I am already falling behind with my new year’s resolution. I apologize for slacking. I started writing an entry last week but did not finish it. I got a hand on good market research from Exane BNP Paribas, as well as Nomura Market Research lately and I think that it is worth sharing the wealth.
Essentially, my entry seeks to tell you what to expect of steel in the near-term. Below is a summary principal driving factors for the steel industry.
Cost of inputs
Rising costs of inputs (iron ore and coking coal) has been the most important driver of steel prices lately. The market is sufficiently balanced at the moment to allow producers to pass these price increases to consumers.
I was perhaps a bit too early to call iron ore contract negotiations in season a couple of weeks ago. After all, discussions and general signalling of intentions have started taking place only lately. Officials from the Chinese Iron and Steel Association kicked off the season with an exercise of out loud wishful thinking when they announced their expectations of a 20-30% rise in iron ore prices. Major iron ore producers would prefer starting negotiations with Japan to establish a price that will later be used as the basis of other negotiations. Doing this in 2009 has allowed them to resist Chinese demands for a lower price. (Interesting commentary here.)
Price Outlook. Analysts at Exane BNP Paribas, Citigroup and Nomura research are expecting that the price of iron ore would increase 30 per cent this year. Goldman Sachs JBWere is slightly more enthusiast as it was reported in the Australian media that it upgraded its iron ore outlook for this year to a 35- 40 per cent increase. Prices for 2011 are assumed to remain somewhat stable (Nomura Equity Research is forecasting an increase of 10% from 2010 levels).
Steel mills are resuming production just as production cuts of coking coal (think Shanxi region) have taken place. Nomura Equity Research forecasted in an early December report that Australian hard coking coal would rise to 180$/tonne in 2010 and then to 225$/tonne in 2011. As for Exane BNP Paribas it expects a target for coking coal at around 200$/tonne in 2010. I would be tempted to think that these estimates are a bit low as Xstrata has made an agreement to provide some Chinese steelmakers for Q1 at USD 190$/tonne. Taking in consideration that some Australian producers of coking coal are already nearly sold out for 2010, it is fair to expect premiums to be paid to secure supplies.
As raw material prices rise, spot prices are rising faster than contract prices. Producers buying from the spot market (think smaller Chinese mills) will face steeper cost increases and could likely experience a tightening of supply as major iron ore producers have to redirect supply towards benchmark contracts rather than spot markets as restocking takes place in OECD countries.
Steel demand: Catch up vs Real Growth?
Last week signs of fiscal tightening in China have shaken commodity markets due to the widespread belief in Chinese stimulus measures being the main driver of the rally in commodities. Still, China remains an important source of demand as a result of its rapid economic development and urbanization. In 2010, the infrastructure budget of China is expected to grow 15% (from the previous year) and will effectively affect steel demand.
To complement this, many steel users in OECD countries have kept very low inventories in late 2009 and are expected to start restocking very soon. The impact of the US stimulus plan is also expected to be better felt this quarter although Buy American will largely limit the benefit to US mills. These factors lead many to think that even without a recovery steel purchases would be increasing.
However, this will not be enough to call it a recovery. A proper recovery in demand (beyond restocking) from steel users in the construction, car and real consumption is expected only next year. Some see the boom times of 2007 coming back in 2011-2012 although this seems a bit far fetched considering where the industry now stands.
Future supply growth is apparently constrained as high cost steel mills have been idled and capital expenditures slashed as a result of the downturn. In addition, producers in developed countries are sticking to a rather robust production discipline to privilege prices over volume. Still Nomura Equity Research expect capacity utilisation rates to rise from 60 to 70 per cent globally (projection excludes China) in 2010 and to then increase to a “normal” levels 80 per cent in 2011.
Chinese steel production outlook is a bit harder to assess. The country produces 47.5 per cent of global crude steel production. The Government is committed to solve its blatant overcapacity problem; however its grip on the steel industry is loosening as a significant segment of it is now under private control. Progress on that front has been modest has mills have been reluctant to comply.
The threat of Chinese exports flooding market has been the reason many North American and European steel producers did not increase their products’ prices in late 2009. However many analysts do not see Chinese exports as imminent threat. There are two reasons for this. First, production costs are rising faster for Chinese mills and as such prices between developed countries and Chinese products are converging. Secondly the very low inventories in North American and European markets, the longer lead times associated with the purchase of Chinese products may simply be unmanageable from a logistic point of view.