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In  it  to win it


Just before Memorial Day--the unofficial start of summer--the U.S. House of Representatives overwhelmingly passed the Water Resources Reform and Development Act to fund port dredging and improvements and repair or replace aging inland waterways locks and dams.

It was a resounding bipartisan investment in infrastructure at a time when steelmakers are vexed by waves of imports and the slow pace of recovery in domestic demand. Lagging construction spending has been one frustration even as other sectors, such as automotive manufacturing, are coming on strong. In response, steelmakers are re-examining their cost structures, tweaking their product mixes and accelerating their technological development.

“The steel industry relies heavily on seaports and inland waterways to move raw materials necessary for steelmaking and bring finished steel products to market,” Thomas J. Gibson, president and chief executive officer of the American Iron and Steel Institute, said following the bill’s passage. “A bill to improve water infrastructure is long overdue. Our nation’s seaports are heavily congested and not dredged to full capacity, while our inland waterways include obsolete and aging infrastructure that often results in costly delays. This long-awaited compromise bill will help ensure our nation remains globally competitive and provide more-efficient and cost-effective navigation for our vital water infrastructure needs.”

AISI chairman Michael Rippey, president and chief executive officer of ArcelorMittal USA LLC, noted at the AISI annual general meeting in Scottsdale, Ariz., in early May the nominal good news that domestic steel demand this year was expected to be 4 percent higher than previous projections of 100 million tons and new trends suggest it could even be close to 112 million tons, but imports are set to capture a greater share of the potentially larger pie. “Through the first three months of this year, finished steel imports have increased by 17 percent from the same period in 2013, capturing an unacceptably high 25 percent of our market,” he said. “The challenges of these imports remain particularly troubling, given that U.S. producers were only using 77 percent of their production capacity.”

John J. Ferriola, chairman, president and chief executive officer of Charlotte, N.C.-based Nucor Corp., agreed. “Steel and other U.S. manufacturers continue to face significant trade and competitive challenges from foreign governments’ trade-distorting policies and practices, including China’s state-owned (version) of capitalism. Addressing these challenges is our highest priority.”

Ferriola acknowledged that there had been some positive news in trade cases, but said he was concerned that two recent Commerce Department anti-dumping duty preliminary determinations “go against the concept of strong trade enforcement. In the first case, brought by our pipe and tube customers, Commerce failed to recognize and address the injurious dumping of oil country tubular goods (OCTG) by South Korea and other producers. In a second case brought by Nucor and other rebar producers, Commerce ruled that Turkey was providing its industry with energy subsidies but concluded that they were inconsequential. Considering the energy-intensive nature of steelmaking, this flies in the face of logic and good common sense that energy subsidies would have little or no value. We welcome competition, but it must be on a level playing field and based upon sound commercial terms.”

The rejuvenation of manufacturing across North America can only continue “if we address the issue of overcapacity,” said Regulo Salinas, vice president of Ternium Mexico SA de CV. He cited Organization for Economic Cooperation and Development (OECD) estimates of almost 600 million tons of free capacity in the world in 2012, including at least 200 million tons of excess capacity in China. The OECD estimates it will take until 2020 to absorb its system over-capacity, but by then more than 365 million tons of additional capacity will have been added globally, Salinas said.

“Continued government-to-government discussions on overcapacity at the local levels within the OECD are helping focus attention on this problem,” Salinas said. “Working together on a regional level, as we do here, is an important part of the process. It allows our government to speak at the OECD with a unified (North American Free Trade Agreement) voice on the foreign trade-distorting policies and practices we believe are contributing to the over-capacity problem, and suggestions for next steps in ways to address each.”

While oversupply is the primary concern of steelmakers, the industry is aware that demand is just as important. Rippey reflected on a major potential source of demand: capital construction. “We all know that our nation’s infrastructure is in very poor shape, and with each passing day it becomes worse,” he said. “I’m an optimist. I’d like to think that there’s room for a longer-term bill to be passed which would allow for proper planning. But it’d be speculative on my part to guess as to whether that’s a realistic possibility.”

“There are two deadlines coming up,” Gibson said. “One is the impending insufficiency of the Highway Trust Fund to meet the obligations of the current law. That will probably happen sometime in August. It’s a little bit like predicting when the debt limit’s going to be reached. The best guess is that’s going to happen sometime in August, which is ahead of the expiration of the authorization for the existing highway bill at the end of the fiscal year, Sept. 30.”

