McKinsey report: European steel faces major challenges in the years ahead

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The European steel industry faces three major challenges, following the impacts of the COVID-19 global and the 2008-09 financial crisis, management consultancy McKinsey & Company stated.

“European steel producers should consider making a series of short-term operational and medium- to long- term strategic moves to ensure economic and environmental sustainability going forward,”
McKinsey said in its March 15 report, “The future of the European steel industry.”

“These strategic moves could encompass restructuring steps aimed at capacity reduction, steps toward strengthening the position of steel companies by diversifying their capabilities and sustainability moves toward low- and no-carbon steel,” McKinsey added.

Volatility is the name of the game. Do you have a steel buying strategy that can handle the ups and downs?

European steel needs to address overcapacity

The first move the sector needs to address is the increase in structural overcapacity. That is particularly true after a demand loss of between 5 million and 10 million metric tons demand loss as a result of the pandemic, the group stated.

“European steel players need to adjust overcapacity to be in sync with next normal steel demand,” McKinsey said.

Adjusting for a greener future

Steelmakers also need a short-term response to compensate for higher costs with profitability improvements and incremental measures that will reduce CO2 emissions. For example, they can do so by increasing the scrap rate, the report added.

Meanwhile, producers need to make investments with a view to medium- and long-term decarbonizing of the steel industry. In short, they should tailor long-term plans and technology choices towards CO2 neutrality, McKinsey noted.

Revisiting the financial crisis

The consultancy cited several reasons for the recommendations, including the 2008-2009 financial crisis. That crisis resulted in a permanent loss of 35 million metric tons of finished steel demand within Europe.

Annual average steel demand from 2011-2019 reached 153 million tons. That marked a decline of 18.6% from 188 million tons in 2004-2008, McKinsey stated.

These demand drops have put steelmakers’ capacity utilization at about 75% — below a sustainable level of 85%, the report indicated.

Capacity utilization fell to nearly 63% in 2020. However, that will likely ramp back to up to 70-75% in 2021-22, McKinsey predicted.

“We expect demand for steel in the EU-28 to drop by 5-10 million [metric] tons between 2019 and 2023,” the report states. “This is primarily because players in key consumer industries, such as automotive, have been triggered by the COVID-19 crisis to adjust their footprints by closing or relocating production from Europe to other regions.

“Furthermore, a permanent lower demand for office space after the COVID-19 crisis due to increased remote work may reduce demand for office buildings, which in turn will lower demand for steel from the construction sector.”

Imports, rising raw materials prices and currency fluctuations

Rising steel imports into the European Union also put downward pressure on capacity utilization. In 2016, the bloc in 2016 moved from net export to net importer of finished products. Those imports came mainly from Russia, Turkey and Ukraine.

Currency fluctuations have further put pressure on Europe’s steel market, the report stated. The average exchange rate between the dollar and euro rose in late 2020 by over 9% to €1.20 from €1.10. The shift made Europe an attractive export destination.

High costs for labor, energy and landed raw materials make Europe’s steel sector uncompetitive, despite high efficiency levels. Furthermore, the profit margin over raw material costs is likely to remain uncertain, as it has since 2019, the report warned.

Tight supply and high demand as automakers replenished their stocks pushed the margin to €380 ($450) per metric ton in 2020-2021. That is more than double the €180 ($210) per metric ton reported in 2019.

“This high volatility in margins over raw material makes it harder for European steel players to plan,” McKinsey also noted. “This is especially true regarding the integrated Blast Furnace–Basic Oxygen Furnace route, which requires long-term planning of raw-material purchasing, preparation, and production.”

Carbon costs

EU steelmakers need to not only reduce overcapacity, but also research investments into low-CO2 technologies. This will require producers to make up to €100 billion ($120 billion) in investments by 2050.

Production costs relating directly to CO2 in Europe are expected to reach €50-100 ($60-120) per metric ton by 2030 in order to achieve the EU’s decarbonization targets. That reflects a rise from over €30 ($35) per metric ton in January 2021. Even that January figure marked a significant rise from less than €5 ($6) per metric ton in 2016.

Those costs can add €100-200 ($120-240) per metric ton of steel for buyers. For each metric ton of steel produced, about 2 metric tons of CO2 are produced, the report stated.

Steps to take for European steel

McKinsey’s report also gave several recommendations on how European steelmakers could face the challenges. First, it cites tightly managing costs, particularly in the face of rising raw material costs and pricing volatility.

“To pass on this price volatility, steel producers may need to renegotiate their sales contracts with automotive, machinery and equipment, and other industries to include floating instead of fixed prices,” McKinsey said.

“These new contracts would also mean that producers would forgo the benefit of potential raw-material price drops in the future.”

Steelmakers will also need to consider several moves to reduce capacity in order to achieve the 85% sustainable level of capacity utilization. This could come by way of consolidation mergers, McKinsey noted.

An alternative to industry-wide consolidation would see producers working together to share production assets or jointly producing necessary inputs. Moves toward low- and no-carbon steel would need several methods, McKinsey said.

“Steel companies would continue to pull available no- and low-capital expenditure levers, such as maximizing scrap rate in basic oxygen furnaces, improving burden mix (high-Fe lump ores or pellets), and rationalizing capacity through sintering, coke batteries, blast furnaces, and other methods,” the consultancy noted.

Carbon reduction incentives, via Europe’s Carbon Border Adjustment Mechanism (CABM) and the European Union Emission Trading Scheme (EU ETS), could help achieve that.

EU ETS places annual caps on carbon-emitting enterprises within the 27-member bloc. Iceland, Norway, Liechtenstein and the United Kingdom also have caps. If an enterprise exceeds those limits, however, they can purchase more from other producers. Alternatively, if carbon emissions are lower than expected, an enterprise can sell those credits to another.

The third and final option would include shutting down and offshoring upstream capacity.

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