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Rising Steel Prices Show Few Signs of Abating

June 11, 2008 – Comments (8) | RELATED TICKERS: MTL , SID , X

Great primer on the steel industry from the blog on Louis Navellier's website:

http://blogs.navellier.com/all_cap/entry/rising_steel_prices_show_few_signs_of_abating/

Rising Steel Prices Show Few Signs of Abating

This post contains steel stocks that are Navellier top-10 holdings (see bottom of post).

Recent news has been filled with talk of rising oil and food prices, and understandably so, their increases over the past year have sparked riots in some countries. But also worth mentioning is the rising cost of steel. Steel prices have almost tripled in the past year, according to industry newsletter World Steel Dynamics—and in our opinion, will likely continue to climb. In the following column, we will examine some of the reasons for the rise in steel prices and discuss the industry outlook.

Steel basics

Steel is an alloy—a solid solution of two or more elements, at least one of which is a metal. It consists mostly of iron, with a carbon content that ranges from 0.2% to 2.04% by weight, depending on grade.

Steel is not a single product, however. There are more than 3,500 different grades available, according to the International Iron and Steel Institute (IISI). The carbon level changes the type of steel, as do various other alloying elements—such as manganese, chromium, vanadium, and tungsten—that may be added during the production process. In general, the lower the carbon content, the softer but more easily formed the steel.

Carbon steel—the most commonly used type of steel, which accounts for the majority of world steel production—is a combination of iron and carbon, with the only other alloying elements allowed in quanitites that are too small to affect the steel’s overall properties.

Steel prices are often referred to in metric tons (also commonly spelled “tonne”). One metric ton equals 1,000 kilograms or 2,204.6 pounds.

Steel production

Numerous raw materials are needed to produce steel. Under one production method—called the integrated method—iron ore is generally combined with coke (a product made by baking coal without oxygen at high temperatures), fuel (often natural gas), and oxygen in a blast furnace. Under another method—the electric arc furnace (EAF) method—scrap metal is used to create steel. Of all the steel produced in 2005, 65.4% was produced via the integrated method, 31.7% was produced via EAF, and 2.9% was produced via other methods, according to World Steel in Figures 2006. As a result, the steel industry relies heavily on raw materials such as iron ore.

At a steel mill, the production process turns raw materials into a product called pig iron, which is refined into a semi-finished product called crude steel. A variety of finished products are then forged from crude steel, including bars, hot-rolled sheets, and wire.

How important is steel?

In 2007, world crude steel output reached 1,343.5 million metric tons, according to the IISI—an increase of 7.5% over 2006. That was the fifth consecutive year that world crude steel output grew by more than 7%. Moreover, it is the highest level of crude steel output in history.

China is the driving force behind world steel production. According to the IISI, in 2007 China produced the most steel of any country: 489 million metric tons, a 15.7% increase over 2006. Without China, world crude steel production would have only grown at 3.3%. Other major producers are Japan, followed by the United States and Russia, as the chart below shows.

Top 10 Steel-Producing CountriesCountry20072006GrowthChina489.0422.715.7%Japan120.2116.23.4%United States97.298.6–1.4%Russia72.270.82.0%India53.149.57.3%South Korea51.448.56.0%Germany48.547.22.8%Ukraine42.840.94.7%Brazil33.830.99.3%Italy32.031.61.2%

Source: IISI. Data shown is in million metric tons.

The world’s largest individual producers are Luxembourg’s ArcelorMittal, which produced 117.2 million metric tons of crude steel in 2006; Japan’s Nippon Steel, which produced 34.7 million metric tons; and Japan’s JFE Holdings, which produced 32.0 million metric tons (according to World Steel in Figures 2007).

Soaring prices show few signs of abating

In 2007, U.S. hot-rolled steel cost around $400 per metric ton. According to industry newsletter World Steel Dynamics, the cost had risen to $1,154 per metric ton by mid-May.

This spring, many steel companies raised prices, and U.S. Steel Chairman and CEO John Surma told Wall Street analysts that flat-rolled steel prices in the second quarter could be as much as $300 per metric ton higher—almost 50 percent above the average $646 first-quarter price.

Many companies are also implementing surcharges to cover raw material costs. AK Steel, for example, recently advised customers of a $640-per-metric-ton surcharge to be added to invoices for certain products shipped in June.

