If China’s government is trying to harness its robust economy, it
may be having only modest success. Although the government
there has taken steps to slow down economic growth, the hunger of more than 1 billion people for a life with consumer goods and lifestyles once considered out of reach may be too strong to harness.
As of late October, scrap processors in North America were still enjoying high ferrous scrap prices (even if a little below peaks hit a couple of months earlier), and steel companies were still compiling financial statements with black ink on the bottom line.
NEW DRIVER. If Japanese investors are eyeing the trend correctly, they still see room for a great deal more growth in China.
On a Friday in late October, after a week where some North American steel stocks lost value because of fears that China’s economy was slowing noticeably, strong results announced by Nippon Steel Corp. helped the Nikkei index in Japan gain back ground.
According to a Reuters report, investors in Japan were also encouraged that day by "data showing only a minor slowdown in China’s robust economic growth." Much as with scrap markets in the United States, China is one of Japan’s biggest export markets for many goods.
A Japanese investment fund manager declared of the day’s results, "China’s economic data is the one and only factor for the market today." He said that the stock values of steelmakers, shipping firms and other China-related companies were helped because there appeared to be "no imminent risk of a hard landing (for the Chinese economy)."
While data for the third quarter of 2004 released by the Chinese government showed a slowdown in GDP growth, it was considered gentle enough to not jar the flow of goods to and from China.
Randy Cousins, a steel industry analyst with BMO Nesbitt Burns in Toronto, says the rate of steel capacity growth "has eased" for several reasons, including pollution control, the tightness of raw materials supplies (such as iron ore and high-priced scrap) and energy shortages. "They are facing infrastructure issues . . . that are a serious impediment," he told attendees of the Institute of Scrap Recycling Industries Inc. (ISRI) Commodity Roundtables in Chicago this September.
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AVOIDING A TAX BITE |
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During the 1998 to 2002 stretch, scrap dealers may have forgotten how to think in terms of protecting profits from tax collecting agencies. But 2004 will almost certainly be a year when such thinking will be necessary. And the good news: A clarification of IRS rules offers a new tax savings technique to scrap dealers. Stanton Williams, president of LIFO Systems LP, Fort Worth, Texas, says companies that have a minimum scrap metal inventory worth $500,000 or more at year’s end may use the substantial 2004 price inflation in metals values to "significantly reduce" their federal income taxes. The LIFO (last-in-first-out) inventory method is a once-a-year computation allowing companies to defer income based upon inventory inflation, Williams says, though companies actually don’t have to manage inventories this way. Williams says in January of 2002 the IRS issued updated regulations for the IPIC (Inventory Price Index Computation) LIFO method that uses government published (Bureau of Labor Statistics) Producer Price Indexes to measure commodity inflation. "As an example, if a company has a scrap metal inventory of $3.5 million at 2004 year end, the first-year LIFO reserve would potentially be $1.75 million (based on the August 2004 PPI index for iron and steel scrap)," says Williams "At a 40 percent tax rate, this would reduce [a company’s] 2004 federal tax obligation by approximately $700,000." He notes that this is an example, "and there are many variables that would impact the actual benefit." More information about LIFO Systems is available at www.lifosystems.com. |
Cousins predicted that steel prices would trend down in 2005, with hot-rolled steel more likely to be in the $450 to $500 per ton neighborhood by the end of next year. He also predicted scrap prices would pull back to around $150 per ton by the end of next year, as supply issues driving the market (a scarcity of iron ore, coke, energy and scrap) could ease as the world adjusts to China’s new demands.
China’s quick move to the top of the global steelmaking charts has caused a spike in steelmaking supply costs, including a surge in ferrous scrap pricing throughout 2003 and into 2004.
At the same time, the Chinese economy’s consumption of finished steel (along with the accompanying global rise in scrap and iron ore prices) has lifted steel prices after years of a cyclical trough.
Cousins said that—even with higher scrap prices—North American steelmakers are enjoying a $450 spread so far this year between what they are paying for a ton of scrap vs. what they can fetch for a ton of hot-rolled steel. This is much more enjoyable than the $170 spread in 1998.
A spread of a different sort pits the $645 per ton being charged for a ton of hot-rolled steel in North America vs. the $343 average cost for a ton of steel produced in China. Cousins questions whether that is a sustainable gap in global markets, though he conceded, "Steel doesn’t travel well, so there are still regional differences in price."
