Commentary

This week, our metals markets fell lower as they were buffeted by seemingly ever-increasing exports of steel, aluminum and other products from China.

Why Manufacturers Need to Ditch Purchase Price Variance

Even though China’s economic growth has been falling, its government still gives producers strong incentives to produce steel and aluminum that eventually ends up exported elsewhere. My colleague Stuart Burns rightfully points out that if Chinese mills are “supported by plunging raw material costs and extensive local state support, gifting them a break-even price around the lowest in the world, then the intent to simply ‘dump’ metal into export markets has few barriers.”

Can Debt Fuel Long-Term Growth?

But what’s the eventual result of state support? In China or anywhere else? Can government debt actually lift these economies back into growth mode? Stuart was there again, with an assist from the Daily Telegraph, postulating that sluggish growth and low inflation is the new normal and “advanced economies — and perhaps emerging ones, too — seem to have run out of productivity-enhancing growth and, therefore, need constant infusions of financially destabilizing debt to keep them going.”

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This is a third post on a series of posts on exponential technologies (see part 1 and part 2).

Why Manufacturers Need to Ditch Purchase Price Variance

Cloud computing is not only an exponential technology but also one that will act as a platform for information sharing and collaboration, allowing other exponential technologies to grow thanks to its connectivity.

Does Anyone Know What The Cloud is?

Understanding what this technology is might seem complex, but cloud computing is simply the union of billions of computers into a network that can be accessed remotely.

Cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.

In other words, cloud computing is allowing machines to be infinitely faster; store and share data; work remotely; be scalable and react smarter.

Simultaneous Use of Unlimited Resources

Cloud computing can also provide the ability to run a program on many connected computers at the same time. Have you ever used gmail or some other webmail program? You’re, essentially, using cloud computing when accessing your mail from Google’s, Yahoo’s or Microsoft’s servers via their webmail programs.

Adobe moved its entire creative suite of software products to its Creative Cloud delivery system in 2013 and gave up selling boxed software thanks to the new platform.

Ongoing computing progress has allowed cloud delivery to go from expensive to common and scaled and priced toward more users and, in some cases, free.

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We have a problem, by we I don’t mean we in the metals markets specifically, nor we in the US or UK, nor even we in the western world.

Why Manufacturers Need to Ditch Purchase Price Variance

I mean we all have a problem: too much debt.

The International Debt Pile

“Whoa!” you say. Hold on, wasn’t the last financial crisis all about too much debt? Haven’t we learned our lessons – corporations are awash with cash, dividends and share buy-backs are at record highs, austerity measures are curbing government spending around the world, household debt — after years of recession — are under control again, what are you talking about?

Quantitative Easing (QE), started in the US by the Federal Reserve, was taken up by the Bank of England, followed by the Bank of Japan, the latest is the European Central Bank at €60 billion-a-month and even the Bank of China is talking about some form of unconventional monetary support, which we can read as QE to support flagging growth.

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While India leads the world in Direct-Reduced Iron production, the domestic industry has been facing an uphill production battle for the last four years.

Why Manufacturers Need to Ditch Purchase Price Variance

India’s DRI sector is hoping for help from the government and clarity in the overall steel policy to see it through, what many have dubbed, its most critical phase ever.

Demand DRIs Up

What is worrisome is that the falling demand for steel, especially construction steel globally, could further, negatively impact the sector. Some are quick to note that India’s DRI units need not worry much on this front as the market in India has remained insulated from global trends owing to steadily increasing domestic steel consumption.

Two other risks facing the sector are imported scrap being used by steel companies in India, DRI is an excellent substitute for scrap in electric arc furnaces, and the reliance by medium-sized DRI producers on inferior technology. That means technological limitations stop the producers from exploiting inferior grades of iron ore and coal.

Further, the limited availability of coking coal only motivates steel production in the country through a combination of DRI and blast furnace. What has added to the misery is the recent round of coal auctions held by the federal government.

Unable to Bid in Coal Auction

DRI companies were unable to participate in the auction, and a hitherto discounted source of fuel was lost, pushing the cost of DRI production by an estimated 40%, some have said. The DRI segment has brought this to the government’s attention.

While many steel companies prefer to use DRI instead of scrap, the slowdown in the global steel industry has seen some amount of the steel melting scrap being imported into India because of lower import duties. What makes steel plants happy in such cases, besides the cheap duty, is the fact that the imported scrap percentage works out to be higher, which eventually negates the cost of imported scrap.

To many analysts, the DRI sector in India is poised on the cusp of a turnaround, but only if there is adequate government backing as well as support from domestic steel companies. Even then, it could easily take four years for the industry to come back to an even keel and ramp up production.

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When domestic markets weaken, most producers turn to export markets to sell excess capacity, but you don’t just break into export markets overnight. It’s not that easy. Sort of like one does not simply walk into Mordor.

Why Manufacturers Need to Ditch Purchase Price Variance

The tried and trusted short-term approach is to sell cheap, making it hard for buyers to refuse the low-priced product being offered.

Sell Low, Buy Even Lower

If those mills are supported by plunging raw material costs and extensive local state support gifting them a break-even price around the lowest in the world, then the intent to simply “dump” metal into export markets has few barriers.

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Why Manufacturers Need to Ditch Purchase Price Variance

High costs and lower demand are just two of the problems plaguing India’s DRI sector. DRI is used by the steel industry in flat as well as long steel product segments, and is also used in infrastructure projects.

