June 4, 2008
Amid Slump, Nerves Of Steel

Executives of U.S. steel-producing companies are maneuvering through challenges that might have panicked even the most hard-bitten 20th-century steel barons.

The cost of raw materials for steel production has more than doubled in the past year and is projected to keep rising. At the same time, a weak U.S. economy has slowed demand for steel among auto makers and construction — two of the industry's largest customers.

In the past, this would lead to a classic squeeze between falling sales and rising costs.

"Usually, when cyclical industries face a recession they lose volume, and they have problems passing through costs with higher prices," said Charles Bradford, steel analyst with Bradford Research. "That's always been the case."

Not this time. Less than a decade after a slumping market that saw about 40 steel makers, processors and distributors file for bankruptcy protection, the industry is posting record sales and profits — with few signs of slowing.

"Our second quarter has the potential to be the best ever of any quarterly performance in the history of our company," said James Wainscott, chairman, president and chief executive of AK Steel Holding, (AKS) during a conference call with analysts after it released first-quarter earnings on April 22 that beat views.

In a conference call after Steel Dynamics (STLD) announced its results the same day, Keith Busse, chairman and chief executive, put it more bluntly.

"To say it was a very good quarter would be an understatement," he said.

Strong demand for steel from China and a weak U.S. dollar are two big reasons why.

The impact of rising demand is obvious. But a weak dollar also has led to lower imports and growing exports, benefiting U.S. suppliers the most. Imports so far this year are down about 8% to 9%, but exports are up 18%

1. Business

It starts with raw materials. Steel makers need iron ore, coking coal, zinc, tin and other metals for making the various grades of steel products.

Others rely on steel scrap. This usually comes from manufacturers and industrial plants as a by-product of metal manufacturing. Other scrap comes from auto wreckers and demolition firms.

The materials toast in hot ovens and then head to blast furnaces or electric arc furnaces until molten hot.

It then is shaped into rolls, tubes, rails and other forms.

From there, it has shipped to steel processors and service centers that act as intermediaries between primary steel producers and the many end-user manufacturers that require further processing. The steel processors and service centers further treat and cut steel products to various lengths and shapes.

One challenge facing steel producers is the costs of raw materials have soared in the past few years. Unusual weather conditions in Australia, South Africa and China this past year affected iron ore mining, helping fuel the price spikes.

The good news: Global demand for steel is strong, and inventories are low. That has allowed steel producers to hike prices, more than offsetting the rising cost of materials.

Sales of steel products are influenced by construction activity, which is affected by cyclical factors such as economic conditions, interest rates and consumer spending. It is a commodity that responds to the forces of supply and demand.

Name Of The Game: Aggressive research and development programs, a focus on energy efficiency and stable access to raw materials and scrap steel will keep furnaces running profitably.

2. Market

Nonresidential construction is the largest customer for steel producers, accounting for about 30% of sales. The automotive industry is second at about 20%.

Both are hurting. New U.S. vehicle sales in April were expected to drop 2.2% from a year ago to 1.3 million units. That also is down 3.7% from last month, according to

Nonresidential construction across the U.S. is slowing as well, according to billing figures from the American Institute of Architects.

But the slack in U.S. demand is more than being made up by heavy consumption in China and other developing countries. Globally, steel prices have risen steadily because producers aren't making enough to meet demand.

"The global supply situation for steel is as tight as I've ever seen in 15 years of covering this industry," said Mark Parr, an equity analyst with KeyBanc Capital Markets. "The industrial momentum in Asia is creating demand at a faster pace than supply can keep up with."

The price of hot-rolled coils, which ultimately end up in cars and appliances, now cost about $900 a ton, up from $532 in the fourth quarter, according to Bradford Research.

China has become the largest steel producer — and consumer — by a large margin. Excess capacity could hurt prices if China exports steel to other markets.

According to the International Iron & Steel Institute, crude steel output reached 1,343 million metric tons in 2007, up 7.5% from the year before. It was the highest level of crude steel output in history and the fifth consecutive year of growth above 7%.

China's steel production rose 18.8% to 489 million metric tons in 2007 — 36% of total output. Without China, world crude steel production would have grown only 3.3%.

3. Climate

The weak U.S. dollar has benefited U.S. steel producers by making imports from rivals more expensive and exports more attractive to foreign buyers.

So far, the market is accepting the higher prices because inventories are low at service centers and global demand is high.

"We remain optimistic for the second half of 2008, given continuing strength in global steel demand and pockets of strength in the North American market," said Andrew Sharkey, president and chief executive of American Iron & Steel Institute.

Even if conditions worsen, the industry is in better shape than in times past.

Once highly fragmented with a very capital-intensive cost structure, the steel industry consolidated in the last downturn through a series of bankruptcies and mergers. It also lowered costs by renegotiating labor contracts.

That result: more flexible operating structures and fewer competitors. That has helped the industry adjust production more quickly as demand fluctuates.

"It's evolved into a highly profit- driven industry that is able to protect prices even if means producing fewer tons," KeyBanc's Parr said. "It's the most remarkable change I've ever seen."

4. Technology

U.S. steel producers spend more than $4 billion in advanced control systems and services each year. That's one reason why steel productivity has tripled since the early 1980s.

Domestic suppliers also are investing in the creation of advanced high-strength and lighter-weight steels for automakers.

The developments come just in time. The Department of Transportation is requiring automakers to make cars that get 35.7 miles per gallon on average by 2015, a 25% increase over current fuel-economy standards. About 60% of vehicle weight is steel.

Technology also is improving recycling efficiency.

Steel is the world's most recycled packaging material, according to the International Iron & Steel Institute. In 2006, 6.6 million metric tons of steel cans were recycled, a recycling rate of 67%, preventing approximately 11.9 million metric tons of carbon dioxide from being released. About 80% of steel used in construction today comes from recycling.

5. Outlook

The IISI sees another strong year for steel consumption, forecasting a 6.7% jump to 1.2 million metric tons. In 2009, IISI predicts 6.3% growth.

"The underlying assumption behind this forecast is that although some weakening in the U.S. and Europe is expected, demand for steel will remain healthy — thanks in part to the emerging markets which will maintain their own dynamism," IISI Chairman Ku-Taek Lee said in a prepared statement.

Steel consumption in the U.S., Canada and Mexico fell 9.1% due to a slowing economy and excess inventory. The IISI forecasts U.S. consumption to grow just 1.9% this year.

Upside: Global consolidation has helped steel producers adjust to the industry's boom and bust cycles. As long as demand for steel in China and other emerging economies stays strong, the industry should roll along.

Risks: An economic slowdown in China, coupled with an expansion of its already-mighty steel production, could weaken steel demand and prices.

A stronger dollar, meanwhile, could change the equation for U.S. producers.

That would make steel exports more expensive and boost the U.S. market's appeal for foreign competitors again.

"If the dollar strengthens, the game is over real quickly," Bradford said.

Source: Investor’s Business Daily, May 5, 2008

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