April 2, 2014
Good-bye CRU-Minus Pricing, Hello Uncertainty
Changes in the way steel is priced have brought a new level of uncertainty to the market, said two veteran executives who spoke at the Platts Steel Markets North America conference in Chicago last month. In separate panels, Paul Gedeon of Lane Steel and James Bouchard of Esmark addressed the challenges of running a service center in today's business environment.
Perhaps the most notable change was U.S. Steel's announcement in mid-2013 that it would no longer use CRU-minus pricing--and the rest of the industry quickly followed suit. CRU-minus deals, indexed to market data from pricing service CRU, tended to favor volume buyers, said Gedeon, president of Pittsburgh-based Lane Steel. "Prices averaged 6-8 percent below the market. If the CRU was at a favorable price, more steel was purchased. If it was at an unfavorable price, less steel was purchased, forcing mills to lower prices."
Today, as mills seek greater control of their own profitability, distributors don’t know what to expect. "We do not know how this will impact the market, but for the time being there will be fewer contracts. That means everything is selling 6-8 percent higher than last year, and purchasing departments are paralyzed," Gedeon said. Ultimately, the new dynamic will have three outcomes, he believes: less contract and more spot sales, lower service center inventories and much-improved mill pricing discipline.
Bouchard, CEO of Pittsburgh-based Esmark, noted that distributors have done a good job of controlling inventory levels since the recession. Historically, when service centers are able to hold inventory supplies at 2.5 months or less, the price of steel rises. As inventories inflate, demand declines and prices soften.
Even with tight inventories, service centers are now caught in a disjointed pricing environment.
"Everybody's pricing cost-plus. Can they cover their scrap, can they cover their iron ore?" he said of the domestic producers. "Our customers don't operate that way. They operate on annual contracts and what their customers and their sales folks are forecasting. So we have a bit of disengagement from the OEMs through distribution back up to the mill. It adds a lot of tension."
This cost-plus mindset is a disincentive for companies to run lean, efficient operations that drive costs down. This inefficiency is evident in the overcapacity at both mills and service centers.
U.S. service centers are operating at about 65 percent of capacity today, which is far too low. "There's stuff that needs to be shuttered. Every service center should be running north of 85 percent in our industry," Bouchard said. His company followed that blueprint, closing down its Century Steel operation in Chicago Heights, Ill., which pushed Esmark’s processing operation to over 90 percent of its capacity.
Despite all the mergers and acquisitions that have taken place among distributors, there has been little meaningful industry consolidation, Gedeon noted. "Service centers are often bought and yet nothing changes. The capacity hardly ever disappears. There’s no practice of utilizing synergies between the acquirer and the acquired to resolve duplication or triplication of operations."
To Gedeon, this is just one of several examples of inefficiencies in the service center segment. "We all complain about the mills being their own worst enemy as far as pricing, but we in the service center industry cannot point fingers. We're as much to blame."