Steel boom set to end: Headwinds around the corner

DEMAND-SUPPLY MISMATCH: Since 2002, steel has entered a cycle with substantial demand-supply disequilibrium. Global steel prices galloped to $1,134 a tonne in June 2008 from $691 in June 2007.

Lakshmi Mittal of Arcelor Mittal believes that supply constraints and strong demand would put a firm floor under prices and profits for the steel industry until at least 2011. It is expected that the world would have to find another 50-75 million tonnes of steel capacity every year for some time.

Being a core sector, the steel industry's fortunes are inextricably linked with world economic growth. Consistent with gross domestic product growth rates in India and China, the sector has been witnessing rapid growth in recent times. Since 2002, steel has entered a cycle with substantial demand-supply disequilibrium. Global steel prices galloped to $1,134 a tonne in June 2008 compared with $691 a tonne in June 2007, amid higher iron ore costs (the main raw material) and growing concern about large carbon emissions by steel plants. Most steel firms have increased prices by a rate greater than their own cost increases.
However, of late, we are beginning to see steel price corrections of 15-20 per cent across the world. Asia is a major source of growth in steel demand and its bankers, at present, are fire-fighting inflation. If they go for the overkill, it may upset the applecart and bring back grim reminders of the industry's inherent cyclicality.
According to steel guru Peter Marcus, managing partner at the US consultancy in World Steel Dynamics, global steel prices are set to fall steeply in 2008, bringing an abrupt end to a boom for the world steel industry. Marcus says he is "overwhelmingly negative" about the outlook for steel prices in the remaining months of 2008, after a 12-month period in which steel prices have increased by more than 60 per cent, even in the face of a slackening global economy. He says the sector could be on the brink of a "supply/demand disaster" due to an upswing in global steel production coinciding with uncertain consumption, as credit problems and weak consumer and industry demand finally feed through to steel plants.
Ralph Oppenheimer, chairman of London-based Stemcor, the world's second-biggest steel trading firm, says strong demand from developing regions will keep prices firm for a few more years. Meps, a UK steel consultancy, believes prices will stay fairly stable until the end of 2008. Credit Suisse estimates that for prices to collapse, Chinese economic growth would have to drop below 7 per cent and demand from the rest of the world would have to drop to 1 per cent from 7 per cent. Most observers find this scenario rather unlikely.
In the light of commoditisation of steel and demand destruction that is becoming visible, ArcelorMittal is moving towards the "high-tech sectors" of the steel industry by attempting to take control of Dillinger Hutte, a German steel supplier. Hutte is a high-tech steel plate maker for industries ranging from pipe-making to nuclear generators.
Global steel giants are likely to maintain their pricing power by cutting production. However, demand destruction in the developed world is playing spoilsport.
Global annualised steel production has reached a record 1.4 billion tonnes, up from 800 million tonnes in 2000. Construction activity in emerging markets, which account for over 75 per cent of global consumption, has been driving the price of steel over the past few years. It is expected that there will be continued buoyancy and capacity constraints for steel in the oil, shipbuilding and gas industries.
West Asia is a strong market for the steel industry, growing at a rate of 3.2 per cent per annum. The demand is strong for construction steel, required to help build mega property projects, such as The Palm Jumeriah, the Burj Dubai and Dubai Marina. A continuing healthy demand for steel is expected due the construction boom in the region.
Other than Dubai, the next five years will see rapid growth of new property markets in Saudi Arabia, Qatar and Abu Dhabi. Saudi Arabia has not commenced construction on any of its major master plan projects, which will add some 500 mt per annum to the country's steel requirement over the next three years alone.
India will be one of the world's fastest growing economies and producer of steel over the next seven years. The country accounts for 50 mt of steel which will double to 100 mt by 2015, driven by a huge demand for industrial steel. More than half of the world's steel consumption has occurred since 1980 and production is forecast to reach 1.2 billion tonnes by 2020.
According to Meps, net exports (exports minus imports into China) from China of steel to all other countries will be just 34 mt in 2008, way down from the 51 mt recorded in 2007. This has helped fan fears in the steel industry that a surge in exports from China's big steel producers could depress steel prices.
North America remains structurally short of steel. With shipping rates high and several foreign producers, such as Russia's Severstal and ArcelorMittal involved in US consolidation, the incentive to disrupt the market with extra supply from overseas is slim. China, now that the Beijing Olympics are over, is slowly returning to the world steel exports markets. After Indian elections, the new government will have lesser incentive to exert pressure over steel companies to cap prices.
As steel prices are allowed to rise, we could near an 'inflection point' where the demand destruction for steel gets more durable. Substitutes, such as titanium, in industries like aerospace and automobile (where lighter substitutes are being employed to counteract sharp steel prices) would also have begun to make their dent in steel demand by then. It is, therefore, likely that the current downturn in steel prices could become more durable after September 2009.