What Influences the Steel Prices on the World Market - Case Study Example

What influences the Steel Prices on the World Market The question of Steel Prices has moved into the center of attention of the economic world since they started sky rocketing over the last 3 to 4 years. As steel is at the core of a large number of products increases in the base product has a tremendous effect on the prices of subsequent product and thus on several price indices. In the extreme, certain business areas can be largely effected by shortages and price increases, strongly influencing their over all profitability and ultimately, in certain cases, threatening their survival. In the following we would like to investigate some of the causes, effects and remedies of this phenomenon and will attempt to make some predictions as to its future development. I. History a) Empiric Observations of Prices b) Use of the Base Product - Steel Containing Products II. Supply and Demand a) Supply i) Number of Steel Plants (Over supply caused reduction in plants via bankruptcies, mergers and plant concentration) Increase of Supply can only be achieved by increasing production capacity via (i) more plants (slow process as lead time is many years due to cost, market entry barriers via government regulations, environmental regulations, investment capital requirement to finance installations, complex mechanics), or (ii) increase of productivity within the plants (possible to a certain extent only until capacity is maxed out, ii) Availability of Raw Materials - Iron Ore and Scrap Metal, . supply & demand, source of raw materials, political restrictions. iii) Trade Barriers - customs, tariffs and restrictions b) Demand i) Local or World Demand - nowadays steel market is global. Local demand unimportant for general picture ii) World Economy - cycle , expansion of economies demand more steel containing products iii) Addition of new markets - development of under-developed countries, present situation China opened Borders only a few years ago, III. Factors interrupting the Economic Equalization of Pricing a) Political Interference by government imposed reglementations, Sanctions (Exportverbot) b) Trade Barriers IV. Future Development of Pricing What influences steel pricing on the World Market The question of steel Prices has moved into the center of attention of the economic world since they started skyrocketing over the last 2 to 3 years. As steel is at the core of a large number of products, increases in the base product have a tremendous effect on the prices of subsequent product and thus on several price indices. In the extreme, certain business areas can be largely effected by shortages and price increases, strongly influencing their overall profitability and ultimately, in certain cases, threatening their survival. In the following I would like to investigate some of the causes, effects and remedies of this phenomenon and will attempt to make some predictions as to its future development. It is being reported that steel price is one of the major contributors to the overall increase in wholesale price index. A little analysis would put the thing in right perspective. Item Weight Index on 24.7.04 (Base:1993-94=100) % Growth over last year % Contribution to price rise All Commodities 100 186.2 7.5 Primary Articles 22.02 191.0 6.3 1.4 Fuel, Power, Lubricants etc 14.23 274.4 10.0 1.4 Manufactured Products 63.75 164.9 7.1 4.53 Iron & Steel 3.64 240.9 45.0 1.6 So while both primary and fuel have contributed 1.4 percent each to 7.5 percent increase in WPI indices during the last one year, the prices of manufactured products has led to a 4.53 percent growth in prices. And out of the manufactured product prices, the prices of iron and steel items have contributed 1.6 percent to the overall price rise. This implies that around 21 percent of the general price rise in the last one year has been accounted for by prices of iron and steel. Under any counts this is substantial and unprecedented. The direct linkage of domestic steel prices with international prices is frequently being cited as the prime cause. Till a few months back it was presumed that flat product prices were directly related to the movement in global market, while the long product prices (Semi-finished steel, Bars & Rods, Sections etc) are more influenced by domestic demand and supply phenomenon and the linkage, if any, works indirectly and with a time lag. This appears to be no longer true. With the onset of globalisation and widespread use of electronic media, the fluctuations in global market have an instantaneous bearing on the domestic market. Steel trading community with its ready access to international market events influences market perception to a large extent. Item Months FOB price (US$/t) % growth during Dec'03-Aug'04 Domestic market price at Mumbai (Rs/t) % growth during Dec'03-Aug'04 HR Coils Dec'03 305 -- 22600 -- Aug'04 570 (+) 87.0 30650 (+) 36.0 Billets Dec'03 305 -- 18000 -- Aug'04 410 (+) 34.0 22500 (+) 26.0 The extent of increase in global prices exceeds that in the domestic prices, but the trend is uni-directional. Domestic price of HR in USA has gone up from $ 349 in Oct-Dec'03 quarter to $ 728 in July-Sept'04 quarter, a rise of 109 percent within a span of 9 months. In Germany the domestic prices of HR during the same period has been raised by 58 percent. Is it therefore fair to term the recent increase in steel prices in the country as import-led Not exactly if one looks at only the finished product prices. Inflationary impact is imported via raw materials also. The cost of those finished steel items dependent on imported inputs like Bars & Rods (influenced by imported melting scrap prices) and HR (imported coking/ non-coking coal) is enhanced and reflected in higher market prices. During Sept'03 and August'04 imported coking coal prices recorded at around 140 percent enhancement leading to huge burden on all those steel manufacturers who are finalizing deals on long term perspective. During the same period the imported price