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Conference Report: Platts Steel

Feel-Good Session

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MCN Editor Dan Markham

Optimism over the improving economy, growing steel demand and pro-business administration was widespread at the Platts Steel Markets North America Conference last month in Chicago.

Service Centers’ Road to Profitability

The path to success for the North American service center is narrow, but it can be navigated with good management. And it can be traveled by small and big players alike. 

“There will always be room for the niche player. Niche players don’t have the bureaucracy, they have captive markets and they are nimble. They are absolutely branded in their particular geographies,” said Don McNeeley, president of Chicago Tube & Iron Company, Romeoville, Ill., who was a panelist at the Platts conference. 

McNeeley was joined by Berlin Metals President Roy Berlin and Steel Warehouse President Michael Lerman on the service center panel, which explored the issues facing the distribution sector. 

Berlin, who recounted the many turns his company has experienced since its founding by his father, said anticipating and embracing the next development in the market is imperative for service centers of all sizes. “You have to look for change, be ready to change and hire people who have the mindset to embrace change.”

McNeeley said service centers are in no position to drive down costs on the input side of the business, nor can they get customers to pay more than the market price. Thus, their focus must be on the middle, the area he called operational excellence. “The only way you’re going to lower your operating expense as a percent of revenue is with cap ex. Who will be the survivors in the future? Look at the public players with the balance sheet wherewithal to continue to invest in cap ex to integrate operational excellence.”

Lerman agreed the key to profitability rests in operations. His company is “attacking our internal costs,” citing endeavors to lower health insurance, logistics, scrap and inventory costs, and to improve safety. “I’m not proud of our safety record from 15-20 years ago. I am proud of where we’ve been the last 3-5 years.”

Obviously, one way service centers have dealt with compressed margins is by expanding their value-added capabilities. McNeeley didn’t mince words about this industry-wide phenomenon. “Value-add is a euphemism for fabrication. How brilliant is the model to compete against your largest customer? You have to be very careful, because you’re walking the razor’s edge.”

The panelists agreed that conditions for service centers and the industrial economy in general are likely to be more favorable under the current presidential administration, with its cadre of steel executives in key advisory roles, its professed commitment to infrastructure spending and the likely changes to the corporate tax structure and the regulatory environment. “Steel is going to drive the nation’s infrastructure and trade policy for the next four years, or eight years, or until impeachment,” McNeeley joked. 

The panelists were less supportive of President Trump’s proposals for a border tax. Berlin said any change is bound to be disruptive and damaging. Lerman expressed worry that attempts to protect the domestic steel industry could backfire if they prompt foreign companies to shift focus from steel production to parts production. “The last thing we want is for our customers to be uncompetitive,” he said. 

And McNeeley noted that the American public would ultimately bear the brunt of a 30 percent tariff on imported goods. “They’re going to add the tariffs to the price of the product. Mexico isn’t paying for the wall; it’s the U.S. paying for it.”

Tanners: China May Address Overcapacity

The new presidential administration and its position on trade, tax policy and infrastructure was a common topic at the Platts conference. But Timna Tanners believes, when it comes to the short-term outlook for the domestic steel market, China trumps the commander in chief.

“So many investors want to talk about Trump,” said Tanners, the steel industry analyst with Bank of America Merrill Lynch. “I’m convinced, at least for now, that what’s happening in China is more important than what’s happening in Washington.”

And, in sharp contrast to other experts at the conference, Tanners believes the situation in China may improve. While other analysts decried China’s ongoing overcapacity, and its threat to global steel prices, Tanners’ firm believes the Chinese government’s vows to get production under control may finally have some teeth. “Last year, the Chinese decided to curtail coal production. This is the year they’re going to curtail steel production,” she predicted.

Two factors will drive the long-sought change to the country’s steel glut, Tanners said. Pollution is a growing concern among the Chinese population as the air quality in Beijing and other large cities deteriorates. “There’s also a greater awareness with the Chinese about profitability at the expense of production, which we learned a while ago,” she said. 

Furthermore, China’s internal demand is looking much stronger than most analysts anticipated, which will pull more steel toward local consumption instead of unleashing those extra tons on the world market. Bank of America Merrill Lynch forecasted a 1 percent decline in China’s domestic steel demand in 2017, but currently it’s running about 1 percent above prior-year levels. “Given the law of big numbers, that makes a big difference in the supply of excess steel,” Tanners said.

Positive signs out of China, including a higher price for hot-rolled coil, will pay dividends at home, she added, forecasting a hot-rolled price averaging $650 per ton this year, a $120 gain over 2016. She believes 2017 could be a year of greater price stability “if the U.S. doesn’t raise prices too dramatically. There’s no reason to invite imports.”

