You can read the first part of this series here.
The cost base for steel producers is also coming down, though not fast enough to keep many in the black. Spot iron ore prices have halved in recent months. But the long term contract price negotiations for 2009 are only just starting now against the backdrop of 80 million tons stacked up in Chinese ports, unused by the mills. Australian iron ore exporters are seeing contract sales cancelled as buyers renege on contracts due to much lower spot market prices. So the widespread expectation is next year’s contract price will be much lower than this year’s. Coking coal spot prices have also come down but again much is purchased on long term contracts that shielded the producers as the price rose but are now hindering their ability to respond to the drop in demand. Scrap based mini-mills will have more flexibility as the scrap price is responding directly to the fall off in demand in the US market. Global scrap prices have dropped from around $600/ton to $150/ton as contracts have cancelled and scrap has piled up at ports.
So how does this bode for prices? Flat rolled steel prices have already come off 20% since the summer. If mills are cutting production to 65% of capacity then demand for raw material will drop proportionally. Prices will therefore follow with a time lag. The strong dollar will see an increase in imports into the US market adding further downward pressure to prices. A combination of lower raw material costs, lower freight and the mills margins coming under pressure (something they are already seeking to avoid by cutting production and hence limiting supply) means it is not unreasonable to expect prices to be 30% lower in the North American market by April of 2009. Prices in Asia have already halved since the summer highs of $1200/ton to $650/ton now. Domestic Chinese HR coil prices are even lower at $475/ton according to MetalMiner IndX(SM) and by our own steel cost breakdown analysis, we believe the cost of production will be at around $423/ton for mills in the first quarter of 2009. In reality, the mills have shown they will aggressively cut production to protect prices. The market is less fragmented than it was in previous down turns so they may have more success in controlling prices by limiting supply. If we don’t hit a 30% drop by the Spring, we will certainly see 15-20%. That 30% may just be a matter of more time.
If you are interested in seeing how we calculated that $423/ton cost of production, drop us a line at lreisman [at] aptiumglobal [dot] com. We’d be happy to send it to you.
–Stuart Burns and Lisa Reisman