of melting scrap has gone up by 27 percent. The cost of production of steel, both long and flat, is thereby adversely impacted. The point to be noted here is the absorption capacity of the market. If demand for these steel items had been poor, the market would not have warranted such hike and the prices of finished items would have been rolled over. The resistance to price hike is only strengthened by low demand which has not happened. The factors so far identified are upward movement in global steel prices, rise in imported input prices and high demand growth -all these have sustained a level of steel prices in India which is unprecedented. A very attractive export market particularly for the flat items exerts an upward pull in the prices of domestic steel. Not long ago, the steep declining trend in the import prices of HR Coils had resulted a downward pressure on the domestic prices through a threat perception of anticipated imports. This invisible hand of market-led perception is at the root of the recent pricing phenomenon. A direct offshoot of globalisation, the market sentiment that also thrives on speculation and hedging matched by inadequate appreciation of all the relevant factors would continue to influence the pricing trend in the market. In response to user segments' frequent demand for lowering down of customs duties on steel to supplement domestic availability, the current rates of 10 percent are likely to be brought down to 5 percent, comparable to the duty levels in many developed countries. A 5 percent reduction in customs duty implies a fall in landed cost of HR Coils, Billets and CR Coils by approximately Rs.1200/-, 905/- and Rs.1530/- respectively at the current level. Would that encourage the users to turn to imported sources In case the global prices move up further, which is quite likely, it may rob the advantage of a lower duty. The inevitable imports, irrespective of the periodic fluctuation in prices are not going to be affected by duty levels. The substitution of domestic availability by imported goods, unless guided by a substantial gap in landed costs to take care of all the hassles of imports, may take place by a sufficiently lower extent. On the other hand, a reduction in customs duty on melting scrap and shipbreaking scrap may enhance the availability of these vital inputs for production of ingots. The hefty price addition at every stage of value addition can be checked. Ultimately, however, the market sentiments would determine the efficacy of a specific policy measure. I. History a. Empiric Observations of Prices The meaning of history for this purpose shall be defined as the price development since the year 2002. Traditionally empire decades the steel industry experienced a contraction: many plants were closed due to overproduction, overcapacity and price decreases. Since 1999, increases in steel prices have been steady, continuously increasing until the last quarter of 2004. The recent drop of steel prices has been mainly allocated to reduced imports by China. Even though China has stockpiled a large amount of steel, the majority of the Chinese demand can now be satisfied by local production, which resulted in an import reduction of 30% in the first quarter of 2005. Depending on how much steel will be locally produced and used in China, its export may increase and consequently influence the worlds steel prices in the near future. If an overproduction occurs this may even further put pressure on the worlds steel prices. An offsetting development could be caused by strong economic development in the western world and India. In the second quarter of this year, the increase of steel prices didn't continue. For the first time in the running steel cycle, steel producers in the EU were not able to implement the announced price increases on the market. The spot prices have rather decreased in nearly all of the production categories. The price curve for the reference product warm-broadband is therefore for the first time since midst 2003 heading downwards again. However, warm-broadband prices in Germany are still more than the double of the standard of the beginning of 2002. Not only in Germany, but also in other European countries the tendency of decreasing prices is the same. The pricing pressure seems to be stronger in South European countries compared to North Europe though. b. Use of the Base Product - Steel Containing Products The steel consumption in the oil importing regions is likely to be stifled somewhat as economic growth is held in check. Raw material costs for steel-makers (iron ore and coking coal) moved up quite steadily for many years up to the start of 2004. Consistently higher demand from China raised fears of shortages as the local producers of steel racked up output in 2003. The increase was equivalent to almost the total output of the German steel industry. Negotiations for 2004 contracts showed rises of 71% for sea-borne iron ore and 120% for coking coal. Pig iron production costs in Brazil are now reported to be near to $US230 per tonne. Over the past two years carbon steel prices have been extremely volatile. In the final quarter of 2003, the domestic average hot rolled prices in Asia, North America and EU were at similar levels at $US340/350 per tonne. By September 2004, North American values peaked at almost $US800 per tonne before declining rapidly to around $US550 per tonne in July this year. In the EU, domestic hot rolled coil values rose to near $US700 by the end of 2004 but slipped back to $US530 per tonne in July 2005. The main element in steel price movement is still the balance between supply and demand. However, in the past two years, the cost of raw materials is playing an ever increasing role in the determinant of the floor prices. It is now clear that the $US200 per tonne hot rolled coil selling price is a thing of the past. II. Supply and Demand a. Supply i. Number of Steel Plants (Over supply caused reduction in plants via bankruptcies, mergers and plant concentration) Increase of Supply can only