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CRU North American Steel 2013

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U.S. Economy Remains On Slow-Growth Course Steel supply chain executives and analysts pondered the state of the steel industry at the annual CRU North American Steel Conference last month in Chicago. By Dan Markham, Senior Editor The U.S. economy is not as fragile as many people believe. Like a giant ocean liner, it's nearly unsinkable, but takes time to change course. “Once the economy is in motion, it has a tendency to keep going at the same pace,” said Robert Johnson, director of economic analysis for Morningstar, who addressed the CRU North American Steel Conference Nov. 11 in Chicago. “Hurricane Sandy shut down the East Coast for five days last year. It didn’t matter. The Arab Spring shot oil prices up, and it didn’t do any damage. We had one of the highest tax increases in history in January when the payroll taxes went up. People said it would destroy us, but it didn’t.” Today, the giant vessel that is the U.S. economy is moving steadily forward and will continue to make progress in 2014, Johnson said. By year’s end, the economy will have grown by 2.0-2.5 percent. Johnson holds a similar expectation for next year. Inflation will come in at 1.5-2.0 percent, similar to the 1.6 percent this year. Employment growth will remain steady at about 180,000 jobs per month, he predicted. Most of the trends for the U.S. economy, both in the short- and long-term, are positive, he added. “Amongst all the turmoil, the U.S. is surprisingly well-positioned.” Looking longer term, Johnson said there are several key reasons for optimism, starting with the boom in oil and gas production. “Adding one job in the mining or energy sector is worth four times the value of adding one to the hotel sector.” Other factors include a good supply of natural resources, plus leadership in the agriculture, automotive and the aircraft sectors. Also setting the U.S. apart is its “large land mass conducive to more construction spending, which helps auto and housing. In Europe there’s no room to build. We don’t have that kind of constraint.” Over the near term, Johnson likes to look at the status of the consumer to determine where GDP is heading. And the consumer is generally getting healthier, he said. Consumer spending is up, housing is at the beginning of a sustained upturn, the stock market has climbed 159 percent since hitting bottom, and inflation remains low. Decision makers in the service center sector appear more cautious about the economy, said fellow speaker Aldo Mazzaferro, managing director for metals and mining at Macquarie Securities Group in New York. Shipments from service centers climbed steadily as the year progressed, a positive sign for the economy, but inventories remain lean. “The reason shipments are so important to watch is because service centers sell to people who don’t carry inventory. They use the steel almost immediately upon receipt, so it’s almost a real-time look at steel consumption,” he noted. Even as shipments have increased, service centers’ months on hand have remained low, showing that buyers remain conservative in the face of the upturn. Any serious spike in activity could lead to a fast turnaround in the market, given how little supply there is in the chain, Mazzaferro said. Until then, service centers will likely remain cautious, particularly if mill utilization rates stay in the 70-80 percent range, he added. “There’s a gap there where the mills have capacity to give, so service centers are assured of short lead times. The only thing a service center cares about is taking care of his customer. As long as he can do that by allowing the mill to help him out, he won’t have to put steel on the floor.” Reconstructing Construction The steel supply chain is still waiting for one of its chief end markets, construction, to shake loose from the recession. Kenneth Simonson, chief economist for the Associated General Contractors of America in Arlington, Va., estimates total spending on construction will finish this year up 5-8 percent. From 2014-17, he predicts, “we’ll continue to see high single-digit growth in total spending.” Breaking it down, Simonson said, private residential construction spending will slow, private nonresidential will climb and public spending will be flat, at best, in the next few years. Perhaps the biggest headwind to an improved construction market is the lack of public financing. Federal spending is down 30 percent in the last two years. Sequestration’s effects will continue to limit discretionary spending in 2014, “and there’s nothing more discretionary than something that hasn’t started,” Simonson said. The situation is not much better at the lower levels. Many states have been battling budget deficits, while local governments, supported by property taxes, have seen their revenues decline along with home values. Even though property valuations have begun to rebound, the lag between the new assessments and the tax payments is two to three years. Another threat to commercial construction is the move by consumers toward more online shopping, which reduces demand for retail space. Granted, the loss of retail construction brings with it a corresponding uptick in warehouses and fulfillment centers for online providers. But the volume there is nowhere near that of traditional