Another Look at Steel Costs

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There is a majestic game of chess going on in Asia. On one side are the big three producers, BHP Billiton, Rio and Vale, on the other are the Japanese and Korean consumers at one level and the Chinese consumers at another. Throw in rising freight rates and spot iron prices, rising iron inventories and the possibilities of (limited) alternative supply sources and you have a game fit for Garry Kasparov or Vladimir Kramnik (sorry they are both Russians but they are rather good at this game).

Not that the incumbents are not up to the task, the producers are experienced players and there is nothing the world can teach the Chinese about negotiations, as any seasoned Asia trader will tell you. The big three have more or less settled with Posco, JFE, Nippon Steel, Kobe and others in Korea and Japan for prices on iron ore fines, lumps and pellets with the producers accepting price drops of around 28-33% for fines and 44% for lumps as we have previously reported. Vale has apparently come down a little more than the Australians due to rising freight rates having a greater impact on material shipped from Brazil.

Meanwhile the Chinese are holding firm for 40-50% cuts and say they would rather cut back on production than accept the same level as the Japanese and Korean mills. As the largest producing country in the world, China has some clout but they face an equally implacable duopoly in the big three (BHP/Rio can almost be considered as one in these negotiations). The Chinese have already started scaling back imports. May was down 6% from record April imports, in an attempt to bring the rising spot price down to the level at which they want to fix the contract price. The big three would not fix the contract price at below the spot price and by scaling back purchases, China takes some heat out of both the freight market and traders’ spot prices. Spot prices are currently about $75/metric ton according to Reuters and the price fixed with Japan/Korea is around $61/metric ton plus freight according to the Australian News. China will need to see the CFR spot price approaching the $60/ton level to get close to the reduction they are seeking which may be a tall order even though they can afford to cut back on imports having secured short term supply sources by pre-buying plenty of inventory this year.

The same producers have also completed metallurgical coal price negotiations with consumers. BHP, the largest, has dropped prices 60% with Nippon Steel and an average of 58% with other consumers according to a report in the FT. Prices are set at US$129/metric ton FOB Australian port, way off the near $300/ton peaks seen last year.

Based on our calculations which we have been tracking since last summer, with the new iron ore and thermal coal prices, reduced ferroalloy and lower power costs, we are coming up with a production cost of $323/per metric ton for integrated steel-making. Now of course this doesn’t say that’s break-even. Capacity utilization, debt servicing and so on will have a major impact. But it raises the question to what extent have these lower raw material costs already been factored into the steel mills projections of profitability (or losses) and if the new iron ore prices will have any impact on finished steel prices.

–Stuart Burns

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