CommentaryMarket Analysis

Even if U.S. steelmakers have been slow to add capacity following President Trump’s tariff protection, it would seem foreign steel makers are willing to commit to domestic U.S. production.

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The Financial Times this week reported on the announcement by BlueScope Steel, Australia’s biggest steelmaker, to examine adding 600,000 to 900,000 metric tons per year of steelmaking capacity to its North Star business in Ohio. This would raise the Ohio plant’s existing production of 2.1 million metric tons per year to some 3 million tons at a cost of between U.S. $500 million and $700 million.

The project would involve the addition of a third electric arc furnace and a second slab caster, according to the Financial Times report. A decision is expected at the company’s February 2019 annual results pending the outcome of the feasibility study, by which time a clearer picture may emerge of what the tariff landscape is going to look like longer term.

Interestingly, Australian steelmakers are exempted from the tariffs; in theory, BlueScope could have invested at home. Australia, however, along with Argentina, are subject to quota limits, so ramping up domestic production to meet U.S. demand is not considered a viable option.

According to the Financial Times, domestic U.S. steel producers are, not surprisingly, doing rather well from the tariffs.

The resulting price rises have fueled a rally in U.S. domestic prices, helping firms like ArcelorMittal surpass forecasts previously set by analysts. Arcelor’s earnings came in at $5.59 billion before interest, taxes, depreciation and amortization for H1 2018. That represented an increase of 28.6% on the same period a year before, as half-year sales rose 17.6% year-on-year in value terms to $39.2 billion, primarily due to higher steel selling prices. Net income was up by almost one-third to $3.06 billion. It hasn’t yet resulted in Arcelor announcing any increased investment in domestic U.S. production capacity — the real aim of the tariffs — but, arguably, steelmakers are waiting to see how the whole tariff situation develops and whether they are truly here to stay (in which case, investment could result).

The U.S. Department of Commerce found foreign steel accounted for about one-third of the 107 million metric tons of steel the U.S. economy used in 2017, the Weekly Standard reported.

Although U.S. producers still have a commanding market share, the report concluded that inexpensive foreign imports were causing domestic steelmakers to lose money, lay off workers, and close plants last year.

U.S. steel plants in 2017 ran at just 72% of capacity, below the 80% level they are widely considered necessary to be profitable. The blame for poor capacity utilization fell firmly at the door of “excessive imports of steel.”

Well, that was last year; this year is something very different.

Following tariffs, steel prices are up sharply, profits are up at the domestic mills and so is capacity utilization. The domestic mills have the option to price balance towards full capacity, shielded as they are now behind a 25% import tariff. They may choose to take higher prices and forego full capacity or adjust pricing to achieve full capacity; we will see what policy has been adopted when Q3 and H2 figures are released.

It is unlikely significant new capacity will be added in the short term, though, despite talk of planned new capacity.

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According to Reuters, steel output in the United States rose 2.9% in the first half to 41.9 million metric tons and gained 0.8% in June to hit 6.9 million tons for the month. Data from the American Iron and Steel Institute (AISI) show capacity utilization at U.S. mills in the year to July was 76.4%, up from 74.4% in 2017, suggesting domestic mills generally are opting for better prices as a route to profitability rather than pricing out tariffed imports.

The spike in aluminum prices this quarter, caused by the initial announcement of sanctions on Oleg Deripaska and his investments, is an issue anyone in the aluminum sector will be only too well aware of.

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Prices spiked in days and were associated with a number of other supply constraint worries. Sharp rises in conversion premiums have not relaxed even though the primary aluminum price has since eased back to where it was just before the announcement.

The price increase and supply-chain panic was a result of the sanctions announced by the Office for Foreign Assets Control (OFAC). Prices fell back as OFAC granted a stay of application until late October 2018, allowing consumers to adjust supply agreements accordingly.