shopping centers and strip malls, Simonson says. Finally, the trend toward less square footage per employee is working against construction of office space. “There has been an increase in employment of about six million people over the last three years, but companies are increasingly crowding employees into less space. They’re doing away with filing cabinets and law libraries, and putting more employees into hoteling space or pool areas without partitions, let alone without private walls,” Simonson said. On the other hand, he continued, some factors are working in construction’s favor, chief among them the ongoing “shale gale.” While the extraction activity at the shale plays is considered mining, there is considerable associated construction spending, including access roads, site preparation, and storage facilities, plus further expenditures both upstream and downstream of the fracking projects. Planned expansion of the Panama Canal has prompted dock expansions, dredging projects, new bridges and rail lines on both coasts. “Many types of construction are responding to the Panama Canal expansion, even though we don’t have contractors working on the canal itself,” Simonson said. The other buoy to construction in the near-term is the housing market, which has rebounded quicker than the nonresidential sector. “All layers of the residential cake—single family, multifamily and remodeling—have been trending positively in the last year,” Simonson said. He believes multifamily will continue to grow for the foreseeable future, but he has reservations about the single-family side as more young choose city over suburban living. David Crowe, chief economist for the National Association of Home Builders in Chicago, disagreed strongly with that aspect of Simonson’s forecast. He downplays the desirability of urban living, which he believes will give way to the traditional backyard and picket fence as households age. In addition, Crowe said, most of the trends and developments are positive for home buying. Pent-up demand continues in the wake of the tremendous downcycle the industry experienced; household formations are on the rise; inventories of both new and existing homes have fallen to below historical averages; and durable goods purchases have gained steam, indicating greater confidence among buyers. Recent surveys have hit historic highs for the number of people who believe now is a good time to buy a home. There are some headwinds, Crowe conceded. Credit remains tough for both home builders and home buyers, many mortgages remain under water, appraisals are still disappointingly low, and the lack of job security is keeping potential buyers on the sidelines. Despite the lower demand picture, construction costs for both labor and materials have been rising. Altogether, NAHB forecasts gains of 10.1 percent in multifamily construction in 2014 to 326,000 starts, then another 9.5 percent gain to 357,000 starts in 2015. On the single-family side, the organization predicts improvements of 31.1 percent in 2014 to 826,000 starts, then up to 1.2 million starts in 2015, another 40.6 percent gain. Remodeling will grow at less than 2 percent in both years. The Steel Sheet Story Global use of steel grew 4.8 percent this year, compared to 2012, but North America had little to do with it. China was responsible for the bulk of the growth, with its 11.1 percent gain representing 89 percent of the world’s consumption. In contrast, North American consumption declined by 0.2 percent, a decline attributed to inventory destocking, said Josh Spoores, a former service center executive who now serves as a principal consultant for steel at CRU. The story was even worse in Europe, where steel consumption declined by 4.5 percent. Weak demand conditions contributed to a decline of 6.0 percent in global sheet prices, compared to 2012. The price was off 18 percent compared to 2011. Despite the rough road in 2013, it is the advanced rather than the developing nations that will lead the global recovery, forecast Spoores and the CRU team. That recovery will be spurred by three key economic factors: an ultra-loose monetary policy in OECD countries; improving U.S. balance sheets; and less fiscal drag in the developed nations. In contrast, while China will continue to see significant growth, CRU envisions no swift bounce-back in Brazil, Russia or India, for various reasons. “BRIC is really no longer. It’s China. There are other emergers with growth opportunities, but there are no new Chinas,” Spoores said. To illustrate China’s outsized place in the steel universe, CRU forecasts Chinese steel consumption will expand by 45 million tons from 2014-18. In comparison, the combined growth in North America, Europe and India will only increase by 35.5 million tons. In North America, CRU expects the sheet market to grow by 3.9 percent annually through 2018, topping out just below 80 million tons. U.S. consumption will grow from near 50 million tons this year to just below 60 million tons by the end of the forecast period. On the pricing side, raw materials will play a significant role. CRU expects prices for iron ore and scrap to fall steadily over the next five years, while coking coal will experience an uptick after its precipitous decline in 2013. The overall decline in these input costs will eventually be felt in the market for hot-rolled coil. CRU expects a price hike in 2014, both