Among the steel-consuming end markets, Tanners said her company is enthusiastic about demand from construction in 2017, particularly on the nonresidential side. But she cautions against over-exuberance on infrastructure. The president has made a vague proposal for a trillion dollars in infrastructure spending, but Tanners believes getting Congress on board will be difficult. “We have no doubt the current administration would like to spend money on roads. What we have doubts about is who’s going to pay for it.”

Energy Market in for a ‘Wild’ 2017:

Nicole Leonard was right for the wrong reasons. One year ago, the project manager for S&P Global Platts projected the start of 2017 would be much better for the energy market than 2016. While that’s true, it’s more about the manipulation of supply than actual demand.

“I didn’t think OPEC would cut production, but they did. The balancing of the market didn’t happen organically like I thought it would. It was an engineered balancing of the market,” Leonard told attendees at the Platts conference. An engineered market is much more difficult to sustain, she said, which is why she remains “bearish in the short term and bullish in the long term.”

Leonard expects energy prices to remain above 2016 levels, but not necessarily at figures that prompt a rush to drill. “Right now, we’re not anticipating prices jumping up to $70 per barrel. We’re looking at $50-60 per barrel,” she said.

However, the path to that average may not be so smooth. Energy could experience a wild ride this year, given the various factors affecting the market. For starters, more people are trading in oil and gas than ever before, and this speculation will skew the results. Additionally, there are ample questions regarding production, including the likelihood of OPEC’s announced production cuts holding firm, and for how long; how much production increases in the U.S.; and what happens with the ramp-up of projects in Norway, the Congo and Brazil, countries that historically are not major suppliers of petroleum products. “There are so many questions in the market. The price won’t be driven by fundamentals,” she said. 

As for the steel sector serving the energy industry, there is some good news, Leonard said. Even with rig counts well off the 2014 highs, the steel going into each well continues to increase. Advancement in drilling techniques has led to an ever lengthening of the holes being drilled, both vertically and horizontally. Each additional foot drilled demands more steel. “The length they’re drilling laterally is increasing by 20 percent every year. There are some places where people are drilling 20,000 feet laterally. That’s 20,000 feet of steel tubing,” she said. “The depth alone from 2010 to 2017 has increased steel demand per well by 45 percent.”

Much of the current drilling activity is in the Permian Basin. That oil play will consume more steel this year than it did in 2014 due to heightened activity levels and the greater steel use per well, Leonard noted. On the other hand, this concentration of activity in Texas, close to the refineries on the Gulf of Mexico, will limit the need for line pipe.

On the natural gas side, Leonard said, there has been an influx of private equity money. Private investors typically are more interested in a quick turnaround on their money. The payoff for natural gas wells is quicker than for oil wells, though oil wells ultimately generate higher returns. The lack of current investment in oil exploration will create a supply shortage in a few years, Leonard predicted, one that will lead to higher prices and another run-up in the sector. “We need higher prices to incentivize investments in long-term assets,” she said. 

Improving Conditions Generate Optimism:

The overriding sense of optimism among steel executives at the Platts conference reflects improving business conditions in the U.S. The economy started to pick up steam in the second half of 2016, and it has only accelerated this year, said Beth Ann Bovino, chief economist for S&P Global Ratings. 

Bovino pointed to a variety of factors working in the country’s favor in general, and the steel market in specific. It starts with an energy market that has hit bottom and is beginning to rebound. Such improvement is a boon for all three of North America’s main economies. The U.S., Canada and Mexico all are significantly supported by oil and gas activity.

The most notable strength of the U.S. economy rests with the consumer. Job gains have averaged more than 200,000 for six months, pushing the unemployment level down below 5 percent, or close to full employment. Moreover, despite a blip in January, wage growth has also started to climb, with more gains expected. “What does this mean for spending?” Bovino asked. “If you have a job at higher wages, you’re going to spend more.”

That bodes well for the residential construction market, which is expected to continue its slow growth in 2017. Analysts believe residential building has begun to shift from multifamily to more traditional single-family housing starts. 

Automotive, the other primary steel-consuming market, has likely peaked, Bovino said, but any decline is expected to be modest. 

For business owners, the potential for a more favorable tax policy and a reduction in federal regulations under the Trump administration is promising, and is contributing to optimism in the stock market. “It could be a positive in terms of getting business investment under way,” Bovino said.

The strong business conditions are likely to lead to more interest rate hikes by the Federal Reserve as it attempts to keep inflation under control. Bovino anticipates three more hikes over the course of 2017.

There are some headwinds. While the employment and wage picture is solid, and the underemployment rate has improved, the participation rate remains worrisome. People who are no longer looking for work, either because they’ve, retired, become discouraged or resumed their education, are not counted in the jobs report. This cuts into productivity and slows growth, she said. Job gains are expected to slow to about 150,000 per month throughout 2017. “That’s normal in a mature economy approaching full employment,” she added.

Other risks to the U.S. economy include external global events such as terrorism, the result of European elections and the effect of the United Kingdom unwinding from the European Union.

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