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July 2014
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New Understanding of Overcapacity

By Dan Markham, Senior Editor

Will China's production excesses continue to drag down the global steel market in the years to come? Perhaps not, predicted World Steel Dynamics at last month's gathering of industry watchers in New York.

China's massive capacity to produce far more steel than its economy needs is a constant threat to steel prices and producers in the rest of the world. While the Chinese oversupply and export risk won't be resolved any time soon, there's a reasonable chance the problem may be more confined within the country by 2015, predicted World Steel Dynamics Managing Partners Peter Marcus and Karlis Kirsis during their opening remarks at last month’s Steel Success Strategies conference in New York. The annual event, which draws steel industry executives from all over the world, is cosponsored by WSD and American Metal Market.

Several factors lead Marcus and Kirsis to believe China's excess capacity may become less troublesome to the rest of the world. For starters, the Chinese government may encourage the drawdown of old, inefficient steel mills, and their exports, in response to serious environmental concerns and the avalanche of trade cases they face around the globe. Export duties and tariffs put in place by the government could slow production of steel that would otherwise end up on the world market.

In addition, demand outside China is expected to expand at a 3-4 percent annual rate. Non-Chinese mills will begin to obtain better prices in their home as a result of the trade actions against the Chinese producers.

Three major forces will certainly continue to shape the global steel market, said Marcus and Kirsis: strong price competition, unpredictable currency shifts and steel's ongoing technological revolution, which promises both new products and better ways to bring them to market.

Three other factors are likely to materialize in the coming years, one of them with serious ramifications for steel distributors. The analysts believe mills will see increasing value in affiliated downstream steel deliveries. "Joint ventures with steel middlemen will allow mills to gain market share and improve EBIDTA. It's an important asset for companies. If a company is lacking it, we'll see acquisitions," Kirsis said.

Other likely developments they predicted: the U.S. will remain the preferred global location for new factory construction, and Chinese steel scrap generation will drive down metallics prices.

In addition to the Chinese steel overcapacity situation, WSD expects six other wildcard scenarios to affect the world market environment for steelmakers:
• Chinese steel demand will decline in 2015, compared to 2014;
• Global steelmaking capacity will shrink;
• The cost curve for hot-rolled band will flatten;
• Steel futures trading outside of China will grow;
• Developing world economies will get passed over;
• And geopolitical and other risks in many developing countries will curtail foreign direct investment there.

The WSD team made one final prediction focused on the U.S. market. They believe there is a 60 percent chance steel will win the automotive body sheet battle versus aluminum on light trucks. The $1.05 per pound cost of steel, including fabrication and yield loss, will win out over aluminum’s estimated $3.50 total cost per pound.

"It's a complicated subject, but there's enough body work reduction in non-surface parts of the car, and improved engine performance and design, that these trucks will not have a huge problem meeting CAFE miles-per-gallon standards with steel," Marcus said.

["Joint ventures with steel middlemen will allow mills to gain market share and improve EBIDTA. It’s an important asset for companies." Karlis Kirsis, World Steel Dynamics]

Mittal bullish on automotive steel
It was the WSD partners' final point that was foremost on the mind of Lakshmi Mittal, who followed the pair on stage to deliver the conference's keynote address. The chairman and CEO of Luxembourg-based ArcelorMittal, the world's largest steelmaker, is confident the material war will be won by steel.
 
"Steel can provide all the weight reduction that auto producers require to satisfy the new fuel efficiency standards for all types of vehicles," he said. "Essentially, we need to deliver a 25 percent reduction in the weight of structural components and closures. Steel can already do this, and we can do it in a more cost-effective and environmentally friendly manner than any other material."

Without specifically mentioning aluminum, Mittal claimed that comparisons made by "the other material's supporters" are not up to date. "I know other materials talk about being 30 or 40 percent lighter than steel, but that’s only accurate if you are using the steel of 2005 as a comparison. Today, we are working with completely different steels, which are the results of hundreds of millions of dollars of investment."

High-strength and advanced high-strength steels, both those already in place and those still in development, will be the preferred choice of automakers, he asserted. He noted that the strength of available steels has multiplied 10 times in the past 20 years, from 170 to 1,700 megapascals, "and we don’t know where the limit is in terms of product development. Every day we open up new frontiers and do things that yesterday didn't seem possible. We understand there is a challenge from other materials, but no one should doubt that steel remains the material of choice."

In addition to its cost advantages, Mittal said steel’s environmental attributes will help guide carmakers' choice. "People are not incentivized to look at the carbon footprint of a product over its entire life cycle, but they should be. This is one important way we can take bigger steps towards an overall more sustainable environment. Not only does steel produce less CO2 than other alternative materials, but it is also the only material that is 100 percent recyclable with no diminution in properties," he said.