Source: Bloomberg

While the market is aware first-hand of the impact, what is only just becoming clear is the impact on the main supplier from Deripaska’s group: Rusal.

According to the Financial Times, drawing on the most recent Q2 company filing, inventories had risen to $2.88 billion at end the of June, from $2.41 billion in December as the company produced 939,000 metric tons of primary aluminum and alloys in the three months to June, but only sold 783,000 tons. Both first-half 2018 production and sales are down from a year earlier, largely due to the Q2 sanctions, even though the company continues to operate profitably.

Although Rusal is looking to boost output of value-added goods (VAGs), as they call processed products, they sharply cut back production of foil, powders and other VAG products in April for fear of not being able to shift production if sanctions were sustained.

As it happens, most global consumers restarted deliveries after a few weeks, but many in the U.S. are still reluctant to touch Rusal product – primary or VAGs – as the October crunch date looms.

Source: Bloomberg

2019 annual contracts are usually negotiated in September, ahead of the October LME week, and in preparation for supplies starting in January of the following year. Unless there is certainty that the OFAC sanctions will be lifted or some form of exemption will be granted to Rusal despite what happens to Deripaska, Rusal will again face restricted sales options going forward.

The case against Deripaska is already severely impacting any trade with entities in which he or his holding company En+ Group have a stake, as banks carry out exhaustive checks on every payment, causing delays of weeks on some transactions.

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Those consumers with other supply options will conclude it is just not worth the effort and switch to alternative sources, further crimping capacity availability in the market and pushing up conversion premiums even, if the primary metal price has yet to respond.

The August Aluminum Monthly Metals Index (MMI) fell two points last month. The current Aluminum MMI index now stands at 93 points.

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LME aluminum prices fell in July. However, the rate of the declines has slowed. Price changes do not appear to be sharp and selling trading volume remains weak. The price decrease looks like a retracement after the peak in April due to Russian sanctions.

Source: MetalMiner analysis of FastMarkets

LME aluminum prices have fallen again toward the stiff support level that aluminum prices had during 2017 and 2018. LME aluminum prices fell towards that support level in December 2017, in April 2018 and back again in July 2018. However, aluminum prices rebounded each time (and again in July) from that level.

How aluminum prices react to this stiff support level will give some insight on upcoming aluminum price movements. Buying organizations will want to follow aluminum price movements closely to identify the perfect moment to buy forward and lock prices.

Chinese Aluminum

Chinese aluminum output increased by 1.6% in June, according to the National Bureau of Statistics.

The gradual ramp-up of new smelting capacity has increased production. The daily output figure increased to 94,000 tons in June versus the previous 90,000 in May, signaling an increase of 0.8% year on year.

Chinese increased exports received a boost from a favorable price arbitrage, with a weaker yuan. Exports reached 510,000 tons in June, the second-highest figure on record.

U.S. Domestic Aluminum

As a result of the ongoing uncertainty in the aluminum market, U.S. aluminum Midwest premiums have skyrocketed this year.

August’s premiums, however, have started to decrease, sitting at $0.19/pound. The current premium has slid to April 2018 levels, but still appear close to its four-year high at $0.20/pound.

Source: MetalMiner data from MetalMiner IndX(™)

What This Means for Industrial Buyers

Despite the recent downtrend, the LME aluminum price trend suggests a continuation of the bull market that started last year.

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Actual Aluminum Prices and Trends

The metals in the Aluminum MMI basket generally fell this month.

LME aluminum prices decreased this month by 3.88%, with a closing price in July of $2,076/mt. Meanwhile, Korean Commercial 1050 sheet traded flat in August, with a reading of $3.57/kilogram.

Chinese aluminum primary cash prices increased by 0.361%, while China aluminum bar fell 5.33%. Chinese aluminum billet prices also decreased 5.33% this month, to $2,197/mt.

The Indian primary cash price fell by 3.27% to $2.07/kilogram.

