Supply constraints may keep steel prices firm

Updated: Mar 28 2005, 05:56am hrs
The overall global steel consumption demand remains firm, especially for flat products despite some weakness observed in Europe. One is not saying that the conditions are the same that they were in the middle of last year.

But, there is no evidence of steel inventories anywhere. Market strength is shifting from one region to another, causing some bit of uncertainty.

If the prices are to drop from the current level at a time when the major steel input prices have risen, production has to rise faster. In fact, although no firm data are available on the growth trend for steel consumption demand, the latest statistics published by the International Iron and Steel Institute (IISI) show remarkable growth in steel output globally. The growth rate recorded this month has been lower than in the previous months, but the increase in output in absolute terms is still significant as the same is being measured on a correspondingly higher base.

The question is when the raw materials are apparently in short supply and the freight rates are high with massive congestion experienced in major ports, will it be possible for the steel industry to sustain this growth trend for the rest of the year

According to the IISI, crude steel production globally rose 6.2% in the first two months of the year over the same months last year. The number should be read also keeping in mind the extra February day last year (the leap year).

Interestingly, almost the entire increase was accounted for by China. Of the total 10.24 million tonnes accounted for by the reporting countries ( making for 98% of the total global production), 9.337 million tonnes were from China alone, with the rest of the world adding less than a million tonnes - practically nothing.

All the major regions but Asia have recorded either a drop or only marginal increase in their crude output. This has happened certainly not because there has been a slowdown in demand.

The prices are the best proof. This undeniably looks to be a case of individual plants facing either capacity or inputs constraints.

In the short term, for the rest of the year, supply position of flat steel products is expected to remain tight due to capacity constraints mainly. Some of the producers may be marginally affected by raw materials constraints. The long products are unlikely to be placed this way. With China producing much more than they need for their own consumption, a lot of long products are already in the global market and much more is expected. This is the reason the long products prices are not as strong and the margins for the producers decreasing as they have to pay the same prices for raw materials.

But, the Chinese mills, not bothered by the lower margins on long products, continue to swallow up iron ore and coking coal, leaving steel makers in the rest of the world to face relative starvation and higher prices for the same. With the huge industrial growth foreseen in China this year also, demand for flat steel products will, in all probability, rise sharply making the country once again tap the world market for flat products in a big way.

To what extent the industry outside China will be able to respond to this demand is anybodys guess. If not, HR coils, the prices of other downstream products like CR sheets and coated sheets will be on fire.

The direction of the market in the short term will however be governed by demand side factors and sentiments which currently are not too weak and if production growth rate drops, will stand more or less at the same level.

While the industry globally is up with big plans to raise capacity in line with the observed and predicted demand growth, not so much seems to be happening around the world, except definitely in China. There is no doubt that steel capacity will grow significantly in the years to come, but, how many years will that take is not an easy question to answer. The problem lies with the fact that each individual country positioned to make steel with the advantage of one factor or the other faces a few disadvantages also and holding up ambitious projects. If a country has iron ore, it has no coal or systemic efficiency or the will to put on track a project that has good chances of completion. Somewhere else, the market of raw materials may not be properly developed although abundance of the same is unquestionable. In another case, those with all the systemic advantages are refraining from adding steel capacity because either they do not have the raw materials or they consider the industry as a liability on their environment.

Even if some of the developing nations with their known advantages have seen opportunities in this industry and make a lot of good plans, misdirected efforts and inconsistent thinking may yield no result.

One has already started seeing a loss of momentum in new steel capacity building. This has happened for several other reasons too, but discussing all those is beyond the scope of this piece of writing. With the highly oligopolistic global mining companies for both coal and iron ore now out to grab a larger share of the steel industrys fortune for themselves, steel industrys economics has undergone a change.

More than what can actually happen, the nature of price increases in coking coal and iron ore, and the prevailing perception of shortages, due to whatever reasons, even if that is erroneous, a strong uncertainty has overtaken most of the prospective entrepreneurs and more significantly, the capital market and the banks.

After all, the steel industry will have to raise funds for its growth. The investors are also worried about the possibility of the steel industry facing a cyclical downturn by the time they are up with their plants. Also, with high capital costs in this boom period, compared to what could have been when the steel market was in the dumps, also pose a few tricky questions on the viability of these projects if a downturn is to be faced later when the prices are down.

The fear gets stronger when so many projects are seen on the board with all of them scheduled to come up almost simultaneously. The fears are not unreasonable but if such fears drive all out, the industry will be left with many little capacity expansion.

Shortages will continue and the steel prices will remain high and the market, strong. While there is no way this problem can actually be sorted out in a market economy (perhaps could be done in a planned one, but, gone are the days!) if funds are available to all and at the same costs.

With no system of bidding for funds and the capital market not being homogenous across the globe, it will hardly be effective in rationing capital investments this way.

However, with the market being good for the trustworthy and ready to provide capital even at a low costs, not much will be available to those not falling into such a favoured category.

There is no unlimited funds for this industry. Even when the going is good now, the banks will continue to have strong prudence norms making things somewhat difficult for many even in the best of times for the industry.

The author is chief economist at the Economic Research Unit, JPC, ministry of steel. Views expressed here are personal