How Low can prices go?

High inventories and soft demand overwhelm the market and depress spot prices to 20-year lows.

By -- Purchasing, 3/8/2001

North American mills want substantial increases for sheet steel prices that have fallen to two-decade lows, but it will be a tough sell to buyers. Manufacturing plans to buy an estimated 8.5% less steel sheet this year, but service center inventories remain high and imports haven't exactly disappeared.

Typical is the view of Harold Fox, director of commodity purchases at Frigidaire Home Products/Dishwashers in Kinston, N.C., who sees hot-rolled sheet slightly lower at midyear and cold-rolled sheet and coated sheet tags level with current prices. "I'm not aware of any sheet steel products that are in short supply," says Fox.

In fact, market data shows that stocks still are in excess at the distribution level. The sheet market entered 2001 with an inventory overhang of 9.8 million tons-3.8 million at service centers and six million tons with processors and OEMs. Sheet steel use edged ahead to 61.3 million tons from 60.9 million tons in 1999. Supply, however, nudged ahead to 71.1 million tons from 70.6 million tons the year before. So, the sheet inventory overhang was 9.7 million tons at the start of 2000. Of that, 3.7 million tons was stored by service centers while processors and OEMs held six million tons.

Demand for sheet steel this year is forecast to drop to 56 million tons. And without a dramatic cutback in mill shipments and imports and a reduction in stocks held by end users, processors and distributors, analysts fear the supply excess could grow to 10.5 million tons. And that's why "steel prices have been the major focus of just about everyone in the sheet market," says analyst Tom Runiewicz at the WEFA Group in Eddystone, Pa., "especially since sheet prices continue to be on the skids."

During much of 2000 steel sheet demand was healthy. "However, we have been in a rapidly changing transition period since the fourth quarter, and the stage has been set for a much different 2001." He suggests that "it will take a long time for the industry to work it's way out of the issues of lackluster demand, high import penetration, extreme competition and, therefore, weak prices." Analyst Charles Bradford at Bradford Research in New York agrees that "steel customer inventories are too high for projected short-term demand."

"Prices have fallen off the shelf and presently are probing unexplored depths," says analyst John Anton at Standard & Poor's DRI in Washington. So, in an attempt to halt the slide, the mills want to raise hot-rolled sheet tags to $260/ton in March, from $220 in February, and to boost cold-rolled and hot-dipped galvanized sheet to $350 from $320. "If nothing else, the price hike announcements are an attempt to set a floor on sheet prices," says Steve Rogers, vice president of sales and marketing at Ispat Inland Steel Co. in Chicago.

Yet, a new PURCHASING survey of OEM buyers finds 76% forecasting prices as flat to down at midyear. And even a steel mill sales executive admits that the attempt to boost transaction prices on flat-rolled carbon steel products in March probably won't take effect until June shipments. Reason: Hot-rolled steel sold to service centers and processors for February deliveries had fallen to $190-$195/ton from $200 in January, while cold-rolled sheet was sold at $300-$310, down from $340. That's because of a surge of lower-priced sheet imports into West Coast and Gulf Coast warehouses in January and February, which put further downward pressure on March and April prices.

Why such low prices

Last April, PURCHASING reported: "The steel sheet marketplace is sizzling. Domestic mill orders are rising, imports are declining, leadtimes are extending and spot-market prices are rising." In truth, with strong demand, steelmakers had great hopes for sheet steel prices in 2000 and scheduled a series of price increases. That optimism had fizzled by midyear, however, as demand began to wobble. Last June, the phones simply stopped ringing at the inside sales offices.

Inexplicably, despite widespread knowledge that buyers had committed to too much tonnage in the first half, domestic rolling mill shipments and imports stayed strong. Analyst Anton at Standard & Poor's DRI says "as the mills boosted prices and then production, they planted the seeds of their own destruction." Market transaction prices fell continually after April's peak, and inventories rose as orders continued to slow from the crucial automobile and construction markets. "The high domestic prices early in the year pulled in imports, leading to large surpluses and ballooning inventories," he adds.

