The minimill cost advantage

Operating costs for flat-rolled minimill producers dropped in 2019 as weaker steel markets have pulled down metallics prices. This has meant that operating costs for minimills were in line with integrated producers in the United States throughout much of 2019. However, that cost level is not expected to be maintained.

US minimills are typically higher cost

On an operating cost basis, U.S. integrated mills typically are lower cost than their minimill peers. Scrap prices are tied to the marginal cost of hot metal production—meaning that the input for scrap-based steelmaking is typically higher than the average ironmaking bulks mix (iron ore, coal and coke). Supply-and-demand dynamics in the steel and scrap markets influence scrap prices, and high steelmaking margins will increase the spread between scrap prices and ironmaking costs and vice versa. In the U.S., domestic scrap prices are influenced by export scrap prices, with U.S. export scrap prices being linked to European and Turkish scrap prices. Scrap prices in Europe and Turkey are in turn driven by the marginal cost of hot metal production in these regions, which is typically higher than in the U.S.

Minimill costs are More volatile

Lower cost U.S. integrated producers, such as Pittsburgh-based U.S. Steel Corp. and Chicago-based ArcelorMittal USA have access to captive iron ore pellets that are charged to the mills on a cost-plus-logistics basis. These same integrated producers also have varying access to captive coal and coke that are charged to the mills on a cost-plus-logistics basis.

Higher cost integrated producers typically buy all or most of their iron ore and coal from merchant producers, such as Cleveland-Cliffs Inc. and SunCoke Energy. In this case, the raw material purchases are typically conducted on a multiyear contract basis, with quarterly price adjustments that take into account changes to seaborne raw material prices, shape premia, steel prices and Consumer Price Index movements.

These pricing arrangements for integrated producers have an important impact on costs. Integrated producers’ costs tend to move slowly, changing with contract adjustments and/or mining cost changes. As such, the costs for integrated steelmakers are less volatile than those for minimills.

CRU forecasts that steel prices and margins will increase from the fourth quarter of 2019, signaling that scrap, and metallics prices more generally, will rise in price.

Metallics prices moved downward for the balance of 2019, and costs for minimill producers have declined quickly as a result. The costs for mini- mill producers are much more responsive to changes in market prices because of the shorter time frames on which minimills purchase their raw material inputs—typically on a monthly basis.

What happened in 2019?

For much of 2019, steel markets have weakened, and scrap prices have dropped closer to marginal hot metal production costs. In the U.S. this has meant that flat-rolled production costs for minimill producers have dropped, with minimills on average producing steel at a lower cost than the higher cost integrated operations that do not have access to captive iron ore pellets. In addition, raw material prices for iron ore and coal were high for most of 2019 because of supply side issues, though these issues began to unwind in September. The result of these swings in raw material prices has led to partitioning on CRU’s hot-rolled coil cost curve.

Will minimills stay lower cost?

CRU does not expect that the current cost level for minimills will be maintained. Low scrap prices reduce U.S. domestic scrap supply, and the growing minimill sector has an increasing appetite for scrap. In addition, CRU forecasts that steel prices and margins will increase from the fourth quarter of 2019, and these factors signal that scrap, and metallics prices more generally, will rise in price. In turn, this will increase minimill costs back above average integrated mill costs in 2020 and they will stay higher than integrated mill costs out to 2023.

This relative improvement in cost position will come as welcome relief for the integrated sector in the U.S., which struggles to realize the earnings before interest, taxes, depreciation and amortization (EBITDA) margins and profitability of the minimill sector. From 2020 onward, the integrated sector will again see cost inflation.

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What does CRU’s Steel Cost Model tell us about the drivers of the cost changes for the integrated sector?

CRU’s Steel Cost Model is designed to provide granularity and transparency that allows the user to understand exactly what is driving changes in costs and competitiveness in the U.S. and the rest of the world. (CRU’s Steel Cost Service provides a comprehensive examination of steelmaking costs for semifinished, flat and long products across the global industry for the years 2006 to 2025. Access to the Cost Analysis Tool allows users to generate individual asset reports with all key operation data via the web-based software. Further information and a demo are available by contacting CRU.)

Overall, costs will rise for the integrated sector from 2020 onward for a variety of reasons:

• Iron ore supplied on a contract basis will feel upward price pressure because of rising hot-rolled coil prices and U.S. inflation.
• Iron ore supplied on a cost-plus-logistics basis will see delivered prices rise because of mining cost inflation.
• Rising metallics prices also will affect U.S. integrated steel producers but will do so to a lesser extent than it will affect minimills.
• Higher wage rates, negotiated by workers’ unions in 2018 when steel prices were high, will increase labor costs.

A forecasted decline in coal prices globally somewhat offsets these cost rises; however, overall, costs are expected to rise.

Given our expectations for the raw materials and metallics markets, CRU does not believe the current low cost base of minimill producers will be maintained: Minimill costs will rise as the steel market improves and additional minimill capacity begins to come online. The integrated sector will see some relief as their costs drop below those of the minimills in 2020 but, from 2020 onward, costs for the integrated sector also will begin rising.

Ryan Smith is a senior analyst based in Sydney with London-based CRU Group. He is responsible for CRU’s Steel Cost Service, which provides comprehensive coverage of the global steel industry and details CRU’s independent view of the cost structures for semifinished, flat and long products. More information is available at www.crugroup.com.