The Stainless Steel Monthly Metals Index (MMI) fell again this month. The slide of four points moved the index to 78 from the previous 82 reading. The index fell back to May 2018 levels.

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The index dropped due to a slight fall in LME nickel prices in July. However, LME nickel prices seem to have recovered again. Stainless steel surcharges also fell this month.

However, stainless steel surcharges remain in a strong uptrend.

LME Nickel

In July, nickel price momentum slowed slightly.

However, LME nickel prices — and the base metals complex, in general — are showing strength so far again this month.

Despite the two-month downtrend, nickel prices have remained in an uptrend since last summer (June-July), when prices started to increase sharply.

Source: MetalMiner analysis of FastMarkets

Prices fell starting in June 2018 from the $15,895/mt level toward the current $13,825/mt level. Buying volume appears stronger than selling volume and, therefore, supports the uptrend.

A fundamental tightness in the nickel market could also add more support to nickel prices.

The Philippines government confirmed that just 23 out of the 27 mines that operate in the world’s second-largest nickel-producing country will continue to operate. The remaining four will likely close. The decision comes from a previous report (released in July).

Domestic Stainless Steel Market

Domestic stainless steel surcharges fell for the first time since the beginning of the year.

The 316/316L-coil NAS surcharge fell to $1/pound, while the 304/304L decreased to 0.73/pound.

Source: MetalMiner data from MetalMiner IndX(™)

The pace of stainless steel surcharge increases seems to have slowed this month, along with steel (and stainless steel) price increases. However, stainless steel surcharges remain in a clear uptrend and are well above 2015-2017 lows.

What This Means for Industrial Buyers

Stainless steel price momentum slowed down slightly this month. However, both steel and nickel remain in a bull market.

Therefore, buying organizations may want to follow the market closely for opportunities to buy on the dips.

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Actual Stainless Steel Prices and Trends

Both Chinese 304 stainless steel coil and Chinese 316 stainless steel coil prices fell this month by 2.78%.

Chinese Ferrochrome prices decreased this month by 2.04%, to $1,930/mt.

Nickel prices fell 7.33% to $13,900/mt.

Ezio Gutzemberg/Adobe Stock

Many had hoped the announcement last month of 10% tariffs on China would be the signal for serious negotiations between the two trading partners, that China may come to the table and be willing to discuss some of the U.S.’s genuine concerns about theft of intellectual property and reciprocal access rights to each other’s markets.

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While much was made about the trade imbalance, most realized there was no quick fix to the U.S. addiction to low-cost Chinese imports or the Chinese state-sponsored export model – both would take years to correct.

But a road map as to how that may be achieved would in itself be a major win from the confrontation. Indeed, a resetting of those issues to a more equitable position would be a legacy that would seal President Donald Trump’s place in history, without any advance on the myriad other battles he has started with friends and foes alike.

Alas, no such progress is being made.

According to a recent Financial Times article, if anything the opposite seems to be the case.

Negotiations have stalled at a low level, the report states, with discussions now limited to, at best, “conversations about whether we are going to be able to have a fruitful negotiation or not,” according to one senior administration official quoted by the news source.

China really had little alternative if it wanted to maintain face than to announce reciprocal tariffs to those originally applied by the U.S., but in so doing the tables were balanced in the view of U.S. negotiators. The president announced his intention to extend tariffs on $200 billion in annual imports from China, plus a possible increase from 10% to 25% on that $200 billion to give U.S. negotiators room to maneuver.

Unfortunately, the decision now seems to have stalled what little progress was being made. On Friday, China announced plans to impose tariffs on $60 billion of U.S. goods, according to a statement on the Ministry of Commerce website.

Beijing seems in no hurry to capitulate, despite the Shanghai stock market down 3.6% and Hong Kong’s Hang Seng index down 2.6% to the lowest level in 10 months. Opposition at home is muted to non-existent. Chinese media and much of the industry see themselves as the victims of an unprovoked attack and, as such, support Beijing in what is seen as resistance to an external threat.

