Steel scrap prices still troublesome

Optimism levels of metals buyers are at 17-year lows. Yet, except for price, customer service ratings for mini-mills are still high. Did metals users overbuy in 2004?

By Tom Stundza -- Purchasing, 1/13/2005

The sourcing manager for a turbines and control systems manufacturing plant in upstate New York had trouble at times last year getting mini-mill steel products delivered when promised. He was annoyed, he says, mostly because transaction prices had nearly doubled. He wasn't alone. The entire marketplace was traumatized by the explosion in steel-scrap costs and finished steel prices that was exacerbated by the fact that import levels were down from past years and domestic electric-arc furnace (EAF) steelmakers were operating at close-to-effective capacity.

"There have been challenges for sure," says T. Joe Crawford, president of Roanoke Electric Steel in Virginia, "especially be-cause of the dramatic increases in the cost of scrap metal." So, while the steel mills have raised selling prices over the past 15 to 18 months, he is just one of several industry insiders who wonder "how far can you go in raising prices before the buyers totally resist them or the pricing action opens the market to foreign competition."

Several market analysts actually believe that time has come. "We believe that there was an inventory correction occurring in the fourth-quarter, with service centers and steel users reducing their orders for steel to reduce their inventories," says Charles Bradford, president of Bradford Research in New York. And imports have been increasing monthly, making steel prices "soft," he says. That's why some analysts suggest the mini-mill industry's peak-cycle earnings (and pricing) probably occurred in the third quarter of 2004. Steel scrap prices fell throughout the final quarter and, Bradford says: "The drop in the scrap price is a good indicator of [weaker] steel demand."

Looking ahead to 2005, mills say demand will grow by another 10% , after rising 25% last year. But analysts say that consumers of steel, for a good chunk of time last year, were ordering more steel than they were consuming—and now have to work down that stockpiled metal.

It's also now apparent that the end-use markets were never as strong as some mills were reporting to Wall Street. "It made no sense for the service centers and some mills to be reporting shipment gains above 20% when one-half of the steel market (automotive and nonresidential construction) was either flat or down," says Bradford. "The rest of the economy just wasn't that strong, either. Thus, the inventory building."

Then there are the buyers, who generally remain dour about: the lack of traction in the metalworking recovery, their need for steel in coming months, the level of steel prices and attempts by some mills to boost them again in the first quarter.

And disregard the rosy economists' view of the first quarter economy—the optimism level of metals buyers polled by PURCHASING Magazine in December was at a 17-month low. Also, the outlook for steel buying was the weakest since July of 2003.

Not surprisingly, steel costs were a big issue amongst the buyers. "There's a lot of room for improvement in business," says the supply management director for a Michigan machinery company, "yet the price increase proposals continue to flow in."

Scrap prices are notoriously volatile in metals, but the gyrations in the market the last couple of years have been completely unprecedented and created severe economic problems for steel producers who rely on scrap as their principal raw material. For example, accountants at Nucor in Charlotte, the largest mini-mill company, say that average scrap and scrap substitute cost/ton used increased 73% from $130 in the first nine months of 2003 to $225 in the first nine months of 2004.

At its current price, scrap may account for as much as 75% of the production cost for hot-rolled coils, bars, rods and beams, says analyst Bradford. And that's why other analysts, such as Peter Fish at MEPS (International) in Sheffield, England, believe that the mini-mills have lost some of their traditional cost advantage over the integrated (iron ore-based) steel producers. "But because of perceived strong demand for steel, the mini-mills didn't have any real difficulty in passing higher scrap costs onto customers, either through surcharges or by adjusting their base prices or both."

Keith Busse, president of Steel Dynamics in Fort Wayne, Ind., acknowledges the progress that the integrated mills have made in reducing the man hours required to produce a ton of steel from over four to less than two. But that still doesn't compare to the one-quarter man hour/ton that Steel Dynamics expects to have achieved when 2004 results are audited. And he insists that EAF-based companies will continue to maintain their intrinsic cost leadership. "We have greater operating flexibility, our capital costs are lower, and we have a superior operating culture."

Interestingly, steel buyers, in general, have been grousing in PURCHASING surveys for some months about late deliveries and quality rejections of high-priced mill products. But, it's evident from their survey responses and follow-up interviews that most of the complaints have stemmed less from service issues and more from the hikes in mill list prices and the calculations used to determine scrap, iron ore and energy surcharges.