Working specifically in ArcelorMittal's favor on the automotive sheet front is the company's global reach, as the auto sector increasingly moves toward global platforms. Carmakers will be producing vehicles the same way in China as they do in the U.S., "so being able to work with the same supplier in different markets is clearly an advantage as they are guaranteed exactly the same product, produced to exactly the same quality standards," he said.

Just days earlier, ArcelorMittal began production at its newest plant producing high-strength automotive steel at China's VAMA, a joint venture with Hunan Valin Iron & Steel Co. "We are very excited about this plant. For the first time, ArcelorMittal will be producing high-strength automotive steel in China, the world's largest and fastest growing automotive market. Our customers will be global brands--such as Volkswagen, GM, Ford, PSA, Daimler-Benz, Toyota, Honda, Renault, Fiat and Nissan--as well as leading domestic manufacturers."

Mittal said the trend line in Europe is highly instructive of what will happen in the United States and the rest of the world. The push for lighter, more fuel-efficient vehicles got started earlier in Europe than in the U.S.

"Not only have the European carmakers had more time to get comfortable that steel can meet all their requirements, but they also have reversed some decisions in terms of the use of alternative materials," Mittal said.

["Every day we open up new frontiers and do things that yesterday didn’t seem possible. We understand there is a challenge from other materials, but no one should doubt that steel remains the material of choice ]for automotive[." Lakshmi Mittal, ArcelorMittal]

North American steel outlook
Capacity, whether in the U.S. or across the globe, is a major source of contention in the steel world. But Saikat Dey, Severstal North America’s CEO, believes concerns about North America's steel production levels are overstated.

The same fears expressed today about new capacity were previously uttered about the former SeverCorr plant in Mississippi and the ThyssenKrupp operation in Alabama, he noted. Despite the addition of more than 6 million tons of capacity by those operations, there was little movement in the steel price or capacity utilization in the years after they came on line.

The reason, Dey said, is the difference between a converting commodity such as steel, where one product is turned into something else, and a depleting resource like iron ore or oil and gas. In the war for resources, tapping the next wellspring of that material involves going after more difficult and costly locations. Companies are forced to go deeper and further to extract the commodity. And the most efficient and affordable sources are depleted first, meaning the capacity loss is to the left side of the cost curve.

With steel, it's the opposite. "Nobody wants to build the next inefficient steel mill," Dey said. Thus, each new facility brings to the market the most efficient technology. The capacity it replaces is the least efficient, so the capacity depletion comes on the right side of the cost curve.

One byproduct of that, Dey said, is an affirmation of the points made by Marcus and Kirsis. "The cost curve is flattening. It has to, because inefficiency comes out of the right side of the curve."

The point is, he said, "we can’t fight all this capacity coming in. A better approach is to learn how to live with it."

Fellow panelist Peter Campo, president of Gerdau Long Steel North America, believes this continent is also a good place to make and sell steel, particularly the long products his company produces. Gerdau forecasts several years of mid to high single-digit growth in demand, with both private and public construction, an improving employment picture and better industrial production driving the need for long steel.

Most of Gerdau's projections are consistent with other analysts' forecasts, though his company may be a little more optimistic on the public spending side than most. Campo said state coffers are healing and a growing economy will deliver even more tax receipts to state and local governments. With faith that the highway trust fund will not be abandoned, "we'll see good levels of public construction return."

Still, he outlined three threats to this outlook, all of which involve the federal government. Imports of long products into the U.S. pose the biggest risk. "We've seen substantial increases in imports before, but not under circumstances where we have so much excess capacity," he said. "If we can implement sound policies and follow the laws, we’ll have a solid production environment."

Additionally, Campo is concerned about what he calls the absence of a rational energy process in the U.S., and a lack of infrastructure investment, which remain troubling. "Unfortunately, we're in an environment where all spending is considered bad," he said. "We have to make the case that true investment will provide jobs and an economic advantage in the future."

["We can't fight all this capacity coming in. A better approach is to learn how to live with it." Saikat Dey, Severstal North America]

The market for service centers
Consolidation at the service center and distributor level is "inevitable and necessary," said Lisa Goldenberg, president of Delaware Steel Co., Fort Washington, Pa., a speaker on the steel middleman panel.

Goldenberg believes the tight lending environment following the recession, and the new relationships that emerged from that period, have created a more reliable method of valuing inventories. This gives a better picture of what a distributor is worth.