World Carbon Steel Prices, Per Metric Ton Hot- Rolled Steel CoilHot- Rolled Steel PlateCold- Rolled Steel CoilSteel Wire RodMedium Steel Sections02/07$562$748$654$507$75103/07$577$758$670$533$76804/07$617$788$698$577$79805/07$623$800$696$606$81506/07$611$800$686$602$81207/07$599$808$681$590$81908/07$603$814$686$594$82509/07$602$810$673$580$82110/07$611$826$680$584$84411/07$615$833$688$584$85312/07$630$837$705$598$85901/08$639$847$716$621$87102/08$699$887$772$687$905

Source: Steelonthenet.com, from MEPS Steel Prices Online, as of May 2008. To obtain current steel prices including forecasts, please visit www.meps.co.uk/world-price.htm

Sky-high raw material prices

According to AK Steel, its price increases are partially due to “the need to recover unprecedented increases in steelmaking inputs,” a claim that has been echoed by most other steel companies worldwide.

Perhaps the most significant raw material used in the making of steel is iron ore. Every year, around February, the three major iron ore companies—Brazil’s Companhia Vale do Rio Doce and Rio Tinto, and Australia’s BHP Billiton—sit down with two European and Japanese steel mills to negotiate an iron ore price for the year. That price is generally accepted across the global steel industry.

For almost two decades, the price of iron ore barely moved. But that all began to change in 2001, when the Brazilian iron ore companies negotiated a 71.5 percent price increase from Japanese and European steel mills, and BHP Billiton gunned for even more on the grounds that due to soaring shipping costs, it was significantly cheaper for Asian companies to buy iron ore from Australia. Those price increases have only continued. In 2008, for example, the Brazlian producers agreed on a 65% price increase.

Even steel producers who use scrap metal instead of iron ore are paying record prices. According to trade reports, auto factory scrap now sells for $690 to $710 per ton, around 70 percent higher than in March.

Another factor in rising steel prices is increased shipping costs. The Baltic Dry Index, a benchmark of freight costs for bulk commodities such as iron ore, coal, and grains, has risen by more than 60 percent since the start of the year on surprisingly strong demand for steel. Peter Norfolk, the director of SSY Consultancy & Research, told The Financial Times average day rates for the largest class of vessels rose from less than $80,000 a day in late January to more than $160,000 in late April.

Cost Increases, Major Steel Inputs, Past 3 Years April 2005April 2008Percent IncreaseThermal coal$54.9 per ton$123 per ton124%Iron ore$0.65 per unit$1.41 per unit117%Natural gas$182.2 per
1000m3$428.4 per
1000m3135%

Source: Steelonthenet.com, from the International Monetary Fund (IMF).

Increasing global demand

While it is clear that raw material costs are increasing, many industry analysts are asking to what extent the rise in steel prices reflects this. They suspect that steel manufacturers may be taking advantage of global demand to increase their profit margins.

World steel demand has indeed continued to grow, most notably from newly industrialized countries building up their economies, such as China.

“Vertically integrated mills like U.S. Steel are benefiting from controlling some of their own raw material costs…making record margins…” writes Stuart Burns in MetalMiner, an industry newsletter. “Their rival Nucor, which is a scrap-based producer, should be suffering terribly from the high price and scarcity of scrap [but] Nucor profits…have been rising steadily as the company passes on raw material prices rises and then ‘adds a little for the house.’”

China Leads Demand For Steel In 2007Country% Of World Steel Output ConsumedChina30.9%European Union17.1%NAFTA countries14.5%Other Asian countries14.0%Japan6.7%CIS4.7%Central and South America3.4%Middle East3.2%Other European countries3.0%Africa1.8%Australia and New Zealand0.7%

Source: World Steel in Figures 2007.

How long can steel companies increase prices?

Clearly, steel companies have to increase prices to the extent that their raw material costs are rising; they are, after all, in the business of making money. But as noted above, some industry experts argue that they are raising prices more than warranted since they know demand will allow it. The question then is this: will steel prices will reach a point at which demand decreases?

According to the law of supply and demand, it should. When supply and demand are equal, an economy is said to be at equilibrium, because sellers are selling all the goods they have produced, and buyers are getting all the goods they have demanded. But when the equilibrium tips, and there is too much demand, prices tend to rise, because producers can get more for their goods. Ultimately, however, when the price of a good exceeds equilibrium, a surplus of the good will result (because buyers can no longer afford it), and producers will be motivated to lower their prices.

This process may already be in motion. In Turkey, a number of construction companies have gone on strike to protest steel price increases. In India, transportation and housing projects have been put on hold. Other countries are limiting the amount of steel that can be exported while reducing tariffs to increase imports. In January, for example, China implemented an export tax on raw steel. As a result, according to the Steel Business Briefing, based on U.S. import license applications, it appears that for April China will likely fall to fifth place among the largest steel exporters (behind the United States, Canada, Mexico, and Japan).

At some point, customers could even start looking for cheaper substitutes, such as aluminum and strong plastics. In response, some steel companies are attempting to reduce their raw material costs. It has been reported, for example, that Nucor has applied for permits to build a Louisiana facility that will produce 3 million tons of iron per year.