Low Steel Demand Hits DRI Producers, Too

According to figures put out by the World Steel Association, in the first quarter of 2015, India, with over 4,500 tons of DRI, headed the list of 14 nations that accounted for 87 % of the world’s total DRI production. The Sponge Iron Manufacturers Association has estimated India to have an installed capacity of 37 million metric tons, although it’s difficult to arrive at an accurate figure due to a general lack of proper research.

EAF and Induction Resources

India’s DRI industry has nurtured secondary steel producers who largely use electric arc or induction furnaces to make their steel, for which DRI comes as handy substitute for scrap.

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Deepwater Wind began construction off the coast of Rhode Island on a five-turbine wind farm that will, eventually, have the ability to power 17,000 homes.

Why Manufacturers Need to Ditch Purchase Price Variance

The 30-megawatt, $290 million wind power project began construction this week 18 miles off the coast of Rhode Island, but, itself, is a much smaller project than the stalled Cape Wind farm project originally planned for the area around Cape Cod in Massachusetts.

US Wind Power Lags

Offshore wind projects are common in Europe and a real driver of renewable energy success there. The fact that the US is only starting to get into the offshore game is a testament to how the regulatory framework and maturity of the renewable energy industry are both lagging here in the states.

The death knell for the proposed 130-turbine Cape Wind project may have come early this year when the two largest electric utilities in Massachusetts backed out of a plan to buy most of the power that was slated to be generated by the proposed turbine project, the latest casualty of what can only be described as an environmentalist civil war over whether to place turbines off Nantucket Sound.

Green vs. Green

The Humane Society, the International Fund for Animal Welfare, the International Wildlife Coalition and and others are against the project. On the other side are groups that might normally be considered allies, including the Natural Resources Defense Council, the Union of Concerned Scientists and Greenpeace.

Opponents, such as environmental lawyer Robert F. Kennedy, Jr., say the natural environment of the Sound should be preserved and that the industrial nature of the turbines would spoil views from the shore. They also say that native birds would be decimated by the 40-foot-tall turbines.

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Zinc producers, along with investors, have been hoping for a supply crunch to materialize after repeated warning of mine closures and predictions of ore shortages, but supply has remained stubbornly robust.

Pool 4 Tool’s Automotive SRM Summit

As recently as October, the International Lead and Zinc Study Group (ILZSG) was predicting a zinc deficit for this year of 366,000 tons, a figure more than halved to 151,000 tons this month, and itself still higher than a recent Reuters poll predicting a 143,000-ton deficit for the year. Overall, about a million tons of supply will eventually be taken out, Robin Bhar of Societe Generale predicts, but one unknown is how much mothballed production could come back onstream.

New Mining Coming Online

At $2,200 per metric ton most miners are operating profitably, a 10% rise (we have seen this much already over the last two months) would probably seal the case for restarts, in addition to several smaller projects already in the pipeline.

Some point to falling London Metal Exchange inventory as a sign of deficit but to what extent this is metal coming off-warrant to be moved into lower rent non-LME storage is not clear. Zinc has suffered from the same distortion as aluminum in recent years, with the stock and finance trade soaking up a percentage of production and inflating the impression of apparent demand.

The current LME forward curve does not support that trade at present, but that doesn’t negate the fact a significant percentage is still locked up in those deals.

For now there is ample ore supply, Reuters reports, as evidenced by treatment charges that have risen to $245 an mt, a 10% gain, from last year. To clear up a misconception, treatment charges rise with supplies as mining groups compete to find smelters to process their material.

Everyone Gets a Surplus

This year, the Chinese domestic zinc market is expected to be in surplus as domestic output and imports rise, while demand for the metal weakens. A slowing manufacturing sector and tightening environmental standards could also trim zinc demand sapping expectations of a rise in demand.

Against such a backdrop the rally in prices seen in recent weeks could be said to be overly bullish, fueled as it is by falling inventory and expectations of a looming supply crunch, the current market realities don’t support a near-term supply shortfall, but markets are said to trade on expectation so maybe investors’ optimism about higher prices is right, just ill-timed.

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In part one of this series of posts we talked about what exponential technologies are and why we should keep and eye on them and be flexible, as they will completely change industries before most even notice.

Pool 4 Tool’s Automotive SRM Summit

Before jumping into each exponential technology, in this post we’ll analyze three forces that are helping to speed up their growth:

The Do-It-Yourself Revolution

There have always been entrepreneurs out there. However, new breakthrough technologies are pushing a new breed of innovators, now more than ever, to solve problems that only big companies and governments were able to solve before. These innovators have free and instant access to information and the the capability to mass-share their progress. This allows an individual or a small group of people to create a new market and to disrupt an existing one within a matter years, sometimes even months.

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Yesterday’s post explained how the Short Range Outlook (SRO) report released by the World Steel Association for 2015-2016 predicted steel demand would grow by just about 0.5% to 1.544 million metric tons in 2015.

Pool 4 Tool’s Automotive SRM Summit

The world’s steel sector looks on with hope to India to see it through this downturn. The country’s per capita consumption was still low, at about 60 kg as against the world average of 220 kg. With the government’s Make In India (manufacturing) plan slowly grinding into motion, it is hoped that this will lead to an increase in steel consumption.

The End of Annual Growth for Chinese Steel

So, the China steel story is over, at least for the short-term. The economic deceleration there, following low investment growth since 2008, is expected to adversely impact any steel growth there, and it has so far this year.

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