be achieved by increasing production capacity via (i) more plants (slow process as lead time is many years due to cost, market entry barriers via government regulations, environmental regulations, investment capital requirement to finance installations, complex mechanics), or (ii) increase of productivity within the plants (possible to a certain extent only until capacity is maxed out General observation The steel price is directly a function of supply and demand. As the supply increases at steady demand the prices will fall. Increase of supply at steady demand means increase of prices. If demand and supply are in balance, equilibrium is reached. Increasing supply In order to increase steel supply in the world market, production capacity can be increased. When all existing steel plants are at maximum production capacity additional supply can only be generated by adding new capacities. Under the assumption of steady or increasing demand, steel prices will have to increase until additional supply can be generated. Entry barriers on supply side To construct new steel plants is a time consuming matter/business. a) construction time several years b) governmental and environmental regulations and permits complicate and delay constructions c) high capital investment are required (search - investment cost for steel plant construction) - RISK! d) complex mechanics ii. Availability of Raw Materials - Iron Ore and Scrap Metal, supply & demand, source of raw materials, political restrictions. Availability of raw materials - The primary raw materials from which steel is made are iron ore, limestone and coke. For the production of steel two major raw materials are used. Shortages of either one may cause increases in ultimate steel prices, especially scrap metal which is mainly a by-product of highly developed economies. A shortage in scrap metal can cause serious bottlenecks that will directly influence cost of steel production and consequently the prices. Another cyclical issue is the high price of scrap steel. Steel is the most recycled of all materials, with an entire class of newer steel companies depending on scrap as their primary input. Scrap prices are twice as high as they were at the same time in 2003. Global Insight expects scrap costs to retreat by mid-2004, but remain well above recent levels. The cyclical disruptions will pass, but a longer-term structural evolution will persist-a shift that promises higher input costs is a long-term reality. Over the long term, scrap growth cannot exceed the rate at which ore is converted to steel. There is room for temporary expansion through more intense scrapping of obsolete cars and factories, but it is not practical to dismantle an entire industrial base to sell as scrap metal. And while scrap expansion is limited, demand has increased dramatically. iii. Trade Barriers - customs, tariffs and restrictions With the US' infliction of up to 30 per cent of tariffs on Chinese steel products, there is spreading a fear in China that the tariffs would severely damage Chinese relevant industries and could even block China's steel exports by triggering a new round of global trade protectionism. WTO statistics show China has become the largest victim of the use of anti-dumping measures, with Chinese companies involved in over 430 cases. b. Demand i. Local or World Demand - nowadays steel market is global. Local demand unimportant for general picture Worldwide demand for steel is driving iron ore and steel prices to new heights. China's economic expansion, which has helped drive oil upward, has also put strains on worldwide supplies of iron ore and steel sending prices through the roof. According to the BBC, for example, the cost of steel jumped 8 percent in January 2005 alone and in China the price of steel jumped 24 percent in the same month. The demand for steel has led iron ore producers to boost their prices. ii. World Economy - cycle , expansion of economies demand more steel containing products With the growing economies, continued growth in construction, shipbuilding, and manufacturing the demand for steel and steel-containing goods, like cars and washing machines, continues to grow. Steel does have the best starting point in terms of sustainability of all materials. In terms of actual achieved rates of recycling, steel is way ahead of its competitors. In terms of the energy required to produce steel and the improvements in energy consumption achieved in recent years, steel is again ahead of the competition. iii. Addition of new markets - development of under-developed countries, present situation China opened Borders only a few years ago The dynamics of the prices will change as China's new capacity comes on stream. Global steel production rose an extraordinary 9% last year and is slated to increase a further 4.7% this year, and almost all of it is from China. China's demand for the metal has sky-rocketed. According to Asian data provider CEIC, net steel imports (total steel imports minus total steel exports) were not worth much more than $200m a month in the early part of 2000. Five years later and they had soared tenfold. This change has sent both Asian and global steel prices through the roof, and has kept producers all over the world running at full capacity. III. Factors interrupting the Economic Equalization of Pricing a. Political Interference by government imposed reglementations, Sanctions (ban on exports) Steel is a heavily traded material across the world. The US dollar is the currency for trade in raw materials and steel products. Currency exchange rates therefore play a key role in determining the trade flows. Freight rates are also an important factor; particularly since their substantial upturn in recent years. High freight rates inhibit exports unless substantial regional domestic price discrepancies exist. b. Trade Barriers Political decisions, also play their part. The US government's unilateral decision to impose section 201 safeguard tariffs' in 2002 had the effect of lifting steel prices around the world. We