A senior steel executive lauded the industry’s efforts in Washington, but wondered about the sentiment among some in Congress that the only good spending is no spending. “It used to be that everyone could agree that infrastructure projects were good for jobs, good for industry, good for everyone. Now we have budget constraints when we really need strong leadership in government to advocate for infrastructure,” he said.

The executive noted that the issue is rapidly moving from an economic one to a matter of public safety--the American Society of Civil Engineers regularly grades many of the nation’s bridges, roads and railways with Cs and Ds--and he hoped that the waterways bill is indicative of a rediscovery of the value of infrastructure spending.

While industry advocates argue their case in Washington and international forums, steelmakers say they understand they have to manage what they can really control. “Outside of trade talks, we are trying to use our network of low-cost mills for quicker response times for orders and shipments,” said Jim Kerkvliet, vice president of commercial sales at Gerdau Long Steel North America, which has 18 mills in North America that sell directly to fabricators and original equipment makers as well as through distributors and service centers. “The focus is timely ordering, confirmation and delivery,” he said.

Kerkvliet hopes that capacity rationalization or even consolidation in the domestic industry will not be necessary. “When we look at the market overall, domestically and worldwide, we see that with proper enforcement of trade agreements the industry won’t be required to reduce capacity or shut facilities,” he said. “But if there is not proper enforcement, then industry has shown in the past that it is not afraid to make whatever changes are appropriate to business conditions.”

On the demand side, Kerkvliet sees the strongest growth in industrial segments, including rail cars, heavy trucks and automobiles--the latter driven notably by automakers increasing domestic production that had once been sent overseas. Other strong areas include power generation and transmission, as well as nonresidential and industrial construction. “We have enough capacity in the U.S. that we don’t see the need for imports,” Kerkvliet said. “With the growth in the economy, we should be seeing growth in steel. As the recovery advances, we should be able to take advantage of that. At the same time, we have to acknowledge that there is excess raw steel capacity of as much as 30 percent worldwide, which is well beyond demand growth forecasts. We will see shifts in that global supply situation.”

More specifically, Kerkvliet expressed frustration that imports of Turkish and Mexican rebar have more than doubled their share of the U.S. market to about 20 percent in the first quarter of this year from 7 to 8 percent in 2010. “In many situations, exporters to the U.S. are not just underselling the markets here, they are underselling their own home markets,” he said. “We know their production economics, and they have no cost advantage. Other global markets have put up barriers, so those exports are coming here.”

With operations worldwide, Gerdau keeps in tune with supply/demand balances in other regions as well. Kerkvliet said that while still growing faster than Europe, Asia--and China in particular--has cooled a bit, while Europe has accelerated slightly. “Worldwide steel consumption is expected to grow 3 to 3.5 percent this year,” he said.

Given the nature of the industry and the inherent supply and demand imbalances throughout its history, Steel Manufacturers Association (SMA) president Philip K. Bell believes that the current situation is different from previous soft markets. “You will hear the refrain over and over that we have enough domestic capacity to supply all demand, but nowhere is that more true than in OCTG. That sector is under a tremendous assault, and continues to be despite favorable rulings out of the Department of Commerce,” he said. “The exporters coming into the U.S. have no domestic market for their tubulars. They exist merely to ship to the U.S. market. Domestic producers can compete with anyone, but only on a level playing field.”

The industry’s response, beyond trade cases, has been to focus on their own cost structures, Bell said, “but that is not going to create profit; you can’t save your way to profitability.” The other response has been in technical advances, which Bell said is one area in which domestic producers still outpace importers, although the gap may be narrowing in some segments.

“Our members are taking an all-of-the-above approach: cost savings, energy efficiency, technological innovation, everything,” Bell said. “The bulk of our members are electric-arc furnace operators, and they have been taking advantage of the newly inexpensive and abundant natural gas in several ways,” including lower prices for electricity as power generation shifts from coal to gas, and also more directly in the increase of direct-reduced iron (DRI) as a complement to scrap iron for inputs.

“DRI reduces residuals and allows mills to improve their operating costs,” Bell said. “It can also allow them to expand their range of product lines.” He cited one mill that has had success selling longer-than-standard-length rails. “A lot of companies are focusing on organic growth like that, product-line extensions, small changes to meet specific customer needs.”

