Steel pricing is largely determined by market absorption capacity

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Updated: March 26, 2019 1:52:38 AM

The ability of Indian steel producers to cover the major components of their cost of operations in the next year would primarily depend on the price of raw materials as cost of raw materials comprises 60% of the total cost of finished steel (with overhead).

The higher prices of ore would enable the high cost ore mines in China to stay in production of concentrates and make up the supply shortfall.

The FY19 is ending with a positive note for Indian steel industry. The demand is up and would nearly touch 7-7.5% growth over last year. The prices were on a rising path in the past 2 months and although it got reduced marginally in the last few weeks, would still make Ebitda looking reasonably good. Indian steel is probably going to be the fastest growing industry among all the global players in the next year.

The ability of Indian steel producers to cover the major components of their cost of operations in the next year would primarily depend on the price of raw materials as cost of raw materials comprises 60% of the total cost of finished steel (with overhead). Due to sudden collapse of the tailings dams of the mines of Vale, it is estimated that around 90 mt of iron ore would be out of production and out of merchant trade. As this shortfall in availability cannot be made up by higher production by BHP Biliton, Rio Tinto and Fortesque mines in Australia, the current price of iron ore Fe 62% at $86/t cfr China is likely to operate within a band of $90-95 in the next year subject to sustained level of steel production from China.

The higher prices of ore would enable the high cost ore mines in China to stay in production of concentrates and make up the supply shortfall. The premium grade coking coal currently ruling at $213/t fob Australia is not likely to move up significantly as technologies leading to lower coke use in blast furnace are making steady progress world over which is necessitated further by the environmental regulation of using less coal for steel plant operations, both factors easing the supply scenario.

The raw material cost advantage is accrued by Brazil, CIS, West Asia and Latin America, while labour costs in Brazil, Russia, CIS and Latin America are lower than average Indian costs of $65/t of steel production. Indian energy cost of $93/t is higher than CIS, Brazil, Japan, Latin America, Middle East and USA.

Recent cost comparisons (WSD estimates) indicate that the average operating cost of CRC in Indian steel plants (including overheads) at $514/t is higher than Russia, CIS, Middle East plants but lower than Brazil, China, Latin America, USA, Japan and South Korea. Western Europe at $699/t, Japan at $698/t and USA at $676/t cost of production of CRC (including overhead) are at the highest level of the cost curve. The corresponding operating cost of HRC in Indian plants at $451/t is equally placed in the global market. It is to be kept in view that these are average operating costs of a representative plant and may vary from plant to plant depending on the component of purchased inputs, price of refractory, maintenance consumables, fluxes, outsourced services etc.

However, the high differential in freight and transportation charges (both roads and rail freight) and high capital costs (10-12% in India against 2-3% in some of the major steel producing countries) make Indian steel products lose out in competitiveness. The subsidised costs of raw materials procured by the steel plants in China (say) also make variations in costs.

Wide fluctuations in the market have forced the producers to price products that may or may not cover the production costs fully and in downturn conditions the producers often need to cover the variable costs and a small portion of the fixed cost elements and wait for the good times to cover full costs.

The current age of protection led by USA and followed by Europe has fully justified the high price of domestic steel which more than cover the current production costs and is enabling the domestic steel mills to recover the losses incurred in earlier years.

US domestic price of HRC, which was ruling at an average $630/t in August 2017, has moved up to $771/t in March’19, a jump of 22.4% in 19 months. The average price of HRC in Japan at $570/t in August’17 is currently ruling at $664/t, an upward rise of 16.5% in 19 months.

Comparatively, average Indian HRC price at $568/t (without VAT) in August’17 has moved up to $610/t (w/o GST) in the current period, a growth of 7.4% during the period (exchange variation not considered). During this period, the prices of iron ore rose from $74.90/t cfr China in August’17 to $86.20/t in the current period, growing by 15.7%. The similar growth in premium coking coal was from $95.25/t fob Australia to $212/t by 8.6%.

Thus, irrespective of the pulls of the raw material prices, the pricing of steel is largely determined by the market absorption capacity reflected by the interplay of demand and supply. This premise is true not only for steel but for any other products, be it automobile, refrigerator, washing machines and any other engineering goods. Steel prices are subject to relative strengths in market demand and supply.

Lastly, a sustainable demand scenario need not prompt steel producer to hike prices in one go – rather to adopt a gradual increase is rational, pragmatic and customer friendly.

-The author is DG, Institute for Steel Development and Growth (Views expressed are personal)

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