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Flat-rolled mart said stuck in an oversupply rut

Keywords: Tags  Timna Tanners, steel glut, Association of Steel Distributors, ASD, flat-rolled steel, steel prices, steel imports, DRI direct-reduced iron

NEW YORK — Stuck in a rut. Spinning your wheels. One step forward, two steps back. Pick a phrase, any phrase: Virtually any combination of words that communicates the inability to move in a deliberate direction will do.

Late last month, Timna Tanners, senior research analyst at Bank of America Merrill Lynch covering the metals and mining sector, opted for the phrase "up the creek without a paddle" as the title of a presentation she delivered at an Association of Steel Distributors (ASD) regional meeting in New York. Addressing an audience of some 60-plus steel distributors and financial types, Tanners took only seconds to zero in on what she considers the overarching theme for steel sector participants the past couple of years: oversupply.

"There is too much steel," she said. "We are swimming in steel. How do we maneuver in an industry where there is just too much supply?"

Before addressing that question, Tanners touched on topics ranging from the coming revolution in domestic direct-reduced iron (DRI) capacity—she is predicting 29 million tons of annual DRI production capacity in the United States by the end of this decade—to the Chinese super cycle, which she thinks is over.

It didn’t take long, however, for Tanners to return to the topic du jour. "We really think it is more about supply than demand right now with imports and excess production," she said. "And you don’t get much pricing power until you get utilization above 80 or 85 percent." Average capacity utilization in the week she spoke was pegged at 76.9 percent by the American Iron and Steel Institute, although it has since inched up to 77.5 percent.

Five days after Tanners addressed the ASD meeting, U.S. Steel Corp. tested her theory by hiking its base prices for all carbon flat-rolled steel products by $50 per ton ($2.50 per cwt) effective immediately, the second sheet price hike attempt this year (, Feb. 27). AK Steel Corp., NMLK USA and Nucor Corp. quickly followed suit, with ArcelorMittal USA LLC and Severstal North America Inc. sounding a variation on the theme by setting new minimum base prices for April shipments.

A quick trip through AMM’s pricing archives shows that domestic sheet mills made a total of 16 price movements in the 14 months from Jan. 3, 2012, through late February 2013. An overwhelming majority (14) of the moves were keyed to lifting prices, while one action "set a floor" under sheet prices and another actually "retracted a hike in a well-supplied market."

Over that same period, AMM’s market price for hot-rolled sheet hit a high of $750 per ton ($37.50 per cwt) f.o.b. Midwest mill in mid-January last year and a low of $580 per ton ($29 per cwt) for two weeks in mid-October 2012, with some uncharacteristic deals reported well above and below that spread.

The jury is still out as to whether and/or to what degree the latest hikes will stick. But if Tanners and a sort of "thermometer approach" she’s developed to call the top and bottom of the steel market is on track, gaining traction is pretty much a matter of simple arithmetic.

"This is how to tell what is going to happen to the steel market," she told the ASD meeting. "It is kind of what I learned over the years." What Tanners learned is not rocket science, but it does delve just deep enough into the psyche, culture and documented history of the domestic steel sector to suggest that the existing lack of pricing power will not soon disappear.

"I think steel prices are going to fall to the top marginal cost of the domestic producer who is willing and able to shut capacity," she said. "Not the one who should cut capacity, the high-cost producer—those guys might keep running at a loss—(but) the large integrated producers, for example. I’m trying not to name names. We know from public information that they post losses. They keep running their mills even when they lose money. But there are marginal-cost producers—mini-mills—that will shut capacity. It is a lot easier to shut a mini-mill than a blast furnace. And they (the mini-mills) will close capacity when the price gets to their cost of production."

Tanners pegs the scrap-based mills’ cost of production at roughly the price of shredded scrap plus $150 to $180 per ton. "I haven’t checked the shredded price but let’s say it’s somewhere between $350 and $400 per ton. So $500 to $550 is about the lowest the price should go for a ton of hot-rolled coil," she said. "Below that, you should see mills start to shut capacity. They are not going to produce at these losses anymore."

The peak price, "assuming a relatively balanced market, which we don’t have, rises to a level you can import to," Tanners said. "If you start to see import offers come in at least $100 or 10 percent lower than domestic offers, interest in imported material is piqued and order levels climb."

Tanners’ 2013 hot-rolled coil forecast—$610 per ton—is admittedly cautious for reasons tied mostly to oversupply but also to an anticipated softening in raw material costs and cooling in China’s growth rate.

Looking ahead, she counseled the audience to curb its enthusiasm on the auto production front. "U.S. auto demand has been the shining star everyone is talking about. But the fact is it’s hard to see a lot more improvement in builds from recent levels. A lot of auto suppliers are running pretty full tilt," Tanners said. "Now we’ll wait and see if heavy equipment and energy are turning, which we are starting to hear. And the big question is when is nonresidential construction going to recover? We still think it is 2014."

Returning to the core theme of her presentation, Tanners pointed out that the United States is not the only nation "swimming" in steel. "(South) Korea is a net exporter, Turkey is a net exporter and we expect that when India can get its iron production back in order they, too, will be a net exporter," she said. "So it begs the question we are always asking: who’s left to import?"

Although Tanners allows that the second quarter could see a little less imports, she doesn’t expect any sudden strengthening in flat-rolled steel prices until the industry’s capacity utilization rate increases more than a few percentage points.

"What we have seen lately, unfortunately, is a lot of price hikes that don’t necessarily stick," she said. "(The mills) have a credibility problem, perhaps until we get to 80-percent utilization or higher. The credibility is enforced by the fact that there are mills that will shut down when they get to the marginal cost of production.

"We have an oversupplied industry, someone needs to cut, (and) no one seems to want to step up and take one for the team, which is understandable," she said. "For now, it is a big challenge."

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