On the Upswing

NEW ATTITUDE. Internal and external reasons account for the improving landscape within the domestic steel industry. Probably the most significant boon has been the overall improvement in the world economy. Additionally, the flurry of consolidation has put the world steel industry into fewer and more fiscally solvent hands.

The question now is whether the industry will maintain its new business philosophy when the industry does turn downward.

According to several consultants to the steel industry, the answer is, "Yes."

Michael Locker, president of Locker Associates, a New York City-based steel consulting firm, says that one big change is that integrated steel mills have decided to hold the line on production. According to a report by Locker Associates, U.S. producers have been able to respond to softening demand for finished steel by reducing production volumes instead of by reducing prices.

Locker Associates reports that the consolidated integrated mills are now able to adjust their blast furnaces to meet declining demand in the United States.

According to the American Iron & Steel Institute, basic oxygen furnace (BOF) steel production in the United States fell by nearly 11 percent last year. Each of the top BOF steel producers took significant action to curb production, with US Steel idling its largest blast furnace for a good part of the year to complete a rebuild. At the same time, Mittal Steel, one of the three top steel producers in the United States, idled its Weirton Steel hot end last May, ultimately deciding to permanently close the mill. Neither of the mills built up inventory to make up for their hot-end outages.

According to the Locker Associates report, while integrated and electric arc furnaces reduced their outputs when demand softened, integrated mills reacted more aggressively to weaker flat-roll demand, which marked a major shift in their overall strategy. In the past, integrated mills were primarily driven by volume.

The result of this output reduction was a higher pricing floor than in prior cycles. Hot roll prices, which topped out in late 2004 at more than $700 per ton, declined to only as low as $435 per ton in August of 2005, before bouncing back to $550 per ton by the end of the year.

The ability to control their production has allowed U.S. steel mills to remain much healthier than in the prior downward cycle. By controlling their production levels, integrated steel mills were able to keep prices from dropping to levels that were seen in previous down cycles, which wiped out a number of steel mills.

Consolidation among the U.S. steel industry was a factor enabling steel companies to hold down their production. Mittal Steel, based in the Netherlands, and US Steel were able to take capacity off line to keep from cutting into finished product prices too deeply. Also, by eliminating excess capacity, the steel industry was able to more quickly rebound with stronger prices.

EAFs also were able to better control their production levels to compensate for a decline in demand last year. However, unlike in years past, according to the report from Locker Associates, the EAF segment was more successful because of its strength in the long-products market, which was more robust last year.

A factor that has previously put integrated steel companies at a distinct disadvantage to electric arc furnaces was the cost of raw materials. While companies such as Nucor were able to produce steel at far lower per-ton costs because of relatively low ferrous scrap prices earlier this decade, the climb in ferrous scrap prices has tipped the balance back toward the integrated steel companies, according to Charles Bradford, principal with Bradford Research of New York City, a consulting group to the steel industry.

Concerning the changing outlook for steel, Bradford says, "If you are a steel company right now and you aren’t making money, you shouldn’t be in business."

Integrated steel companies, which, by percentage, use far less ferrous scrap as a raw material, have been able to more successfully weather the higher ferrous scrap prices recorded in the last couple of years.

RAW MATERIAL COSTS. Companies that purchase ferrous scrap are now seeing their per-ton costs climb far higher than those who have a more captive raw material market. US Steel, which controls much of its raw material, on the other hand, has been able to keep its production costs much lower.

Additionally, mergers and bankruptcy plans are reducing legacy costs for integrated mills, lessening the disadvantage that these companies have been operating under relative to EAF mills and giving them more flexibility.

However, while basic oxygen furnace steel mills rely more on iron pellets and pig iron than on ferrous scrap for their raw materials, iron pellets have also increased sharply in price.

According to Tony Taccone, a steel industry consultant with First River Consulting, Pittsburgh, three iron ore producers—Companhia Vale do Rio Doce, BHP Billiton and Rio Tinto—control around 70 percent of the world iron ore market. Even with the goal of strengthening the steel industry’s pricing power through mergers, the stranglehold that iron ore producers have on the market makes integrated steel producers’ ability to drive down raw material prices only partly successful.

These iron ore producers have been pushing through several aggressive price hikes. However, for the most part, U.S. steel makers have been able to avoid these price increases because they own much of their own raw material infeed.

In North America, many integrated steel companies are finding it helpful that they already have sizable stakes in their own raw material network. Tacone notes that Dofasco recently purchased an iron mine while US Steel also owns its own iron ore mining facilities. He says that steel companies are attacking yields and trying to keep raw material costs under control.

Meanwhile, EAFs, which are confronted with volatile ferrous scrap prices, are look ing to reduce their dependency on open-market ferrous scrap by extending their raw materials supply lines.

Commercial Metals has extended its scrap buying network as a way to offset the uncertainty within the market. Schnitzer Steel also has developed a fairly substantial network of scrap suppliers to smooth out the volatility.

For other companies without the network of scrap suppliers, many are looking to become more active in using pig iron, direct reduced iron and hot briquetted iron. This may include building or purchasing plants that manufacture these products.

However, while owning or operating a DRI plant may be an alternative, Bradford says these operations require a significant amount of natural gas, which is also a volatile commodity.

THE NAME OF THE GAME. Most industry observers feel that consolidation will continue to take place among the steel industry and that a number of domestic steel companies will be added to the mix.