expect more anti-dumping cases in the future, now that China is a net exporting nation. The main reason for the current situation on the steel market is seen in high stock in the steel trade and in the steel producing industry. It is getting more obvious, that steel supply in the last year was far above actual demand. High stock weighs down on the market : The main reason for the current situation on the steel market is seen in high stock in the steel trade and in the steel producing industry. It is getting more obvious, that steel supply in the last year was far above actual demand. During the last year the growth of steel supply in the EU turned out to be twice as strong with over 6% than the actual steel consumption. In fact, deliveries of German steel producers have risen at about 8%. At the same time imports from third countries have clearly risen during the second half of 2004. In total, stock grew with approximately 4 million tones in the EU. On account of the dramatic price increases and for fear of gap in supplies, many traders (retailers) and manufactures have in the last year built up immense stockpiles. These stores are now being reduced slowly, also in order to reduce even higher capital losses. Steel availability has improved drastically, delivery periods went down. Therefore, new orders are mainly focused on the actual short-term demand. Simultaneously the dynamic of the world economic situation slackened and steel demand prognoses were reduced in many places. Worldwide, the noticeable steel consumption is supposed to still rise 3.7%, after expectations at the beginning of the year were more than 5%. In the previous year around 9% was achieved. The growth concentrates mainly on China, where steel consumption is supposed to rise 14%. As a result of this development, incoming orders of steelworks are momentarily noticeably under previous years standard. As the market is in many segments seen as oversupplied, prices got under pressure. World market: Visible price decline in the USA Extremely high stock and the in the previous year increased imports have in the last few months lead to a decline in steel prices on the US- Spot market. Experts are expecting that the momentary stock reduction may last many months and therefore also think it possible, that prices during this time will decline further. After steel prices in Asia were showing an upward trend until the first quarter, the atmosphere has lastly changed also changed here. Spot prices have in the previous weeks partly dropped and individual producers, such as the third-biggest Chinese producer Wuhan Steel or the Japanese company Tokyo Steel announced that for the third quarter there will be a price decline. Steel prices in Japan, Korea or Taiwan are being pressurised by the increasing competition from Chinese imports. The Chinese export trade of steel has in the previous year changed drastically. Just like in the fourth quarter of 2004, the country was also net exporter of steel in the beginning of the year. Experts are expecting that China will as a whole keep importing more steel than export for the whole of this year, this however on a significant lower level than in the previous years. This means, that the sold steel quantities will at least partly have to look out for new markets. The Chinese growth in demand is weakening extremely, whereas during the year new production capacities will open. Already in the first four month of the year 2005, the Chinese steel production increased approximately 25%. It is possible, that production will reach up to 340 million tonnes for the total of the year and with that it is much higher than the foretold values. Steel manufacturers announce production cuts Reacting to the changing market circumstances, individual European steel producers have in the previous few weeks announced to cut down production. The prognosis is that until autumn the worldwide stock will be reduced to the norm. At the same time the European market leader announced another doubling of profit for the first quarter. IV. Future Development of Pricing "Dent" or trend change From the steel industries we hear that from the shortest development on the steel market, we are dealing with a short-term "dent". After a weaker turnover development in the first quarter, it is expected that stock will soon normalize again and attract orders. There are already first signs for that. Due to the highly increased raw material costs, more price increases are unavoidable and will take over as soon as a more stable market will allow it. The big question is, however, when the market will be stable again. After different steel manufacturers have only a few weeks ago announced their hope of being able to put up prices in the third quarter already, it seems more realistic for the fourth quarter. Considering the momentary market situation, it is expected that spot market prices in the EU will continue falling in the third quarter. For a prognosis of the further development starting from the fourth quarter it is still too early as it depends on numerous and difficult assessable factors. It is possible, that the introduced production cuts will stabilise the market. Because of the high EU-prices, it is expected that EU imports will remain at a high level in the following months. On the international level we have will have to wait how the steel market in China and in the USA will develop. Conclusion References: 1. China and commodity markets - From accelerator to brake http://www.economist.com/finance/displayStory.cfmstory_id=4488944 2. What Chinese steel exports mean for the world http://www.moneyweek.com/article/846/investing/commodities/chinese-steel.html 3. Rise in HR steel prices seen on reduced output - Ambarish Mukherjee http://www.thehindubusinessline.com/2005/08/10/stories/2005081002860100.htm 4. http://www.meps.co.uk/ 5. Steel Market Outlook - Mike Petro http://www.oesa.org/pdf/presentations/MikePetroPresentation.pdf 6. Global Steel Industry Analysed http://www.engineeringtalk.com/news/mep/mep187.html Read More