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July 2013
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Global Steel's Depressed by Excess Capacity

By Dan Markham, Senior Editor

Though the magnitude of the oversupply is subject to opinion, steel industry watchers agree that overcapacity around the globe will keep prices and profits depressed.

From the opening remarks by World Steel Dynamics’ Managing Partners Peter Marcus and Karlis Kirsis, to keynote presentations and panel discussions, the clear theme of last month’s Steel Success Strategies conference in New York was simply “too much steel and not enough demand.”

The annual gathering of global steel executives, sponsored by WSD and American Metal Market, was characterized by muted forecasts based on the industry’s overcapacity and its effects on the supply chain. While there was considerable debate about the degree of overcapacity, with estimates ranging from 200 million to 500 million excess tons, there was less argument about the prime culprit: China.

The economy of the world’s largest country has grown incredibly in the last decade, but that ascent still has not kept pace with its ballooning domestic steel industry. Now, with Chinese economic growth finally abating, there’s little sign its steelmakers have taken notice.

What’s worse, there’s little hope of any short-term improvement, barring the unlikely execution of Alonzo Ancira Elizondo’s ambitious plan. In his keynote address, the executive chairman of the board of Mexican steelmaker AHMSA called for the creation of a multinational industry panel tasked with choosing where capacity is excessive or inefficient and shutting those plants down.

Others seem to accept that the current reality is one the industry will be stuck in for quite some time. While some rationalization of capacity is expected in Europe, the major structural changes necessary in China will be considerably tougher to accomplish. And it’s not the fault of the Chinese central government, which seems to recognize the problem with its domestic steel industry. The fault lies more with the provincial governments, which continue to promote local steel production, not with an eye toward profits, but with keeping thousands of residents employed.

“There are 6.9 million people who work at steel mills around the world, and 4 million of them work in China,” said Craig Bouchard, co-founder of the original Esmark and Shale-Inland companies who is now running a new entity, Cambelle-Inland, “Anyone who thinks there’s the political will in China to consolidate steel mills and do big layoffs is out of his mind. It’s not going to happen. It’s not a significant possibility.”

That simple fact makes the oversupply situation one the supply chain will have to endure, at least for the next few years. John Lichtenstein, managing director for Accenture’s global metals industry practice, said there are four reasons why supply and demand are unlikely to balance any time soon.

For starters, he said, “there is no plausible demand scenario under which this amount of excess capacity can be absorbed, certainly within the time frame of the remaining careers of any steel executives today.” Especially since demand in China is trending down as the country’s growth-at-any-cost strategy is giving way to concerns over a possible real estate bubble, excessive debt levels and environmental issues.

Second, Lichtenstein said, progress toward meaningful global consolidation has stalled. The value of consolidation was evident in the industry’s response to the recession. However, the transnational deals that were popular before the economy crashed have all but disappeared due to a variety of factors, including difficulty finding synergies across disparate geographies and economic nationalism. China’s restrictions on foreign ownership of its domestic mills will handicap any legitimate efforts to make the global industry less fragmented.

Additionally, consolidation generally requires healthy companies willing to purchase unhealthy ones, but at the moment, there are few healthy companies, Bouchard remarked. Publicly traded companies have a debt-to-equity rate in the vicinity of 70 percent, compared to a more manageable 27 percent just 4-5 years ago.

Third, Lichtenstein continued, the resetting of raw material prices has resulted in a flatter steel industry cost curve, eliminating a potential driver of industry restructuring. The previous era of high raw material prices gave a significant edge to those companies with better access to raw materials, leading to a winners and losers dynamic that fed consolidation. Weaker demand for raw materials, coupled with an increased supply, has reduced the importance of a captive supply and evened out the competition. “While it sounds somewhat perverse, the steel industry might miss the good old days of high raw material prices,” Lichtenstein said.

Finally, government entities historically have played a key role in the restructuring of the steel industry. But today, outside of China, most of the global steelmakers are not government-owned enterprises, muting the ability of policymakers to affect change.

“On the one side, government can retard restructuring by slowing closers of excess capacity. On the other, it can support the process by drawing attention to the dire and structurally unsustainable conditions of portions of the industry, as the European commission has been doing,” Lichtenstein said. Unfortunately, the commission’s effort, even if it results in the removal of 20-40 million tons of outdated capacity in Europe, “will not make a dent in global excess capacity, nor does it insulate the EU from the effects of continuing global excess capacity.”

So what does this mean for the global steel industry? The short-term outlook is not positive.