"This newfound transparency, or perhaps the previous lack of transparency, was always a major issue in valuations and acquisitions. It is my contention that this is becoming less of an issue, and we’re about to see another wave of consolidation."

James Tumulty agrees. His company, Pittsburgh-based Calibre Group, is a merchant bank that specializes in offering financing to industrial companies. "In our view, consolidation in the service center industry will continue. The market is acting as if the manufacturing revival is real, and is willing to pay for it. The credit markets have fully recovered."

Tumulty said service centers have four options in the coming years. They can use capital to purchase complementary businesses, eliminate or outmaneuver competitors or grow vertically. The looser equity markets make this a more reasonable strategy today than in previous years.

Companies may also use those lending standards to recapitalize their businesses, with banks and financial intermediaries willing to lend up to what was the value of the business just 12 to 18 months earlier, he said.

A third option is to sell the business. Tumulty recommends this practice if the operator lacks confidence about manufacturing's revival or has no firm succession plan. "This is a very nice time to get a good multiple for your business," he said.

Finally, and the strategy he does not advocate, is to do nothing. "This runs the risk your competitors might outflank you by investing in their businesses."


Platts Steel Forum: Changes Afoot in Flat-Roll

When 2013 was drawing to a close, flat-rolled demand and steel pricing appeared stable. Then the U.S. was hit with one of the most brutal winters in decades and all those predictions of a calm steel market quickly faded, recalled Platts Editors Dan Hilliard and Mike Fitzgerald in their remarks last month. Platts gathered steel executives and analysts for a short forum in New York on the eve of American Metal Market and World Steel Dynamics’ Steel Success Strategies conference.

The winter’s record cold temperatures and snowfalls caused energy prices to spike and slowed shipments to customers as commerce stalled. Demand for steel tanked, causing the hot-band price to plummet from about $680 to $635 per short ton nearly overnight.
 
On the supply side, icy conditions on the Great Lakes halted iron ore shipments to domestic mills. Producers felt the consequences of the rough winter with outages and maintenance issues in several locations.

“As a result, total raw steel production dipped by about 130,000 short tons. Producers realized they could raise prices and get away with it. The question is: ‘What happens next?’” Hilliard asked.

Fitzgerald predicts the back half of the year will see further softness in pricing as North American production levels return to normal and imports continue to increase. Buffering the market from those two trends is a demand picture that looks promising across most end markets. “When you talk to people in the market about demand, you don’t hear many complaints,” Fitzgerald said.

Still, there are lingering effects of the hard winter. The stress put on blast furnaces during the start-and-stop winter months may begin to show up once those mills are running at full production later in the year. The trade wars are also worth watching. In addition to the ongoing antidumping cases, additional suits could be filed on cold-rolled and galvanized material, among products, he said.

All eyes are on the changing North American production landscape. ArcelorMittal/Nippon Steel is working through holdover contracts inherited from its purchase of ThyssenKrupp’s mill in Calvert, Ala. Big River Steel in Arkansas is progressing toward its launch. And Severstal’s North American assets in Dearborn, Mich., and Columbus, Miss., reportedly are on the auction block.

“U.S. Steel and CSN seem like the frontrunners, with JFE also looking at it,” Fitzgerald said of the Severstal process. A possible combined bid between AK Steel and Steel Dynamics also has been reported.

Analysts in attendance were asked to share their insights on the current steel market. Chuck Bradford of Bradford Research expressed skepticism about the Severstal sale, questioning whether U.S. Steel had the money to buy the facility, and whether JFE had the stomach after the company’s previous venture into North America with National Steel was such a failure.

“Anytime you see companies named as having interest, it’s mostly to gather information in the due diligence process. Some of the people who are reported to be bidding for Severstal were reported to be bidding for the TK plant, and not a single one put in a bid besides ArcelorMittal/Nippon Steel. It’s the standard investment banker game to get some interest going to get the price up,” he said.

On the flat-rolled pricing front, Aldo Mazzaferro of Macquarie Equities Research said he does not expect much movement in the steel price in the second half. “The industry is still practicing very good production and pricing discipline.”

In contrast, Timna Tanners, metals and mining analyst for Bank of America Merrill Lynch, believes the widening spread between domestic and import offers will affect pricing. The Chinese steel industry has a $40 per ton advantage in the cost of iron ore that it has not fully realized. “Export offerings will drive the U.S. price down, and our second-half forecast is $620 per short ton on hot-rolled coil. The U.S. is the only real end market with good demand, so there’s a lot of incentive to export to us,” she said.

Even if further trade cases are filed to protect U.S. producers, it won’t stop the import deluge. “If it doesn’t come from one country, it will come from another,” she said.




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