Global Steel Q3 Quarterly Toxic Mix: Peak Costs and Softening Demand Citi

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Global Steel Q3 Quarterly
Toxic Mix: Peak Costs and Softening Demand
 Production cuts needed soon — After a ~25% correction in spot steel prices since
end-May, mills are attempting to bring back confidence in the market by raising prices.
Our measure of aggregate steel demand — steel weighted IP — is till positive, but
running at 84% lower than June-10. We expect further deceleration as July and August
data points emerge. Our conclusion is that steel mills are left with little choice but to cut
production. This is usually announced as maintenance related shutdowns but will
probably be done to tighten the market and put a floor on prices.
 Headwinds to real demand — Over the next 6-12 months, we expect investors to
focus quite a bit on consumer confidence and monetary policy, when gauging steel
demand. In developed economies, weakening consumer confidence has already
started to take a toll on construction and auto activity, and several steel management
teams have also highlighted a sudden loss in confidence as a factor in weak activity
from service centres. Auto sales data, especially in emerging markets, have been the
key disappointing factor recently, while construction, unsurprisingly, remains lacklustre
in developed economies.
 Peak costs — Steel-making costs continue to be quite sticky. Tight Asian supply of iron
ore (Indian export restrictions) in particular have been supportive of iron ore prices and
rising steel utilisation rates for global steel production into Q2 have kept demand for ore
strong. As a result, raw material prices have been very steady, while steel prices have
collapsed. For a generic steel mill paying market prices for all inputs, we estimate costs
have increased by 40% in 2011 vs. 2010, after a 27% increase in 2010. This means
that costs are now 9% above the last peak seen in 2008.
 New projects do not make much sense — New steel projects do not make much
economic sense, in our view. We examine how capital costs for the sector have
evolved and how low-cost regions like Brazil are now high capital cost regions for new
capacity. Returns are therefore unlikely to cover the cost of capital.