July 2016

Price Decline on the Horizon?
World Steel Dynamics predicts the price of hot-roll will drop again before year’s end, but will not linger at the bottom as long as it did in 2015.

By Dan Markham, Senior Editor

The entire global steel industry was hard hit by the drop in hot-rolled pricing in the back half of 2015. Peter Marcus and Karlis Kirsis, managing partners at World Steel Dynamics, warn steel executives to get ready for the sequel.

In their kickoff remarks at last month’s AMM/WSD Steel Success Strategies conference in New York, the analysts predicted the industry will face another “pricing death spiral” in the coming months. They described the early-year run-up in steel prices as a “dead cat bounce,” rather than a fundamental change in market dynamics. Fortunately, they said, the 2016 fallback will likely be shorter lived than last year’s, but the price is ultimately dependent on Chinese steel mills cutting production.

“The Chinese have an unsolvable dilemma. They can’t separate their home and export price,” Marcus said. “When their export price goes down to $300 per ton, they have financial losses that are quite monumental. And they can’t concentrate the industry because there are approximately 92 wide hot-strip mills vying for market in the country.” Nonetheless, WSD believes the coming losses will finally force the Chinese to take some capacity offline. “The looming 2016 hot-rolled death spiral will not be as long lived as the one in 2015 because global steel production is sticky on the downside. Too many mills have incurred extreme balance sheet debt to continue to export at such low prices,” Kirsis said.

At home, and abroad, domestic steel companies have embraced another approach, rather than simply waiting for the Chinese to rein in their overcapacity. “In desperation, many steel mills ran to their governments asking them to enforce the trade laws and take other actions to diminish the Chinese steel mills’ deliveries to their home markets. For once, government listened. We are now seeing an unprecedented avalanche of trade suits and other actions,” Kirsis said. In fact, the trade cases have had the desired effect. Imports into countries with ongoing, or merely announced, trade filings have dried up.

Government intervention is a tried and true tactic, Marcus said. “Is mercantilism the panacea for the steel industry? In fact, to many manufacturing companies, the answer is yes. Mercantilism has worked for those who have practiced it. Whether you like it or not, that’s the way it goes,” he said, pointing to the examples of Great Britain in the 19th century, the U.S. in the first half of the 20th century, and Japan and China in the second half. “Mercantilism and free trade are antagonists. Academics applaud free trade; industry hates it.”

With the trade cases in place, the outlook is much more promising for U.S. steelmakers, the analysts predicted. Even a decline in pricing in the second half won’t be as harmful this time around, as the mills are benefitting from serious cost-cutting efforts, reduced foreign deliveries, low raw material costs, and better debt and equity as a result of the first-half price spike. Moreover, the U.S. price should remain at a healthy premium over the global market figure.

Domestic minimills are particularly well positioned, as Marcus and Kirsis anticipate persistently low prices for scrap metal, now that material from the first wave of the Chinese manufacturing boom is due to hit the scrap market. The global scrap reservoir has no choice but to grow to more than 400 million tons, they estimate.

Looking ahead, there is reason for optimism. By 2018, WSD expects the global steel market to take off. “We expect a 14 percent eradication in steel industry capacity in China and elsewhere. The Chinese export armada will be defeated. Steel demand outside China will surge as fixed-asset investment will grow in many countries. Financial contagion will lessen and construction and investment projects will be activated,” Kirsis said.

View from inside the industry
Global steel trade was also a common topic for domestic steel executives who shared the podium with Marcus and Kirsis, though they tended to use phrases such as “level the playing field” and “enforce existing trade laws” as opposed to mercantilism.

Keynoter Mario Longhi, president and CEO of U.S. Steel, naturally addressed China and global trade issues. His company has taken the rare step of filing a Section 337 trade suit against China, alleging price fixing, illegal transshipments of materials and theft of trade secrets, among other violations. Like WSD, he believes the industry’s pleas to government and other agencies are finally gaining traction. He pointed to the recent declaration by G7 leaders expressing concern about Chinese overcapacity, and the discussion of steel overcapacity at a Chinese-U.S. strategic economic summit as encouraging steps. “This is a clear sign our industry’s concerns are being heard and addressed by officials with the power to affect the necessary change,” Longhi said.

However, any positive momentum would be stalled if the World Trade Organization accepts China as a market economy. A decision to grant China’s much-desired status change could come as early as December. “China should be treated as a non-market economy. Any other outcome would be disastrous for steel,” said Longhi.

The WTO weighs five factors when considering whether a country is operating as a market economy: the extent to which its currency is convertible to the currency of other countries; wages are determined by free market practices; foreign investment is permitted; there is government ownership or control of the means of production; or the government has control over the allocation of resources or over price and output decisions.

“It’s clear that China manipulates its currency. Recent trade cases provide ample evidence that China continues to operate state-owned enterprises. They manipulate raw materials, and we all know how welcome foreign investment is in the country,” Longhi said.

Another speaker, Peter Campo, CEO of Gerdau North America, said the global oversupply situation driven by China is one that won’t be solved soon. “We have 70 percent capacity utilization and 2-3 percent demand growth. This problem is going to be with us for a long time.”

