Marcus: World steel industry is in a “rutted road”

During the SteelOrbis fall 2012 conference & 67th IREPAS meeting held in Munich on September 30-October 2, Peter Marcus from World Steel Dynamics (WSD) has assessed the current situation in the world steel industry and provided an outlook for the days to come.

Can you please explain services provided by World Steel Dynamics in brief?

WSD is a strategic information service and we put spin on information and we try to tell people where steel industry is going in the near and longer term basis. We have 15 people and we put out a whole ray of different reports, which serve the market. We're also involved in consulting and we work with investment bankers.

We have a wide variety of reports, including but not limited to "Early Warning System", "Production Costs", "Steel Strategist", "Capacity Surveys" and "Steel Prices and Demand".

In terms of our limited edition reports, we have our global steel information system and we provide monthly online interactive reports that give process-by-process analysis of steel plants, iron ore mines, financial results.

So WSD offers a conceptual framework for the industry: How is it evolving, and then we offer views on the structure of the industry on near and long terms basis, so we have concepts like "the industry may enter an age of discontinuity" and "the world has been in major changes in structure and heading to a new continuum in a whole ray of things."

If we talk about the world steel production. How do you see the outlook for global steel production?

We think that the steel production this year will increase by only about two percent and in the fourth quarter will be declining. We also think that next year world steel production will increase by a small margin.

Right now we are actually in trouble all over the world. We still see growth in countries like India and Brazil, but we have new issues in China. The US prices are actually falling and we know about Europe and we know about Japan. There's a global malaise in the present time.

What do you think is the reason?

We have a concept called the fixed asset investment flywheel. If you look at fixed asset investment activity in a quarter, in China maybe only 10 percent of that activity was initiated in the last quarter and 90 percent earlier and outside of China perhaps 25 percent is initiated in the last quarter and 75 percent earlier. So, as capital appropriations by governments and enterprises are diminishing outside of China and slowing in China, the flywheel is slowing down and this is probably why steel demand outside of China will be up only moderately this year and could be very well be flattened down next year.

And in China?

In China, they are 60 percent in bigger trouble than people realize and the country may see only a minor growth in demand next year. With 40 percent government spending and overcoming some inventory liquidations across the industry, they may do better next year. So China is a very iffy area, means prices may trend upside, but perhaps it's going to be another rough year in China.

How will newly announced investment program affect Chinese economy?

China's GDP is something like $78 trillion a year, and roughly half of that is gross fixed capital formation, which you can also call adjusted fixed asset investment. So the amount of programs that have been announced relative to the size what they have been spending on moderate, it's certainly a sign that they are seeking to stimulate fixed asset investments. But they are running into certain problems, such as... municipalities are major sources of stimulation of investments and land sales by municipalities are down and borrowings by municipalities are way up. And consumer sentiment about housing is not as positive and new housing starts have not been going up as much. Even the backlog may have gone up because of the flywheel effect. So one has to take a very close look at China.

I go to China once or twice a year for many years. We employ two Chinese people, one is on the ground in China and the other one has been in our office since 2004 and he is a professor of China Iron and Steel Association (CISA). And I have variety of contacts in China, who I'm speaking very often. So we put out a major effort on China, we are monitoring what is happening there and where it's going. And we are publishing each year a thick core report, including data about capacity change. And we have also reports on cost curve for hot rolled band plants, and we have a new report about wire rod mills and Chinese mills are included. We have a forthcoming report on iron ore. All will be online, interactive and will include substantial detail about China.

How do you see the outlook of the iron ore market?

In general we think there's a lot of supply coming on and we think that iron ore production costs in China are much higher than in most other countries, may be $100/mt on average, but not $115/mt. And we believe that the iron ore production in China is importantly a function of what steel mills want to buy and perhaps less a function of the price. So steel mills want to cut inventory and not buy, the production would drop. So we think that their iron ore production this year would not go up much, as steel mills are cutting production and we think that the big decline in iron ore prices has calmed down. I'm in the view that the Chinese steel production is probably heading down, and it means less production also for iron ore. But we don't think that it will deliver 450 million metric tons of concentrate high upgraded iron ore this year. If the price slips, it will go back down to 400 million metric tons. So we think there's a lot of oversupply in the marketplace and we think that Chinese demand is growing only moderately. My forecast is that iron ore price delivered to China next year may average $95/mt for 62 percent iron content. So that would be about $20/mt less for 75-80 percent sinter feed FOB Brazil. And then for iron ore pellet, which is typically $30/mt above of the price of sinter feed, we think that the price of premium may slip by about $15/mt.

Do you think it would also affect the price of scrap?

Traditionally scrap price is impacted by pig iron, a little bit by the price of steel scrap substitutes, by the costs for the mill to produce pig iron compared to cost of scrap and spot international iron ore and coking coal prices have also become important in the past few years. So scrap will be impacted also by exchange rates, regional demand, by coking coal, iron ore and pig iron prices, as well as freight rates. And in general we think that scrap price, after a fairly sharp recovery following a deep drop, now is dropping sharply again and next year it will be lower than they are today globally.

In WSD, for scrap price, we multiply the cost of iron ore delivered to China by 1.6 and cost of coking coal FOB Australia by 0.6 and we add the incremental pig iron operating cost for a typical global steel company, which is about $50/mt. And from that, the degree of the scrap price varies from the production costs will influence our view as to what may happen to the scrap price. That's one of many factors. Another factor is that when the scrap price goes higher, scrap collection volume increases, and when scrap price goes down scrap collection volume diminishes.

Another very important factor is that scrap generation in China will be rising as the reservoir for 40 year old scrap going up sharply and that will increasingly have an impact in the future. Currently there is 40 percent export duty for both steel scrap and metallurgical coke. I suspect that export duty for metallurgical coke may be eliminated since the World Trade Organization may warn China that this duty is illegal.

Scrap price is affected also by rebar, wire rod or HRB prices

Marketplace in any industry and for sure in steel industry is the function of the structure of the industry and the ability of different mills in different points of the cycle to pass on their costs. So with the production costs dropping around the world on the margin due to lower iron ore, coking coal and scrap prices, we think that these will be reflected in prices. So versus the current price of about $540/mt FOB for hot rolled band (HRB), we are forecasting that next year this price can be about $500/mt FOB next year. Since costs are lower, that does not mean that producers will do worse.

What do you forecast about world steel market in the days to come?

WSD has three scenarios for different steel industry conditions in the remainder of

2012 and in 2013. The first one is the Open Road scenario, where global steel demand may grow by three percent. The second one is Driving-Over-the-Cliff scenario where demand goes down. And the last one is Rutted Road scenario, in which the steel industry's bus (with a Chinese steelmaker at the wheel) is traveling, is immersed in deep fog and interspersed with deep crevices. And we think that in the next five years, there are good odds for this scenario, where the annual demand growth will be perhaps about 0.5 percent. After four or five years, as the restraints on growth will be overcome, with crisis in the Eurozone and the US are overcome, then world may grow rapidly. But until then, there will be tough years, especially for steel producers.