Will Steel’s Skies Ever Be As Blue?

Panelists at last month’s Steel Survival Strategies conference forecasted slowly improving conditions for the steel market, but questioned whether the industry will ever be the same in the aftermath of the current recession.

By Myra Pinkham, Contributing Editor

Are there blue skies on the horizon that are just being obscured by the black clouds of the current U.S. financial crisis or is the global steel industry undergoing yet another structural change that will alter the view forever? Once the blue skies return, will they ever be as blue as before?

One thing is certain, said World Steel Dynamics Managing Partners Peter Marcus and Karlis Kirsis, who co-sponsored the Steel Survival Strategies XXIV conference June 22-24 in New York along with American Metal Market. “A blue sky world for the steel industry will reflect the massive adjustments made during the black skies period,” most notably a purging of high-cost steelmaking capacity.

Lourenço Gonçalves, president and chief executive officer of Metals USA Inc., Houston, observed that the current dismal market conditions offer a sharp contrast to last year when the outlook for steel was robust. “With the collapse of the financial market, the general economy slowed rapidly and financing became almost impossible to get,” he said. “Steel sellers were left with empty order books. Prices dropped as dramatically and as fast as they rose. Companies that were previously regarded as being immune to the ups and downs of the economy are currently awash in red ink.”

“Even those of us who have been around for a while have never experienced as precipitous of a drop,” said Lou Schorsch, chief executive officer of ArcelorMittal’s Flat Carbon Americas division. It is of small consolation that the almost 40 percent decline in global steel demand through the first quarter of this year “wasn’t of our making,” he added.

“Each of us would love to travel back in time to just a year ago and put things back together,” said James L. Wainscott, chairman, president and chief executive officer of AK Steel Corp., West Chester, Ohio. But even without a time machine, Wainscott is convinced the North American steel industry is poised for recovery as soon as the economy improves. “That’s because the steel industry has prepared for the future, having gone through a significant round of restructuring earlier in this decade,” he said, and is now globally cost-effective.

Schorsch noted that steel demand has plummeted in all regions of the world, with the “glaring” exception of China. “Prices are worse in the United States and the European Union, where the problems—or abuses—in the financial sector were the most pronounced.” First-quarter apparent steel demand declined 49 percent in the United States and 43 percent in the European Union vs. a year earlier.

However, unlike 20 to 30 years ago, the developed world is no longer the leading driver for steel demand, he said. In 1980, the developed world represented 56 percent of world steel demand. “Today it only represents a third, with another third being China,” Schorsch said.

Supporting the view that a structural change is occurring in the industry, John Lichtenstein, a partner in Accenture, said he believes the long-term rate of decline in the U.S. share of global production will accelerate in the next few years as emerging economies recover more rapidly than the United States. “The United States will continue to have a sizeable market for steel. However, it will be increasingly influenced by global forces, particularly in the pricing of its inputs.”

While no longer the largest steel market, the United States remains the best steel market in the world, Gonçalves said. “Regardless of fears of periods of inflation, recession or economic woes, U.S. steel consumption remains the most stable in the world.”

The problem with the U.S. steel industry, and why it continues to experience such dramatic volatility, “is that it reacts with emotions rather than logic,” Gonçalves said. “We all know the condition we were in as we entered the 21st century. We had an excessive number of integrated steel companies operating a great number of blast furnaces and none of them were making even the cost of capital. Additionally, a number of companies had invested in electric arc furnaces under the mistaken idea that anyone could profitably operate a minimill.”

During that “black period” about 10 years ago, one steel industry consultant admonished his audience at the conference “to roll up or blow up,” in other words, to get serious about consolidation, Lichtenstein recalled. “The industry did embark, albeit involuntarily, on a transformation that helped enable stronger financial performance, but now, 10 years later, it once again finds itself at a crossroads.”

There is no question that consolidation has helped. Gonçalves observed that the industry went from its top eight producers posting a combined net loss of $368 million in 2001 to a $4.5 billion gain in 2007. What changed so dramatically over such a short period of time wasn’t the condition of the supply chain, any technological leapfrogs or a dramatic boost in demand. “The biggest change was in the mindset of managers. When management focused on profits, good things started to develop,” he said.