globally and in the United States. It will hold mostly steady in 2015, before the raw material price declines begin to take some bite out of the steel price. For steel plate prices, which have declined dramatically to near hot-rolled coil levels, “there’s only one direction to go,” Spoores said. Still, consumption of plate will continue to lag sheet products, with a projection of only 3.0 percent growth from 2014-18. Like sheet, the plate price is expected to increase in 2014, flatten in 2015, and then start to trend downward again, Spoores said. As always, one threat to the North American market for all steel products is import pressure. While import penetration has always been much lower for sheet than for other steel products, its impact is still felt. “That 3.4 percent penetration makes all the difference,” said fellow panelist Kalyan Ghosh, CEO of Essar Steel Algoma. “It’s not the volume, it’s the sentiment that a boatload has just arrived.” Futures in the Present The use of hedging through futures trading has a long way to go in the steel sector, though steel buyers who want to test the waters have ample opportunity, argued speakers on a futures panel. It may only be “the bottom of the second inning” in development of the futures market, but the financial products are readily available for those inclined. For the year to date, more than 1 million tons of steel have been traded on the global futures market, with even more hedging done in over-the-counter deals. That’s already ahead of last year’s total of 800,000 tons, but well short of the “four times the physical market” that is characteristic of a mature futures market,” said Young-Jin Chang, director of metals research and product development for CME. “We’re still looking at fractions of a percent of the market being engaged, and that doubled year over year. If it doubles again next year, and the following year, you’ll start to develop a healthy options market around the forward curve and we’ll all grow significantly,” said Jeremy Flack, president of Cleveland’s Flack Steel and one of the service center industry’s most outspoken advocates for the use of financial tools in buying and selling. Despite some initial reluctance throughout the industry, steel buyers are slowly coming around to the idea, Flack maintains. “You see service centers put people in charge of risk management at their companies, and end-users who use hedging in other commodities are starting to look at steel more seriously. It starts as discussions and a couple of years later turns into transactions.” Steel Warehouse, North America’s 14th largest service center, is an example of one company that has taken the leap. “If you have a customer who wants 500 tons a month, and you have a shipment that’s coming in six months down the road, it’s [futures trading is] out there. Just because the market’s in its infancy, it’s still a legitimate tool you can use right now,” said Joshua Lerman, risk manager for the South Bend, Ind.-based distributor. Not surprisingly, the typical steel buyer enters the futures market cautiously, using the forward curve to hedge a small percentage of its buy. “If they’ve got a 100,000-ton buy, they’re not going to hedge all of that,” said David Huff of Applied Value LLC, which advises end-users on financial options. “It’s similar to the situation where they started to explore offshore sources. They didn’t want to do it all at once; they wanted to explore it. And the only way is to learn by doing.” The more buyers become engaged in the process, the better the system will become. When activity slowed in the physical market in 2013, there was a corresponding decline in transactions in the futures market. This is typical behavior for all commodity exchanges, Chang said. “We’ll get to the certain point where the investor community and speculative community come in because there’s enough liquidity in the market. That’s actually a good thing, because it gives the hedgers more options. What we’re seeing in hot-rolled coil is nothing unusual.” While service centers and some end-users are coming around, the producer community is still slow to embrace the futures concept, fearing a loss of price control, Lerman said. But such fear is unnecessary. “All a futures contract is is an agreement by the buyer and seller on the price in the future. A steel mill already does this with its customers. All we’re talking about is translating some of that into a more formalized market and having price discovery,” Flack said. “I think it’s important for the mills to engage in this. It needs to be looked at as supporting the market, rather than taking something away from the market.” Lerman initially shared the apprehension. “It took me a little while, but it has given value to our company and our customers. Not only will we hedge, but it’s another tool and a service we can offer to our customers. It’s good to take some risk of your books, and that’s been a value to us since we’re naturally long on product.” Moreover, the service center operator who isn’t open to the process runs the risk of losing business. Huff said his end-use clients interested in hedging want to work with distributors who will engage in the process with them. “Every single client we have is looking for someone to work with, to help guide them along. This makes service centers more attractive. Maybe not this year, but in the future.”