Production at steel factories finally dropped to about 65% in the last few weeks of 2000, the lowest level in 30 years, but they had been up to nearly 95% of capacity in the summer. Also, historic spikes in natural gas prices saddled the energy-hungry steel mills with huge power bills. With market prices falling, steel companies' margins took a beating. By the fourth quarter, sheet and plate producer Gulf States Steel of Gadsden, Ala., had shut down and sheetmakers LTV Steel of Cleveland and Wheeling-Pittsburgh Corp. of Wheeling, W.Va., had filed for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code.

Most of the nation's biggest steel sheet mills posted heavy fourth-quarter losses. "The devastating combination of continued high steel import levels and a slowing domestic economy resulted in significantly reduced order levels, operating rates and shipments," notes Thomas J. Usher, chairman of USX, the parent of U.S. Steel, "and sheet prices that were among the lowest in the past 20 years." The first quarter hasn't been much better, financially, for the mills. Manufacturing in the U.S. automobile, light truck and automotive parts sector is expected to see a 10% decline in 2001. First-quarter cutbacks in motor-vehicle assembly have reduced demand dramatically for cold-rolled and galvanized sheet.

"It's still a pretty ugly market," says a service center executive. "Sheet hasn't moved very much lately since sales have been quiet. So, the inventories are not getting chewed up very much." Underscoring the price weakness for hot-rolled and cold-rolled sheet products, growing competition among tubing manufacturers and other processors are pushing them to demand even lower prices from the steel mills on coil feedstock.

"And we are becoming increasingly concerned about the outlook for galvanized prices given the recent announced cutbacks in auto production," says analyst Anton at Standard & Poor's DRI. "The construction industry and the car companies are the major buyers of coated product. With the slowdown in automotive assembly ahead, we expect the spread between hot-rolled, cold-rolled and galvanized to come down over the next three to six months."

Analyst Mike Gambardella at J.P. Morgan Securities Inc. in New York says that "more normalized purchasing patterns among steel-consuming industries" may become evident this quarter. "Since the inventory reduction phase began last May, many steel consumers and producers have worked hard to bring down inventory to more manageable levels, and some companies currently are procuring steel on a 'hand-to-mouth' basis," he explains. "With imports declining and domestic supply thinning out, such purchasing habits aren't sustainable, especially if demand begins to show signs of recovery. While a 'return to normalcy' won't increase producer price realizations in the near term, it is the first step to a more sustained price recovery in May-June."

Imports aren't the issue

"The U.S. mills believe that there has been a focus to export by many major foreign producers who have capacity far in excess of home market demand," says analyst Runiewicz at WEFA . " As a result, they believe foreign mills have targeted the U.S. and gained market share by dropping prices substantially." That's why every domestic sheet mill has blamed low steel prices on foreign competition.

However, last year's sheet imports of about 10.5 million tons was almost two million tons less than in 1999. The import share dropped last year to 14.6% from 17.2% the year earlier. On the other hand, domestic mill shipments rose by more than 2.5 million tons from 1999 to 61 million tons. Imports of sheet products actually peaked in 1998 at 13.4 million tons and 19.8% of that year's market.

Still, the dollar is strong, which hurts domestic producers by making them less competitive with foreign rivals who continue to have a financial incentive to ship sheet steel into the U.S. In fact, the continued slump in cold-rolled sheet prices nationally has raised speculation that domestic mills may file another set of anti-import trade complaints. That's despite the lack of success by the mills with their earlier round of complaints in 2000 and the recent decision by the International Trade Commission to remove duties imposed earlier this decade.

Atop that, a review of Census data shows that last year's sheet steel import prices actually were flat-to-higher, depending on grade, when compared with 1999 prices. Upshot: The domestic mills were their own worst enemies last year, pushing excess product out of rolling mills and cutting prices in the second half to maintain cash flow and market share in a weakening and glutted bazaar. Analyst Bradford at Bradford Research says that "customers have consolidated to strengthen their purchasing power and foreign competitors have consolidated to reduce costs, yet the consolidation that the U.S. steel industry so clearly needs has yet to occur."