In the U.S., however, opinions are more diverse.

Some among the president’s traditional hardcore supporters are still staunchly behind him, but criticism has been growing from other quarters, not least farmers who see themselves in the firing line as China switches buying from the U.S. to South America.

The president’s case may garner more national support if the case were articulated more comprehensively.

There is only so much national consensus that can be achieved via Twitter. The case for nurturing domestic industry has huge merit and, in reality, the cost to U.S. consumers could be relatively low. However, rather than debate and persuade, the barrage of tweets — mixed in with tweets about building a border wall and FBI investigations into Russian attempts to influence voting — creates a chaotic message board. As a result, trade – the most important issue of the day – is subsumed in a barrage of messages and policy priorities.

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To give the “Art of the Deal” space to work on the international stage, the president needs, whether he realizes it or not, the ongoing support of voters, impacted communities (farmers, for example) and the manufacturing sector he purports to represent. As negotiations stall and the process drags on, this imperative will only intensify.

China Zhongwang Holdings failed to close a deal to buy Aleris last year after concerns were raised about the national security and corporate responsibility track record of the Chinese group.

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Not that we think of Novelis as Indian, but they are. Since 2007, the ex-Alcan flat-rolled manufacturer has been owned by Hindalco, part of India’s Aditya Birla Group. Novelis was already the world’s largest flat-rolled aluminum product producer before the Aleris deal.

Now, with the addition of Aleris, Novelis will acquire some very sophisticated aerospace technology — particularly in the plate market — and further secure the combined group’s position in high-technology products for the aerospace, automotive and defense sectors, not just in the U.S. but globally. Aleris is particularly strong in Europe and has just opened a new rolling mill in China.

Hindaloc will acquire Aleris in a $2.6 billion deal, which will include $775 million of equity and $1.8 billion of debt, funded by Novelis rather than the parent, Reuters reported.

The market reacted positively to the news.

The combined entity, comprising Novelis and Aleris, will have annual revenues of $15 billion when Aleris’ $3 billion has been added.

Revenue aside, the group’s combined sheet-rolling position will become even more significant at 4.4 million metric tons, raising concerns in some quarters about its market-dominating position.

Although Novelis has invested heavily in facilities to meet rising automotive demand, it is traditionally one of the largest suppliers of aluminum for beverage cans, which is more at the commodity end of the market. Novelis’ ability to competitively serve these markets could be of immense value if the culture can be migrated to Aleris, whose focus has been more in the high-value aerospace and automotive industries and has struggled with profitability.

Market dominance fears aside, Western producers need to invest and create critical mass to counter growing exports from China’s giant semi-finished product manufacturers, which are continuing to add capacity despite having much more than the domestic market can consume.

China is exporting in excess of 4 million tons per annum of semi-finished products, so far aimed more at the commodity end of the market. But Chinese producers have the ability, certifications and domestic experience to service aerospace and automotive markets, too.

Current trade tariffs notwithstanding, Chinese producers are going to be increasingly targeting these markets, if not penetrating the U.S. then displacing Aleris and Hindalco in Europe, South America and Asia.

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In the short term, the merger of Novelis and Aleris could generate cost savings, technology transfers and adoption of beneficial best management practices. In the longer term, it should be seen as positioning a more robust Western market leader against a growing threat from China, eager to compete in higher-value markets and willing to play the long game to get there.

We had a little mythbusting discussion the other day here at MetalMiner®, including, among other examples, that tracking raw material inputs is no predictor of finished product prices.

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Take, for example, iron ore.

Prices fell this spring and have been bouncing around either side of $65/ton. However, in China, the world’s biggest consumer, finished steel prices and production have been ripping along.

According to Reuters, China produced 80.2 million tons of crude steel last month, setting a new daily average production record for a third month in a row at 2.67 million tons.