While supportive of trade laws, Campo recognizes that even restrictive antidumping and countervailing duty orders do not necessarily keep Chinese steel out of the domestic market. Steel products that are barred from coming to the U.S. directly can make their way ashore indirectly, either through transshipments and modest changes to the material in another country, or downstream in white goods and other products. He cited the example of the Bay Bridge renovation in California, where country-of-origin laws prohibited the use of imported steel in the project. “The contractors said if we can’t import the steel for the bridge, we’ll just import the bridge.” Finished steel sections of the structure were shipped from China.

Campo also noted that the current system does not account for the environmental impact of producing steel and other metals, at least not equitably. “You’re not just importing steel, you’re actually importing carbon,” he said. More consideration should be given to the carbon footprint of producing and transporting imported steel vs. domestic production.

China’s justification of its overproduction falls apart when viewed through the lens of the U.S. economy, said Olympic Steel Chairman and CEO Michael Siegal, another conference presenter. “People say we have to worry about China’s overpopulation, that they have to keep everyone working or they’re going to have a revolution. That’s nonsense when we have a revolution in the United States. Look at the streets of Baltimore, Chicago and St. Louis. These are communities that used to have steel mills. We must have the commitment and resolve to keep our worker’s safe and allow them to have jobs,” he said.

Getting back on top
One hundred years ago, the U.S. was the world’s largest steel producer. Today, the third-largest country is responsible for just 5 percent of the global steel output. “How did this happen?” asked Nick Sowar, the principal partner and global steel leader for Deloitte LLP.

It wasn’t just one development, but a series of events, that have reduced U.S. steel production and manufacturing from a position of dominance. Booms in other parts of the globe, labor-management strife, increased regulation and questionable trade practices by other nations have all contributed to the manufacturing malaise in the U.S. However, it doesn’t need to be this way, Sowar said. “The U.S. continues to be an outstanding location for world-class manufacturing, far better than China.”

He pointed to several factors working in favor of domestic production, including policies that spur innovation, energy availability, physical infrastructure, and the legal and regulatory environment. The only area where the U.S. trails the developing nations of China and India is cost, he said.

Sowar outlined five separate steps that should be taken to help the U.S. reclaim its manufacturing dominance: growth through public/private policies stimulating steel demand, plus infrastructure investments; collaborative investment and promotion of trade and apprenticeship programs; continued investment in steelmaking innovations; quality improvements, such as improved melting technologies and thin-slab casting; and policies that promote fair trade.

One stumbling block manufacturing must overcome is the talent gap in the U.S. “For decades we’ve heard the enlightened elite telling young people that a four-year college degree is the answer to all their dreams. Anything else, like trade school, is for underachievers and losers.” In fact, for some high school graduates, a job in manufacturing offers a more secure future than many courses of study. “Solid-paying jobs in manufacturing go unfilled because of the skills gap. This is a sad state of affairs this country has put itself in,” he said.
Platts: Economic Headwinds Easing

It’s no secret the U.S. has experienced much slower growth coming out of the 2008-09 recession than in past post-downturn expansions. But looking forward, a number of factors are working in favor of the U.S. economy, said Satyam Panday, an economist for Platts, which conducted a one-day steel forum in New York the day before the Steel Success Strategies conference.

Over the past six years, U.S. GDP has grown at an average of 2.1 percent, well behind the expansions of more than 3.5 percent from 1984-90 and 1991-2000, and even trailing the 2.7 percent growth rate from 2001-07. “Even though this is a lower growth rate, we have to compare it against the potential of the economy,” Panday said.

Two key headwinds working against economic growth in the past half-decade have been the state of the global economy and demographics at home. Growth in the rest of the world has slowed to under 3 percent since 2012, a full percentage point below the norm. At home, the labor force has endured a decline as the baby boomer generation exits the workforce and the large millennial cohort begins to come on board.

As always in the U.S., future growth will start with consumer spending, which drives 70 percent of domestic GDP. “When consumers are doing well, domestic demand is good,” he said. Household balance sheets, a weakness that contributed mightily to the latest recession, have strengthened considerably. The debt-to-income rate, which once was about $1.25 of debt for each $1 earned, has dipped to 90 cents per dollar. That’s significant progress, particularly compared to the Eurozone, he added.

The stock market also has rebounded, as have home prices, which are particularly important to the middle class as they represent much of that group’s net worth. Additionally, the U.S. has not only recovered all of the jobs lost during the recession, but the workforce is beginning to see some real wage growth. Job growth has slowed, with only 38,000 jobs added in May, which was inevitable given the country’s demographics. “The unemployment rate is at 4.7 percent, which is right in the middle of what the Fed thinks of as normal at 4-5 percent.”

By the end of 2017, housing starts should finally return to their historical averages, Panday predicted, as a number of positive forces are at play in the housing market. Annual vehicle sales have likely plateaued, though at a healthy 17.4 million. Other industrial production is weak, hurt by low energy and commodity prices and a strong dollar.
For the steel supply chain, the greatest potential for growth is in infrastructure investment, both because of the recently passed federal highway bill and the enormous need for improvements to the nation’s aging roads and bridges.

On the monetary side, Panday expects another one or two interest rate hikes before the end of the year, though his forecast was made before the UK voted to exit the European Union. In either case, the Fed will “take a cautious approach, and this will be the shallowest rate hike period we’ve seen in history.”

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