STILL HUNGRY AT HOME. The message that I. Michael Coslov, chairman and CEO of Tube City LLC, West Conshohocken, Pa., brought to ISRI Roundtables attendees was slightly different. Coslov says that ferrous scrap dealers will have plenty of business this year and next, whatever happens in China.
"True, China has had a big impact on raw materials," said Coslov. But he said scrap prices in the United States zoomed up because electric arc furnace production in North America "came back on so fast, people overestimated the reservoir of scrap."
A lesson for steelmakers, says Coslov, is not to abandon the production of alternative iron (or scrap substitute) products when markets recede. "You don’t stop production at an HBI or DRI plant because of a price [slump]," he said.
Coslov also said that the consolidation of the steel industry has been a good trend for scrap suppliers, even though some were worried it would hurt their negotiating power. "Steel consolidation has been helpful to the scrap industry because now you can sell with more confidence that you are going to be paid," he said. "Before, it was a minefield."
For scrap dealers to have hungry steelmakers to serve, those steelmakers will need to have healthy customers to serve in North America.
However, two other speakers at the ISRI Roundtables expressed doubts about the future of America’s manufacturing base.
Lester Trilla of Trilla Steel Drum Corp., St. Louis, portrayed the declining state of the steel drum industry in North America, which has lost ground to plastic drums, while also losing customers in the petro-chemical industry to offshore operations.
The total production of steel drums in the United States has fallen from 40 million at its peak to about 30 million in 2003. "We’re 30 percent smaller than we were 10 years ago," he said of his industry.
The number of steel drum fabrication companies has also drastically declined. According to Trilla, there are currently 14, and mergers or closures could soon bring that down to 11. "When I got into the business there were 11 in Chicago alone."
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SHADOW OF DOUBT |
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Wall Street traders, reportedly worried about a potential slowdown in the Chinese construction boom and its steel demand, began selling off stocks in steelmaking companies in mid-October. According to CBS MarketWatch, a range of U.S.-based steelmakers saw their share values slide down Wednesday, Oct. 13, with the trend continuing into Thursday morning. Wednesday, steel stocks began dropping rapidly after Bradford Research, New York, downgraded Nucor Inc., Charlotte, N.C., and Steel Dynamics Inc., Fort Wayne, Ind. The accompanying report predicted weaker prices and softer orders for the steel industry. Nucor shares lost $4.49, or nearly 5 percent of their value, Wednesday, while shares in Steel Dynamics fell nearly $3.00 in value, losing 7.5 percent of their worth in one day. Analyst Charles Bradford told CBS MarketWatch high ferrous scrap prices would also affect the profitability of the two companies. "We are reducing our rating on Nucor shares due to increased spot steel price weakness and a sharp rebound in the price of steel scrap, the company’s largest [single] cost," he said. He added that Nucor and Steel Dynamics were still competitive companies overall, but that weaker orders would affect their profitability in the near term. A Goldman Sachs analyst quoted by CBS Marketwatch expressed caution regarding whether the Wednesday share price drops were warranted, because steel pricing and demand was still strong in many parts of the world. |
High steel costs may continue to influence the move toward plastic drums, and a shift of North American manufacturing to China could move drum production to that nation. "We’re thinking of building a plant offshore," Trilla said.
Some U.S. manufacturers have pointed to China’s non-floating currency as an unfair advantage for Chinese facilities competing against U.S.-based plants.
John Nolan, a vice president with Steel Dynamics Inc. (SDI), Fort Wayne, Ind., told attendees of the ISRI Ferrous Roundtable that U.S. manufacturers cannot compete on a fair basis as long as China’s renmibi (also known as the yuan) is allowed to stay pegged at one-eighth of the value of the U.S. dollar.
Nolan represents SDI and the Steel Manufacturers Association (SMA) on the China Currency Coalition (www.china-currencycoalition.org), a group of about three dozen trade associations and labor unions petitioning Congress and the Bush Administration to take action on the pegged Chinese currency value.
Nolan blasted the Clinton Administration for sleeping at the switch in 1994 when China devalued its currency and then introduced the peg.
The Bush Administration has also been largely silent on the issue and rejected the coalition’s filing of a complaint under Section 301 of U.S. trade laws seeking action.
Nolan said the United States faced similar circumstances in the early 1980s. He said the 1985 Plaza Accord, which brought the dollar down in value vs. Western European currencies, was "followed by the longest economic expansion in peace-time," restoring manufacturing jobs in the durable goods sector.
The author is editor of Recycling Today and can be contacted at btaylor@gie.net.
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