The hand-in-hand relationship of the steel industry and consumables sector that supplies it has analysts upbeat that there are better times on the horizon. The question, though, is how far away is the horizon.
Equities analysts covering the North American steel industry believe most costs related to consumables travel hand-in-hand with steel production levels. And with steel production levels falling, demand for consumables is shrinking in lock-step.
"The need for graphite electrodes and other consumables is for the most part directly proportional to (steel) production levels," said Mark Parr, a steel industry analyst at KeyBanc Capital Markets Inc., Cleveland. "If production goes down, your need for consumables goes down. It's like if your wife goes away for the weekend and you leave the dishes in the dishwasher. If you don't run the washer, you don't use detergent."
But not all things run in parallel, making the cost of consumables—like fluxing materials, graphite electrodes and refractory furnace linings—a little more difficult to track at times.
"With oil prices down, it would stand to reason that anything related to oil would be down," said veteran steel industry analyst Charles Bradford, president of Bradford Research/ Soleil Securities Inc., New York. "But in the case of needle coke (used to make graphite electrodes), it isn't working that way. You need oil to make needle coke. But oil is going down and needle coke prices are going up, even though they come out of the same barrel."
Commercial Metals Co., Irving, Texas, told analysts at a luncheon in early November that its electrode costs for 2009 would be up between 40 and 50 percent compared with 2008.
"I found that surprising," John Tumazos, an independent steel analyst in Holmdel, N.J., said. "There must have been a time lag on a stale contract there or something to that effect."
Steelmakers cited rapidly rising raw material and energy costs as key reasons behind skyrocketing steel prices during the first half of 2008, a phenomenon that saw hot-rolled sheet soar to a peak of $1,100 per ton by August from about $560 in January 2008.
The global credit crunch and general economic slowdown combined with weakening steel demand beginning in September to send prices back down the ladder. By late November, hot-rolled sheet had fallen to $650 per ton, with all indications it could go as low as $500 before the global financial crisis ends and consumers gain enough confidence to begin buying again.
Steelmakers responded by reducing steel production, cutting back both blast furnace and electric furnace operations. In early November, production was off 24 percent from a year earlier, with some predicting production would be down by 50 percent by January.
Those cutbacks reduced demand for consumables, although most believe the downturn is cyclical rather than structural in nature, leading to optimism that demand will return in force once the economic woes ease.
"The mills have made an effort to get production in line with underlying demand," Parr said. "Contracts for consumables usually are done in the fourth quarter. I would expect there to be some contract delays on refractories and electrodes into the first quarter based on the economic uncertainty."
GrafTech International Ltd., Parma, Ohio, one of the larger manufacturers of electrodes, reduced its fourth-quarter earnings expectations as a result of the financial uncertainty. The company expects 2008 sales to increase 18 to 20 percent from 2007 levels, down from previous guidance of a 20- to 22-percent increase, while operating earnings are expected to range between $315 million and $330 million, down from previous guidance of $320 million to $330 million.
"In a general sense, Commercial Metals was saying they expected their costs to be about the same in 2009 compared with 2008," Bradford said. "Energy costs are coming down and transportation costs are coming down. The second part of that, though, is that volumes also are off. If you are producing less, you are going to need fewer refractories and fewer electrodes."
Tumazos offered a similar view. "The values of things like electrodes are directly proportional to steel output," he said. "If you are not making any steel, you're not going to need any electrodes."
For the most part, the cost of consumables is relatively minor compared to overall steelmaking costs, Parr said. But in the unlikely "doomsday scenario" in which steel producers extend production cuts for a lengthy period due to prolonged weak demand, those who provide consumables could face long-term pain.
"The dishwasher analogy might not be that great, but what it comes down to in that scenario is that people would use even less consumables, like they would detergent," he said. "When you get to that scenario—even though I don't think it will happen—maybe you think getting things sort of clean (using less detergent, or in this case consumables) is good enough to accomplish what you need to accomplish." SCOTT ROBERTSON