Note that the U.S. International Trade Commission (ITC) has revoked duties imposed in the mid-1990s on cold-rolled steel imports, while keeping most duties on coated sheet steel in force. The commission's decision is part of a sunset review vote on trade cases dating back to 1992. ITC decided to lift existing dumping duties on cold-rolled carbon steel sheet products from Germany, South Korea and the Netherlands, and to lift existing countervailing duties on imports from Germany, South Korea and Sweden.

ITC also decided to maintain existing dumping duties on imports of corrosion-resistant zinc-coated steel flat products from Australia, France, Canada, Germany, Japan and South Korea, and existing countervailing duties on products from France, Germany and South Korea. However, analyst Bradford of Bradford Associates says that "with all the new coating capacity in the U.S. and the fierce competition between the domestic companies, it is hard to believe that importers really have much impact on the market for coated steel." He points out that "coated steel prices actually seem to have held up better than other flat-rolled steel prices during the past few months when hot-rolled prices tanked."

Automotive throttling down

Automotive is the largest market for sheet steel-with sales of hot-rolled and cold-rolled sheets that can be specified as mild, high-strength, ultra high-strength, bake-hardenable or coated-with zinc (hot-dipped galvanized or electrogalvanized), aluminum (aluminized) or paint (coil coated). A pleasant surprise for steel suppliers over the past three years was the surge in automotive production to an average 15.5 million motor vehicles-including medium- and heavy-duty trucks-in the U.S. and Canada between 1998 and 2000.

The slowing U.S. economy has hit the Big Three automakers pretty hard. U.S. auto sales for 2000 set a new record of 17.4 million cars and light trucks, an increase of almost 3% from 16.95 million sold in 1999. But, instead of celebrating, the Big Three are forecasting a slowdown in sales to 15.5 million tons, and are reducing motor-vehicle assembly.

Automotive's steel demand, therefore, is likely to drop dramatically-since motor-vehicle production is being forecast in some economic circles to slip under 14 million units in 2000. And that could cut as much as 2.3 million tons of steel from the Big Three's purchasing plans this year.

General Motors Corp. says first-quarter North American production will fall by 21% from the same quarter of 2000. At a recent North American Auto Show press briefing, GM executives noted that "the overall reduction reflects moderating near-term demand due to economic and consumer uncertainty and relatively higher-than-desired dealer inventories." The GM cutbacks are similar to the announcements from other U.S. automakers-Ford Motor Co. and Chrysler Corp.

Other sheet-steel-using sectors-including office equipment, appliances and construction materials-also have had a healthy steel appetite for the past several years. That's because consumer confidence has been positive and durable-goods spending has held up. However, the Consumer Confidence Index tracked by the Conference Board of New York fell in January for the fourth consecutive month as consumers have become less confident about both the current and short-term economic outlook.

Analyst Runiewicz at the WEFA Group suggests the non-automotive sheet-steel-buying outlook will change this year in different patterns-depending on their individual cycles and business patterns. Machinery production, for example, is expected to keep growing-although probably not at the 5% rate that has marked activity for both the electrical equipment and non-electrical equipment sectors. Runiewicz also sees a slowdown in production and sheet steel demand growth in both the fabricated metals and appliances sectors. He doesn't see a continuation of the 2% average annual growth in fabricated metals-or a continuation of the 3% average annual growth for appliances.

On the other hand, the combined public and commercial construction industry could explode this year and spur solid demand growth. Over the past 10 years, he says, the combined public and commercial construction industry has only grown by less than 2% annually. However, the Transportation Equity Act for the 21 ^st Century has altered WEFA Group's forecast. With $217 billion to be spent on public construction projects, the entire non-residential sector is expected to see almost a 2.5% average annual growth this year-and through 2004. Commercial construction also is expected to be healthy this year, he says, although the non-residential outlook is hazy after that.

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