Despite strong domestic steel prices, China’s steel exports last month rose to 6.94 million tons, their highest level since July 2017. Older, more polluting mills continue to be shuttered as part of Beijing’s program to curb pollution via increased inspections.

Reuters sees this as evidence that newer mills have ramped up operations to cash in on fat margins. China’s steel output in the first half of the year rose 6% to 451.2 million tons.

Richard Lu, analyst at CRU in Beijing, is quoted as saying that mills were earning a profit margin of about 800 yuan ($119.50) per metric ton of steel, while analysts at Huatai Futures put profit margins for mills in northern China at over 1,000 yuan per ton — one of the highest on record, the news source says.

Mill utilization still has further to go though; despite record output, mills are not running flat out. Monthly utilization rates reached 71.6% in June — the highest since October — but suggestive output levels could continue into the winter heating season, even as mills around major cities are made to close to reduce pollution.

However, that would presuppose demand remains robust; signs are beginning to emerge that demand is softening.

RBC Capital Markets mining analyst Paul Hissey is quoted as saying the bank expects steel demand to fall in H2 due to a slowdown in infrastructure and property demand and continued volatility around tariffs.

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Ultimately, a softening in steel demand will lead to a fall in steel prices; it is the anticipation of such that is a factor in falling iron ore prices.

As we noted, the correlation in raw material and finished product prices is stronger in falling markets than rising, despite the raw material price falls leading the finished product.

Source: wto.org

Ultimately, it went along expected lines.

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India and a handful of other nations held trade dispute settlement consultations with the United States over its steel and aluminum tariffs in Geneva, but got absolutely no concession from the latter, according to reports coming out of the meetings.

India, Canada and Mexico confabulated with the U.S. on the issue of the latter imposing additional duties of 25% & 10% on steel and aluminum imports.

Earlier this month, China, Norway and the European Union also held similar talks with the U.S., under the aegis of the World Trade Organization (WTO) in Geneva. Almost all such disputes are held under Article 4 dispute settlement consultations. MetalMiner previously reported about the Geneva meeting and its attempt to try and break the trade tariff imbroglio.

The U.S., as many had expected, stuck to its guns that no law required it to provide any reason for the Section 232 measures on steel and aluminum, since they remain “sovereign determinations” that fall under Article 21 of the GATT 1994, according to media reports.

Apparently, in an earlier meeting, the U.S. told the representative of another country in such a meeting that Section 232 revolved around issues of national security, and was thus not available for review or capable of resolution by WTO dispute settlement.

Representatives of India and other nations raised several questions around the proposed tariffs. They claimed the additional duties constituted a “disguised safeguard” measure, as the U.S. Department of Defense had said that there was no threat to the country’s national security from steel and aluminum imports.

The U.S. delegation, on the other hand, maintained it was unable to share the reasons for the decisions under the Section 232 provisions. Delegates also wondered how countries such as Australia, Brazil, Korea and Argentina had been exempted from similar additional duties, and why these imports did not pose a national security threat to the U.S.

Clearly, unable to get much from the U.S. at this meeting, the only recourse the six nations may have is to approach the WTO with a request to establish a disputes settlement panel to rule against the U.S. measures.

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In March this year, the U.S. had also launched a challenge at the WTO against India’s export subsidies, arguing the programs give Indian companies an unfair advantage. The U.S. claimed these export subsidy programs harmed American workers by creating an uneven playing field on which they must compete.

Stock markets in the West react to peaks and troughs on the Shanghai stock market as if the market were a true indicator of the health of the Chinese economy. Shanghai has been down since talk of sanctions has spooked markets in China, Europe and the U.S.

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But in some parts of the world, where dependence on China is more than a simple +/- 0.1% of GDP, whole economies are reacting to the fear of a slowdown in China.

