a big drop when you consider how weak they were supposed to be. By comparison fleet sales were down 13.2 percent.” As part of their effort to improve profitability, the Detroit Three are pulling back on lower-margin sales to rental car companies and corporate and governmental fleets, DiCianni notes.

“In the past, fleet sales and incentives were used by the Detroit Three as a means to keep sales steady,” says Roy Platz, ArcelorMittal USA’s director of marketing. “First they used incentives, then dumped cars into the fleet market, but now there seems to be a new paradigm as they are realizing these big red sales do little for their economic health.” Incentive discounts just tend to pull sales forward or even make people hold back purchases hoping for further rebates, he adds.

DiCianni does not dispute there is broad-based weakness on the retail side of the auto business. “I think that automotive companies are in a recession, whether or not the general U.S. economy is,” he says. “But I don’t think the outlook is all gloomy. It could result in pent-up demand, which could be very positive for automakers by 2010.”

Even in the current down market, some automakers are sticking with their game plan. One example is Honda, whose reputation for high-quality, fuel-efficient vehicles has produced record sales in the past few years, says spokesperson Chris Naughton. In fact, the New Domestics have been gaining market share at a rate of about 2 percent per year vs. the Detroit Three.

“The New Domestics’ vehicle lines are more fuel efficient. They have more hybrids and a higher resale value. People feel they are getting better value with those vehicles,” Diener says.

The actual affect of today’s gasoline prices is somewhat controversial and hard to measure, DiCianni says. “Sales of big SUVs and pickups are going down, but consumers are buying luxury cars instead, which still use a lot of gasoline. You would think that sales of compact cars would be exploding, but they’re not. The people who generally buy those vehicles [younger or lower-income people] are precisely those most feeling the squeeze from the economic downturn. They are moving out of the new-car market entirely and buying used cars, and using the money they save to pay the higher gasoline prices.”

The end result is that there has been a measured and gradual reduction in the size of vehicles being sold, including a shift from body-on-frame (truck-based) sport utility vehicles (SUVs) to unibody crossover vehicles (CUVs). But is this just because of gasoline prices? Many industry observers doubt it.

Most attribute the downsizing trend to a mix of factors: baby boomers who’ve become empty nesters and no longer need big SUVs, and the appeal of the CUV’s fresh styling and car-like ride and handling.

Pipas notes that the move toward CUVs was occurring even before gasoline prices rose so dramatically. He doubts that SUVs will regain favor with buyers even if gasoline prices fall again.

High fuel prices and concern for the environment have generated growing interest in both hybrid and flex-fuel vehicles, though automotive metals suppliers won’t feel the effects for some time. “There is definitely a future for all kinds of alternative fuel vehicles, but costs need to come down before they become part of the mainstream,” Pipas says.

Some of the hybrid hype has been a knee-jerk reaction to the alarming gas prices, says DiGuiseppe, who agrees the future is promising for development of alternative fuel technologies. “It’s been positive for suppliers of aluminum and other light materials given that there has to be a way to lighten the weight of these vehicles to make up for the extra weight of the battery.”

Automotive designers have been striving to lighten conventional vehicles, as well, to make them both more fuel-efficient and safer ahead of new government CAFE requirements that take effect in 2020.

Do such efforts portend a future decline in steel consumption? Not necessarily, says AISI’s Krupitzer. The average North American light vehicle is still 60 percent steel, he notes, up from 55 percent 20 years ago. “In fact, the material that is showing the most rapid increase is high strength steel, which is more cost competitive vs. other lightweight materials.”

“There was a time we felt aluminum would revolutionize the automotive industry, that everything steel would be aluminum,” says Kaiser’s DiGuiseppe. Realistically, even though 2 pounds of steel can be replaced with 1.2 pounds of aluminum, aluminum still costs three times more than steel, even at steel’s current elevated price. Wholesale substitution just isn’t practical, he admits. “Steel will always be part of the business, but there are also many opportunities for aluminum to help lightweight vehicles.”

While Honda has increased its use of certain lightweight alternative materials such as aluminum and magnesium, it has also stepped up its use of high strength steels, says Honda spokesperson Ron Lietzke. Honda is using more aluminum in the body panels, hood frames, skins, bumper beams and rear knuckles, and magnesium in head covers, intake manifolds and steering wheel armatures, for some of its models. Its new Civic has a body made of 50 percent high strength steel vs. 32 percent in the previous generation.

Today’s weak U.S. dollar is having some positive effects on the American auto industry and its metal suppliers. “We are starting to see more inquiries from automakers offshore for aluminum,” says DiGuiseppe.

Some New Domestics, particularly European automakers, are considering increasing vehicle production in North America due to the currency exchange rate, even if it means selling those vehicles overseas, he adds.

The weak dollar may also prompt Volkswagen to get off the fence and announce a new greenfield plant in the southern United States—a potential new metals customer. The automaker, which already produces in Mexico, has expressed interest in expanding its North American presence.

Honda expanded its Anna, Ohio, engine plant and its Russells Point, Ohio, transmission plant two years ago, enabling it to produce parts that previously had been shipped in from Japan. Honda is now in the process of building two new North American assembly plants in Greensburg, Ind., and Aliston, Ontario.

Other New Domestics have also been expanding in their new home. Toyota, which recently began producing Camrys in Lafayette, Ind., is planning to begin production of the Venza CUV in Georgetown, Ky., this fall. Toyota also plans to open a new plant in Woodstock, Ontario, later this year and another in Tupelo, Miss., in 2010.

Kia is set to open its first U.S. assembly plant in late 2009 or early 2010 in Westpoint, Ga.

While 2008 undoubtedly will be a rough year for both automakers and their suppliers, some industry observers see it as the bottom of the trough, with conditions improving steadily next year and beyond.

High Metals Prices Squeeze Auto Suppliers

With metals prices rising across the board at the same time that demand is weakening, profit margins are being squeezed throughout the automotive supply chain. Parts suppliers—service centers’ customers—are especially feeling the pinch.

“I see a train wreck coming,” says Jeffrey Diener, general manager of Lee Steel Corp., Southfield, Mich. “I don’t think people can continue to increase steel prices like this in a slow economy. It has had a tremendous impact on those doing business with automakers, as it is difficult to pass on the increase. People have only been successful passing it on in part.”

Ronald P. Krupitzer, vice president of automotive applications for the American Iron & Steel Institute, admits that steel prices have risen substantially due to a shortness of supply, but he says it was “a long time coming” for a steel industry that has seen “20 years of stagnation.”

The same market fundamentals have caused other raw materials to rise as well, including aluminum, copper, gold and plastics, observes Roy Platz, director of marketing for ArcelorMittal USA in Chicago. While he acknowledges there is resistance to these price increases, he says most people realize that with the global raw material markets so tight “this is the shape of things. No one is really surprised.”

Surprised or not, parts suppliers are having a hard time passing on these increases to car companies that are struggling to regain profitability themselves, says Bob DiCianni, ArcelorMittal USA’s manager of marketing.

Automakers are doing what they can, says Carri Chandler, a spokesperson for Toyota. “We work closely with suppliers on issues such as quality, improving production efficiency and controlling costs. They are our partners and we want to see them succeed.” Honda sometimes acquires metal for suppliers to help them get better prices than they would be able to get on their own, adds Ron Lietzke, a spokesperson for that New Domestic automaker.

Despite these efforts, 2008 is shaping up as another tough year for parts suppliers, with further bankruptcies likely, especially among companies closely tied to the Detroit Three, says Erich Merkle, vice president of forecasting for IRN Inc., Grand Rapids, Mich. “Suppliers with diversified businesses will not likely be hit as much.”