Can Consolidation Lead to Profitability for US Steel Companies?

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JamesMayheadshot_150Guest contributor James May is managing director of Steel-InsightRead the first part of the article – including the 3 buckets comprising the steel industry value chain – here.

Steel is a cyclical business and steel mill profitability – the spread over raw materials – is usually closely related to utilization rates and the availability of steel.

When steel is in strong demand, but limited supply, the lead times for steel are driven higher and buyers are willing to pay more for it and also build up inventory to avoid being short of the material. Typically this is then followed by an increase in supply due to rising profitability. In North America, this can come in the form of higher output domestically or from an increase in imports drawn in.

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Lead times, therefore, come down. At this point, buyers decide that they have enough material and don’t need to buy any more. Producers however are slow to react and imports may still be on their way. The result is that they begin to discount to secure orders.

This, in short, is the normal cycle. The issue right now is that parts of this are not operating normally. The US industry either cannot or will not raise utilization rates – we think it is a bit of both.

Why US Steel Industry Won’t Raise Capacity

First, poor profitability since 2008 has starved the industry of capital investment in operating assets with several closures e.g. RG Steel, USS Hamilton, Evraz Claymont etc. While there is some new capacity e.g. Big River Steel, it takes a minimum of 3-5 years to gain permitting and build a plant.

Second, the industry has consolidated. This year alone, ArcelorMittal bought out ThyssenKrupp in Calvert, Alabama, SDI & AK Steel split Severstal North America between them and Nucor gobbled up Gallatin. The result – the Big 4 now control over 80% of the US & Canadian market. They are far less likely to be disruptive and discount during the down-cycle.

US & Canada HR coil market share by supplier capacity – Oct. 2014

USsteelprices2

Source: Steel Insight

Finally, the US industry has been enormously successful in trade defense. Despite the odd failure – AK Steel and electrical steel or the rebar industry vs Turkey – the vast majority of AD actions are successful. Almost more importantly, it makes long-term but relatively low-volume suppliers to the US market – the Japanese, the Europeans, etc. – extremely cautious in supplying the market for fearing of losing it all.

Now, I’m no stock analyst, but it seems to me that the US steel industry has worked itself into a good position. Raw material prices are falling and likely to stay low, while domestic supply is restricted and there are limits to imports. As long as demand stays strong, and all the indications are that the second half of the year and 2015 will be pretty good in core consuming sectors, then that wide spread is here to stay.

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Steel-Insight is a steel industry price-forecasting publishing company, based in Toronto. James May, the firm’s managing director, has been a steel industry analyst for 15 years and advises some of the major global steel trading companies, steel producers and steel consumers on the outlook for steel pricing and industry trends. For more information, visit www.steel-insight.com.

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