Some of consolidation’s promises remain unfulfilled, however, he added. When the financial meltdown hit last September, it caused many end-users to delay purchases, but most of the mill production reductions did not start to occur until the fourth quarter. “Consolidation should have provided a faster response,” Gonçalves said. “Because of lack of demand visibility and excess inventory, the industry fell back on the same bad behavior of the past and unnecessarily dropped prices, hoping to affect demand. Unfortunately, the rules of steel economics remain as true today as 50 years ago. Lower prices don’t drive demand.”

The steel industry’s current crisis is distinctly different than the one a decade ago, added Lichtenstein. “On one hand, external economic conditions are more severe, but on the other hand the industry is in a much healthier position to weather this crisis as a result of stronger balance sheets, consolidation-enabled discipline and a managerial mindset focused on profits.”

Several structural shifts are also under way, he noted. In addition to a withering of the U.S. market’s global influence, Lichtenstein predicts that ownership of the North American industry will become even more integrated with the global economy over the next few years. Already roughly 50 percent of North American steel capacity is owned by companies with headquarters outside of the region.

Schorsch observed that mill, service center and OEM inventory levels have already come down significantly in reaction to widespread uncertainty of global economic prospects. In fact, U.S. steel service center inventories are now at their lowest levels since the 1980s, at only 2.5 months on hand, even with extremely depressed shipment levels.

Automakers in the NAFTA region are also paying attention to their stocks. Although automotive sales are down approximately 40 percent, production is down even more. “As a result of these inventory movements, we will start to see a substantial improvement in operating rates in the very near term,” Schorsch predicted. He admits, however, that a full recovery will require a strong rebound in end-use demand in addition to an inventory liquidation. “We are by no means out of the woods yet.”

Lichtenstein added that further capacity rationalization will be required as a protracted recovery, permanent shifts in demand patterns and new facilities coming on line will leave the United States with too much capacity in certain product groups.

Based on the addition of about 10 million tons of hot-roll capacity by 2012, capacity utilization rates will just reach 75 percent, even if demand returns to 2008 levels, Lichtenstein said. “To obtain hot-mill utilization of 90 percent or more, the United States would have to either become a net exporter of three to four million tons of flat-roll or close two to three hot-strip mills.”

This appears to be the view held by many at the conference. WSD predicts that multi-plant companies, especially integrated producers, will maximize output at their most strategic facilities and, in doing so, shut down or de-emphasize smaller BF/BOF based plants.

One industry official estimated during a sidebar conversation that as much as 15 million tons of temporarily idled U.S. integrated steelmaking capacity and several million tons of minimill capacity could be shuttered permanently. Some rationalization of capacity has already begun, most recently with Gerdau Ameristeel announcing the permanent closure of its Perth Amboy, N.J., rebar plant.

Agreeing that there could be need for permanent closures, Thomas Danjczek, president of the Steel Manufacturers Association, noted that in some product categories there is currently more capacity than demand even without taking imports into account.

“The prospects for capacity rationalization to occur in a timely fashion are enhanced by the industry’s consolidation,” said Lichtenstein, “as the closures of facilities are more easily accomplished by multi-site producers than an industry of single-site operations.”

Assuming the market experiences an L-shaped recovery, where demand does not return to 2007 levels until 2012 or beyond, “companies need to take steps now to be able to generate adequate shareholder returns while operating at 20 to 30 percent below pre-crisis levels,” Lichtenstein said. Now is the time for steelmakers to take strong steps, such as further cost reductions, locking in raw materials and outsourcing more back-office and operational support functions.

“[Steelmakers] should also get closer to their customers,” he said. “With utilization rates in the 40s, the temptation is to view every order as a good order and every customer as a good customer, which of course is not the case. While struggling to fill today’s order books, a company should also focus on tomorrow’s orders, in particular on those companies with whom they want to be most closely aligned.”

Schorsch remains bullish about the steel industry’s long-term prospects, especially the relatively rapid recovery of much of the developing world. “The recovery will be much more delayed and problematic in the developed world, but those countries no longer set the tone for the global steel industry,” he said.

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