“As steel demand stagnates in most regions of the world in 2013 and into 2014, there is an increased likelihood of a poor pricing environment,” said Marcus and Kirsis in their opening presentation. In fact, the duo said, the possibility of a “pricing death spiral,” a brief period where the price declines to the marginal cost of the typical steel mill, is not out of the question in the next six months.

Others agree the uninspiring pricing environment will drag on for quite some time. “We’re stuck in what seems like never-ending doldrums for steel,” said Bouchard. “With steel being a tradable and movable product across national lines, it means we’ll be stuck in a trading band for hot-rolled coil prices of $500-$600. It might go a little under, it might go a little over, but that’s the trading range coming up. You can’t get away from supply-demand.”

Lichtenstein also envisions exports rising in the new environment, particularly those from China. The level of exports as a percentage of total production could jump from the low of 5 percent two years ago to 10 percent in the coming years, he said.

Looking beyond 2014, Marcus and Kirsis believe the steel market will begin to improve in 2015 as global demand increases outside of China. They also foresee significant rationalization of steel production capacity, “as about 1 in 7 steel plants located outside of China can’t make it in a low-profit-margin environment.” That includes an estimated 15 million tons of capacity in the United States.

However, they acknowledge the recovery could be delayed beyond 2015, particularly in the event of another financial crisis—a not-so-unlikely possibility.

[“There is no plausible demand scenario under which this amount of excess capacity can be absorbed, certainly within the time frame of the remaining careers of any steel executives today.” John Lichtenstein, Accenture]


Shale Gas Will Remake Global Steelmaking

While most of the speakers at June’s Steel Success Strategies Conference delivered decidedly downbeat projections, their most promising market for steel was clearly North America. The twin factors of a robust automotive market and an awakening construction sector make the U.S., Canada and Mexico the oasis in the global steel desert.

Moreover, the outlook for the North American market is bolstered by the still-emerging natural gas revolution. Nick Sowar, the global metals sector leader for Deloitte, delivered an encouraging look at just what the natural gas boom will mean to the steel industry.

“In an industry as established as steel, it is rare that a new development can have the kind of meaningful impact widely expected from a low-cost, steady, accessible and long-term supply of natural gas,” he said. “It has reached the point where global steel companies are being compelled to ask difficult but necessary questions about whether, when and how to adapt their strategies to take advantage of the bounty of natural gas rapidly being extracted from shale fields in the United States.”

This move toward a low-cost energy source is a dramatic change from historical trends, he said. Over the past four decades, energy costs have increased 163 percent, vastly outpacing the cost of other steelmaking inputs. “With natural gas acting as a catalyst, the global steel industry could be remade starting right here in the United States,” Sowar said.

This new low-cost source is most beneficial for production of direct-reduced iron, a technology most notably embraced by Nucor’s at its new plant in Louisiana. DRI has been around since the 1950s, but has always been cost-prohibitive compared to scrap. “In the 1970s and again in the 2000s, the price of natural gas fell to levels that made DRI attractive, but the dips failed to last long enough to have a major impact,” Sowar said.

That changes with the shale technology and the enormous reserves now available, as prices are expected to remain low well into the future. Even with increased demand for liquefied natural gas that’s expected as a result of the boom, a truly tight supply/demand balance is not expected to materialize. Deloitte projects the price impact to be modest, at less than 2 percent.

The benefits to the industry of the use of affordable DRI are plentiful, Sowar said. On the production side, they include lower processing temperatures than required by blast furnaces; streamlined front-end processing due to reduced handling; lower maintenance costs as equipment is subject to less abrasion, corrosion and general wear and tear; capacity planning flexibility through construction of smaller DRI plants; and fewer impurities resulting in purer iron and higher quality steel.

These advantages will result in a change in the steelmaking landscape. It’s possible the low-priced iron in the United States will result in stranded capacity at facilities in India and China, he said. Additionally, low-cost U.S.-made steel will become more attractive on the global market. In any case, U.S. steelmakers who rely on the DRI process will enjoy higher margins. They will also benefit from cleaner production, which may take on greater importance as environmental emission concerns grow worldwide.

The domestic steel industry won’t just benefit by itself, said Craig Bouchard of Cambelle-Inland. While the energy-intensive steelmaking will enjoy the greatest advantages, other industries that steel serves will also be able to capitalize on the new dynamic. “A manufacturing renaissance is coming. It is a sustainable competitive advantage for the U.S.,” Bouchard said.

However, it should be understood, Sowar added, that the natural gas reserves aren’t limited to the United States. Many other countries, including China, have projected reserves as large as or larger than those found in the United States. They simply don’t have the technology and infrastructure in place at the moment to exploit the supply.

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