A recent Financial Times report details how the Aussie dollar has slumped 4.5% in just two weeks. Trade tensions have risen over investors’ fear for the prospects of the country’s largest trading partner, an indicator of how dependent has Australia become on China’s health and prosperity.

Likewise, copper, which for decades has been dubbed “Dr. Copper” for its supposed sensitivity to the health prospects for global growth, should maybe be renamed “Sino Copper” for the way in which it increasingly has become tied to the fortunes of one country (China) rather than the global economy.

After touching a four-year high of $7,348 a ton on June 7, copper has plunged 14%, or more than $1,000 to $6,303 a ton, the Financial Times reported, as investors fear a slowing China will be detrimental for copper demand later this year and next.

China is the world’s largest importer of copper, and Australia — the fifth-largest copper producer — is intimately tied to the world’s second-largest economy. China is its biggest customer, not just for copper but also for iron ore, coal, aluminum, bauxite and a range of other materials.

A follow-up article will analyze a wider range of metrics to better understand the state of the Chinese economy and to what extent the country’s growth trend for 2018 is a direct result of tariffs (compared to factors in play before April).

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What that will show is that China had much to contend with prior to tariffs and a trade war broke out. While massive foreign exchange reserves and a well-funded banking system means the economy is essentially sound, the current trade issues have come at a bad time for policymakers in Beijing and may partly explain the relatively restrained response from the authorities.

Falling aluminum prices over the last month have given rise to some asking if aluminum is now on a prolonged downward trend.

Tempting as it is to look at day-to-day movements, a more holistic analysis suggests otherwise.

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As a recent Reuters article suggests, April saw the Rusal-related sanctions effect lift prices dramatically. The supply market went into shock at the prospect of 6% of the Western world’s capacity being denied to the market by U.S. sanctions on Oleg Deripaska, blocking consumption of Rusal aluminum primary metal.

The resulting scramble for supply caused massive price inflation for those that could get metal. Some processors caught out to the point of reduced supply for the late second and early third quarters. A backtrack by the U.S. eased concerns and action by Deripaska to exit or relinquish control of En+, Rusal’s largest shareholder, have further eased concern.

Gradually, the price has unwound and at current levels is a whisker over its low point in April.

Source: LME

Aluminum’s slide is part of a wider base metals retreat in the face of a stronger dollar, plus macro concerns about trade wars and a cooling Chinese economy.

One metric that commentators sometimes consider at a basic level is inventory levels. Falling global or exchange inventory is indicative of demand exceeding supply.

With aluminum, that has not always been as clear, since more metal is held off exchange by the stock and finance trade than is held on the major LME, CME and SHFE markets.

In the early part of the decade, some analysts simply ignored these numbers on the basis they couldn’t estimate with any degree of accuracy what was happening to these shadow stocks, and believing they were locked up for the long term (making their presence almost irrelevant). This publication never took that view and has always tried to bring an estimate of off-exchange market inventory movements into our estimates.

At its peak, these massive stocks approached 10 million tons, while LME stocks hit a peak of some 4.5 millions tons. However, since 2016 both have fallen quite rapidly, such that today CRU estimates off-warrant stock at some 6 million tons and the LME, when metal awaiting load-out is stripped out, falls below 1 million tons, according to Reuters.

Nothing illustrates the deficit condition of the aluminum industry outside of China more powerfully than those figures.

Over 1.5 million tons per annum has been absorbed on average into the market over the last three years — and the rate has been rising.

As the remaining metal is held by fewer parties, distortions are beginning to appear in market pinch points, specific pricing points used by the LME market to roll over positions, such as the third Wednesday of the month.

Source: Reuters

This graph from Reuters illustrates the spike in spot or cash prices over three months, a condition called backwardation that is illustrative of a market under stress.

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The frequency the market slips into backwardation has been increasing, with three spikes this year alone. A market in deficit is unlikely to exhibit bear pricing for long, current apparent weakness is more a factor of short-term dollar strength and anxiety over trade conflicts.