Cost Pressures on US Steelmakers Should Ease Next Year

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The absence of a global futures market for iron ore leads one to think price moves in Asia or Europe have little or no impact on domestic raw material costs to producers in the US. It’s also true to say consumers of copper or aluminum watch the LME or track the SHFE with more regularity than a consumer of iron ore tracks Asian OTC markets. The price of non-ferrous metals is often directly linked to movements on commodity exchanges around the world in a way that iron ore is not.

However, as recent gloomy forecasts from US steel producers covered by Reuters shows, rising iron ore costs in the US domestic market are having an impact on integrated steel producers’ costs and will be indirectly influencing scrap prices; hence, they will hit EAF steel producers as well.

In part, the deteriorating returns for US steelmakers are a result of a weak market, still bereft of construction-sector demand. The integrated steel mills in particular are struggling to balance under-utilized capacity, imports dragging down prices and higher raw material costs. In isolation, there is no reason beyond inflation why iron ore mined in the US should be more expensive now than it was 3-4 years ago, but it is. The reason: as slow to adjust as the iron ore market is compared to some other commodities, adjust it does. So what is happening in Asia and elsewhere is very much in the interests of steel consumers trying to judge the fortunes and direction of their steel-producing suppliers next year.

The good news is iron ore prices are falling in Asia. Although Rio blames lower prices on Vale diverting cargoes to China originally destined for Europe as depressing prices, a Financial Times article delves into the issue further.

Source: HSBC

A press release this week from The Steel Index advised TSI’s 62% Fe Iron Ore index fell by US$10.20/dry metric ton on Oct. 25, its largest one-day fall since the index was launched in October 2008, totaling a 23.7-percent slump over the last four weeks. Spot prices are now below quarterly contracts and true to form, some Chinese steelmakers are looking to renege on quarterly contracts if iron ore suppliers don’t renegotiate the price.

The reasons most observers give for the fall in prices is worries over the global economy, weak economic sentiment and Chinese credit tightening measures; but of these, we feel credit tightening is having the biggest impact. A steel executive at a southern China mill is quoted in the FT as saying, “Around 20 to 30% of the small and medium mills in this area have shut down their furnaces, we also feel the pressure of reduced liquidity. When we make sales, the cash comes back slower and slower. Liquidity is a big concern. Steel mills are also running down inventory rather than buying new supplies, exacerbating the drop in demand.

Source: MetalMiner IndX

Demand has certainly been impacted in China. The liquidity squeeze is having the desired effect on construction with a knock-on impact on prices of construction materials. Witness the fall in domestic rebar prices in China, as the above graph taken from MetalMiner IndX data shows.

Domestic iron ore production in China is rising, even if the quality is not as good as imported material. HSBC expects import prices to continue to fall towards the Chinese marginal cost of production over the next two years. Providing steel demand doesn’t take off (not a development we would expect), then global iron ore prices should ease, and with them, cost pressures on US steel mills.

–Stuart Burns

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