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April 2010 SBB Steel Markets North America
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Can So-So Steel Demand
Support Mill Price Hikes?

By Dan Markham, Senior Editor

Modest demand for steel in most world markets could put pressure on hot-rolled sheet prices in the second half.

The steel price will decline in the third quarter, and it will happen rather quickly, predicted industry analyst John Anton, director of steel services for IHS Global Insight Inc. Anton was a panelist during last month’s SBB Steel Markets North America conference in Chicago.

Steel prices rose at “an amazing rate” in late 2009 and early 2010, he noted, spurred on by double-digit increases in the cost of scrap, iron ore and freight. While current demand is better than it was last year, it remains well below normal. Moreover, Anton expects China to tap the brakes on its runaway growth in the second half, lowering steel consumption there. With North America, Europe and South America all experiencing continued sluggishness, the price hikes of the first half simply aren’t sustainable, he said.

With the world economy just beginning a long, slow recovery, even markets on the upswing, such as automotive, will remain far short of their steel consumption of three or four years ago. If U.S. automotive production tops 10 million units as predicted, Anton noted, that’s only two-thirds of the vehicles made in the peak years.
 
Anton said the scenario he envisions for 2010 has played out in even-numbered years dating back to 1996. “Prices rise in the first half of an even-numbered year, plateau in the third quarter and then come down hard. This time I think they’ve gone up so fast and demand is so weak, we will not have a plateau. Prices will start turning down in the third quarter, and the fourth quarter will be essentially flat.”

The predicted price decline will not be a catastrophe for steelmakers, he added. Prices for raw materials will likely fall as well, with scrap dropping into the low $200 per ton range. Moreover, steel prices will still remain above 2009 levels.

Commenting on specific products, Anton projects hot-rolled sheet will fall by as much as $70 per ton in the third quarter, then trend slightly upward. In contrast, plate prices should only strengthen. “Sheet has risen, some of the bar products have risen, but plate really hasn’t benefited yet. It’s just starting to now. For plate, the momentum is upwards.”

Demand for bar products should be fairly flat, while structural shipments will continue to fall as the nonresidential construction market remains weak.
 
The stainless steel base price will be stable, but not the surcharges, he added. A shortage of ferrochrome as a result of South African power outages is a certainty, while nickel will fluctuate. “Ferrochrome prices are heading north, and as best as we can tell they will keep heading north through 2011.”
 
M&A on their minds
For most of the past 15 months, mergers and acquisitions in the steel industry have been stalled. As the industry moves further away from the economic meltdown of 2008-09, investors, analysts and supply chain members themselves are curious when the buying and selling will resume.

Rumors are beginning to circulate about players that are either available or acquisitive, noted Dan Sullivan, director of the industrial group for the investment banking firm Houlihan Lokey. Whether individual rumors have any truth behind them, their existence is one indicator that the steel industry is beginning to ripen for acquisitions.

Other leading indicators of M&A activity, Sullivan said, are better access to capital, the return of strategic buyers with stronger balance sheets, pent-up seller demand and the uncertainty of organic growth opportunities as the economy struggles to recover. There is still a significant valuation gap between buyers and sellers, which could delay consolidation until late in the year, he added.

“We think there’s going to be some activity, though not so much among the mills,” said steel industry analyst Chuck Bradford, president of Bradford Research. Steelmakers have already undergone considerable consolidation. “The service centers are a different beast, especially the small ones.”

Smaller companies are more vulnerable as the economy improves and their working capital needs grow. Service centers will need cash to restock barren shelves. “There are a number of people we have heard about, smaller guys, who are having trouble getting money from the banks,” Bradford said.
 
Paul Gedeon, president and CEO of Lane Steel in Pittsburgh, agreed that some distributors may be challenged by the recovery. He doesn’t foresee any major M&A activity until the latter part of the year, when owners can go into talks with better looking financials. “There may be some changes within the sector as a whole within the coming year, but at this point nothing to suggest anything dramatic.”

After taking such a beating, will financial players have the stomach to remain in the service center market? “Private equity groups that own service centers and got hit in 2008 and 2009 may say this is not the business for them and sell to the bigger [strategic] players waiting to take advantage of these opportunities,” Gedeon said.

NuMit, Nucor’s recently announced joint venture with Mitsui and Steel Technologies, raises the question of whether more steel producers will venture into the distribution business in 2010 and beyond. Panelists were doubtful of a trend.

“Every time they get in, they get back out. Only time will tell if this time is different,” said Peter Brebach, president of Colorado Springs-based Iron Angels of Colorado.

Tom Modrowski, CEO of Esmark Steel Group in Chicago, said his company’s experience argues against such cross ownership. “We were the reverse of that in the last go around, and we probably didn’t do the best job on the mill side. Maybe the moral of that story is service center guys ought to be service center guys and mill guys ought to be mill guys,” he said. 
 
Capacity concerns building
Among the recurring themes of comments during the SBB conference was the state of steel capacity and utilization, particularly in the United States. Are the domestic mills bringing back capacity too quickly? Can the U.S. economy absorb the new capacity planned to come on line in 2010 and beyond? Is there any chance mills will still shutter older, excess capacity? How will excess production affect steel prices?

In 2009, U.S. steel mill capacity utilization tumbled below 45 percent in the first half of the year. Today, capacity has climbed close to 70 percent, largely to help replenish depleted inventory levels. North American producers have announced additional plans to resume production at idled mills. Bradford predicts utilization will reach 75 percent this year. 

 And that does not count new capacity in the works. California Steel recently completed a one-million-ton flat-roll expansion. Severstal’s Columbus, Miss., facility will expand its output by 1.8 million tons in 2011. The Essar Group has a 2.5-million-ton iron-ore mining and processing project on the table for 2012. Most significantly, ThyssenKrupp will open its 4.5-million-ton carbon-steel facility in Alabama later this year.

On the tubular side, almost 2 million tons of production capacity will be added between now and 2012, including a new 400,000-ton welded OCTG facility owned by Boomerang Tube that will open in Liberty, Texas, in August.

Analyst Timna Tanners of UBS forecasts that an additional 31 million tons of new capacity will be added globally in 2010, and another 32 million tons in 2011. Thirty-eight percent of the new capacity planned for 2010 is in China.

Bradford is convinced all this supply-side activity will lead the industry down a familiarly destructive path, with excess production damaging industry profitability. “We’ll do it to ourselves like we always do, have excess expansions,” he said.
Service centers remain the primary destination of product from domestic steel mills, representing one quarter of all shipments. The pie on the right, which breaks down the service center segment, shows that fabricated products are the largest service center market.
  
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