Also, it's hard to pinpoint whether the complaints are aimed at integrated (blast furnace-based), EAF mills or both. A mini-mill executive insists in an e-mail to PURCHASING that "our customer ratings have [been] at the same high levels as in the past in all categories except price, where we havefallen substantially." That shouldn't come as a surprise, considering the fact that transaction prices for a market basket of mini-mill steel products increased by almost 70% in 2004 above 2003 averages.

"Granted, there were some difficult times during the year in the mini-mill marketplace caused by the volatility of prices—scrap for the mills, end products for the customers," says Thomas Danjczek, president of the Steel Manufacturers Association (SMA). "But, the industry believes the vast majority of its customers were satisfied overall with delivery, quality and fitness for use of the sheet, plate, bar, light structural and rod products sourced from the mini-mills."

According to Danjczek, the continuous fault-finding by some buyers responding to PURCHASING's monthly poll doesn't correspond with independent surveys of mini-mill supplier satisfaction by Jacobson & Associates. That customer satisfaction poll has been surveying 2,500 steel buyers periodically throughout every year since 1994—and constantly rates the electric-furnace steelmakers as high-quality suppliers.

One mini-mill steelmaker insists that its customers "were extremely satisfied with our performance in delivery, quality and service. Our reject rate is far lower than it has ever been. Over the past year, we delivered 98% of orders within the week promised. But he admits that "with the strong demand we encountered this meant customers didn't always get what they wanted when they wanted it but they did get it when we promised."

Similarly, "our quality-related claims and complaints for 2004 are at all-time lows." says Don Daily, president of Gallatin Steel in Ghent, Ky., a joint-venture between Dofasco of Canada and Gerdau Ameristeel of Tampa, that manufactures hot-rolled sheet in coils from recycled steel. Daily says the mini-mill "recently received high accolades from Jacobson & Associates on quality, delivery and service when compared to our direct competitors and compared to all 29 North American flat-rolled mills."

"In any event," Danjczek says, "what 2004 taught all of us in the mini-mill sector—whether scrap dealers, EAF mills, service centers or customers—was the importance of relationships." Since successful mill relationships with customers tend to rely on a combination of price and service considerations, some mini-mills probably do have relationships in need of repair this year. But, the SMA executive insists that, while still not perfect, "the mini-mill/buyer interactions are better today than earlier last year."

Several EAF steelmakers, for example, went from quarterly bookings to monthly order-taking to better match and adjust shipments to orders. And there are reports of more-intensive market investigations because of the uncertainty surrounding the 2005 activity in automotive, general manufacturing and major appliance assembly, and building activity—especially the nonresidential construction arena.

That may explain why so many buyers appeared content to sit back and wait out the fourth quarter, using up the steel they already had in stock before coming into the market for more. In fact, only 29% of mini-mill steel buyers planned to make purchases in December—the lowest percentage since June 2003 (27%).

Crawford of Roanoke Electric Steel pretty much speaks for the industry when he talks about the establishment of new record levels for sales and net earnings in 2004 "primarily due to increased shipments and margins for mill products, attributable to increased selling prices." He adds that "a number of production and shipment records were also set during the year to help meet our customers' needs."

Danjczek insists that members of SMA, the mini-mill producers, are making major efforts to improve competitive capability and service efficiency. Having grown from supplying just 10% of total domestic production three decades ago to 50% today, he suggests the future of U.S. steelmaking belongs to mini-mills.

The idea, he says, is to mesh with the supply sector's interest in having high quality steel delivered to customers fast and at competitive prices. However, buyers need to remember, says another mini-mill executive, that "long-term, good customers are taken care of first. Customers that haven't been loyal to us, or new customers, came last in the scheduling scheme."

This is important when buyers are dealing in a steel sector undergoing radical change. Companies such as Nucor and Steel Dynamics are getting bigger while companies such as Birmingham Steel, Georgetown Steel and North Star Steel are disappearing—being absorbed by the bigger players. Still, Dan DiMicco, the CEO of Nucor suggested at a recent industry conference that the newly restructured U.S. steel industry is creating healthier profit-driven—rather than survival-driven—competitors in both the integrated and mini-mill sectors. "Buyers have to realize that healthy, fair competition will make mini-mills better," DiMicco says. "Our culture, our people, our relentless pursuit of excellence, and our willingness to take risks and develop new technologies will make mini-mills better."