More drastic responses to the influx of imports, including reducing capacity and industry consolidation, are not off the table, but may not be necessary, Bell said. “Industry has proven to be highly resilient. If you look at the list of top producers currently and the same list just 10 years ago, it has changed a lot. There is always some level of capacity rationalization and combination, whether it is at the asset level or corporate level.”

To be clear, Bell believes the challenges are different this time compared with previous cycles in the industry, but the response from steel mills has been consistent. “Further asset transactions or consolidation may happen, but that is part of the normal course of business in our industry,” he said. Some companies have formal programs for spinning off assets, while others are more opportunistic. Bell likens the process to the steady deal flow of acquisitions and divestitures of prospective and producing acreage in the oil and gas sector.

“Companies are focused on cost control and growth,” Bell said. “There are market forces that they can influence and those they cannot control. SMA supports their efforts by taking the message of domestic production to the public. There have been some attempts to erode the Buy American policies, but we are working to ensure that governments at all levels understand that domestic steel production supports jobs, taxes and communities.”

It was no accident that U.S. Trade Representative Michael Froman was the keynote speaker at the SMA’s conference May 12-14 in Washington. For all the planning the association and its member companies do to respond to market conditions, “no plan can survive contact with reality,” Bell said. “We need more transparency from government as it negotiates trade agreements. What protections are they putting in place to prevent currency manipulation or dumping? How difficult will it be to bring trade cases under some of the agreements now being negotiated?”

Even if those provisions are satisfactory to industry, the biggest external factor remains demand in the rest of the world, Bell said. “All of the Bric countries--Brazil, Russia, India, China--are cooling, and we believe that the U.S. is poised for a manufacturing renaissance. Our country’s infrastructure needs rebuilding and our industry has capacity waiting to be put to use.”

Daniel Webster, U.S. metals client service advisor and principal at consultancy PricewaterhouseCoopers LLP (PwC), agreed that some aspects of the current import challenges to the industry are different, but added, “This is the new norm. It’s like there is a big box hanging over the industry that keeps spitting out new issues for the industry to deal with. Whoever survives is going to be in great shape, but conditions will continue to be challenging until that box stops.”

A PwC analysis confirms that, at least so far, the industry has not resorted to increasing levels of mergers and acquisitions to respond to the import challenge either within North America or worldwide. Quite to the contrary, transactions are quite low.

M&A activity in the global metals sector slowed significantly in the first quarter of 2014, falling to its lowest level since 2008, according to a first-quarter report by PwC. That trend was largely attributable to a decline in steel deals--many metals players stalled on dealmaking as overcapacity and pricing remained a key concern, and instead focused on investing in the downstream segment of their businesses.

“Given the overcapacity issues facing the global steel and aluminum industries, and the pricing uncertainty experienced in the past few years, metal companies have shied away from M&A activity to focus on investing in operational improvements and the development of more value-added products,” wrote Sean Hoover, U.S. metals leader at PwC. “Despite the quarter’s decrease, we believe the deal market will recover in coming quarters if global capacity and demand come more in line and the economies in the U.S. and eurozone continue to strengthen.”

During the first quarter of 2014, there were 13 transactions valued at $50 million or more, totaling $3.3 billion, a 78-percent decline from $15.1 billion in the fourth quarter of 2013 and 55 percent below $7.3 billion in the first three months of last year, according to PwC. One deal valued at almost $1.8 billion accounted for more than half of the total transaction value in the first quarter of this year, compared with three mega deals--deals valued at more than $1 billion--during the fourth quarter of 2013, which accounted for just under $4.5 billion in deal value.

On a regional basis, Asia and Oceania led in deal activity in the first quarter, accounting for nine transactions valued at $2.6 billion, or some 80 percent of the total deal value. This activity included a mix of local, inbound and outbound deals, with local China deals dominating the M&A environment. There were three deals involving North America totaling$327 million and four deals involving Europe, which accounted for $840 million.

Webster offered a final positive note. “Most people know that the auto sector is doing well. March was the highest month for car sales since June 2008. Major appliance manufacturing is also doing well. Construction has been bad, but OCTG and the whole energy sector is still strong, despite all the imports,” he said.

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