Commodities | Nov 14 2008
By Andrew Nelson
It’s not surprising that steel prices are falling, with the global economic downturn kicking the legs out from under the demand picture. What is surprising is the pace of the decline, with steel producers now stuck with high order books, expensive inventory, limited near term flexibility and a weakening market to sell in to.
However, the broad financial market dislocations seen in September and October are not the only culprit and have in fact only exacerbated a regular seasonal slowdown in activity in the demand centres of the Middle East and China. Much of steel’s prospects for the year were based around the story of increasing demand from Asia and the Middle East, driven by construction and infrastructural expansions in their booming economies.
But the Middle East slows during the Ramadan season, while Asian activity decelerates to accommodate for the onset of monsoon season. All up, Mediterranean and Far East steel billet contracts have both plunged by more than 70% from June to mid-October.
The drop of in demand in the Middle East and Asia wasn’t the primary cause for steel’s fall, it simply exposed the underlying fragility of US and European demand. Add to this a frozen market and a severe contraction of liquidity and you’ve got the rapid lowering of global growth expectations that we’ve been looking at for the last few months. This is ultimately what caused prices to tumble.
Barclays Capital points out that November has brought some stability back to LME steel billet prices, with both contracts rising firmly back above US$300/tonne, but when you compare it to a record peak of US$1200/tonne level reached in June this year, it’s hardly anything worth cheering about. The bank also points out the price fall are not simply an LME based exchange-traded phenomenon, as billet prices in the US, Far East and Russia are all down between 38-54%.
The good news is that prices are still a long way off from their historical lows, with Barclays noting that in the recession of 2001-02, US steel billet prices fell as low as US$188/tonne.
Sure, production cuts are on the cards and the world’s largest ArcelorMittal has already announced a cut of about 35% of its production in Q4. Several other producers have followed. But Citigroup Global Markets explains that with production lead times at around 8 weeks, production cuts will not be implemented until December and will extend well into 2Q09 keeping raw material demand extremely weak though the course of 2009.
From a historical perspective, Citi thinks there might be a continuation to this short-term correction in steel prices given they have fallen through the cost floor at around US$650/t. The broker notes inventory de-stocking continues to accelerate and prices will likely stay below costs in the near-term as inventory is reduced. So while shipment levels are falling rapidly, Citi thinks North America will still end the year with almost 6 months of inventory versus a normal average of 3 months, Germany has almost 4 months versus an average of 2 months and Japan will end the year with almost 1.5 months of excess inventory versus the normal level of 1 month.
Citi was previously expecting a 2% global slowdown in steel demand in 2009 and this was at the bottom end of market consensus, but the extent and projected duration of the financial crisis and its impact on investment has increased so significantly that Citi has taken the red pen to its forecasts. The broker now expects global steel demand to drop to minus 2.6% not plus 5.4% for 2008 and to retract 4.1% in 2009 and by 2.8% in 2010 versus its prior expectation for growth of 1.1%. All in all, the forecasts imply a 13.3% absolute reduction in steel demand activity over the next two years.
To put this into context, Citi points out the worst global steel production growth phase ever that was experienced over a two years period was in 1991 and 1992 when the industry reduced production by 12% in absolute terms over two years.
Barclays Capital think that these prediction cuts, following a period of de-stocking, should help stem further price declines and will eventually support price rises once demand growth returns. In the shorter-term, this week’s announcement of China’s vast fiscal package may offer some extra hope as we head into the second half of 2009.
Economists at the British bank are forecasting a bleak beginning to 2009, with both the US and Europe projected to experience negative growth in the first two quarters, but they, like Citi, expect a small recovery in 2H09 given the expectation of a return to positive economic growth in the US and China. In fact, Barclays thinks the China story may even provide support over the near term given this week’s announcement of a shift to an aggressively expansive fiscal policy.
Ultimately, Barclays admits that the prospect for LME steel prices to reach their record prices again over the next few years is open for debate, but it thinks the days of steel billets priced at below US$300/tonne are numbered.