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Steel Industry Endures Soft Patch; Low Market Prices Can't Keep Up With Production Costs

Posted on: Sunday, 21 August 2005, 18:00 CDT

MORGANTOWN, W.Va. -- U.S. steel mills have trimmed production but continue to slog through a quarter that many companies say will be the low point of the year and a dramatic drop from the third quarter of 2004, when the market hit what many now see as an artificial high.

Six weeks into the third quarter, steelmakers are struggling to balance lower prices and still-sluggish demand for their products with the soaring costs of scrap and natural gas.

"The horse race at this time will be keeping selling prices ahead of the cost of operations," says Harry Page, president of West Virginia's Wheeling Pittsburgh Steel Corp.

Key industry players, including Netherlands-based Mittal Steel Co., Pittsburgh-based U.S. Steel and North Carolina's Nucor Corp., have all warned investors to expect a drop in third-quarter results, and analyst Charles Bradford says some companies could report profits 30 percent to 100 percent below the same period last year.

"Last year's third quarter was the best the industry ever had. There were companies who made as much in a year in their prior histories as they made that quarter," said Bradford, of New York's Bradford Research-Soleil Securities Corp. "This is going to be a - terrible third quarter."

But Mark Parr, a steel analyst with KeyBanc Capital Markets in Cleveland, says producers could see a fourth-quarter rebound if prices rise as expected in September, if demand climbs as projected and if domestic producers "maintain supply discipline" rather than quickly ramping up production.

Bubble bursts

Steel prices skyrocketed last summer, driving up the cost of everything from cars and tractors to home appliances. But those record prices and the rampant buying turned out to be a bubble, with steel users building up inventory in hopes of waiting out further price increases, then holding back on new orders.

Nor did consumers see any short-term benefit when the prices began to drop.

"When you're talking about cars or washing machines or whatever, those people are buying steel a year forward or more," said Robert Crandall, steel industry expert and senior fellow at The Brookings Institution, a research group in Washington, D.C.

At best, price fluctuations might appear a year or two later, he said. But other market factors help keep prices high, including the rising costs of oil and energy.

"You're going to have a tough time picking up effects in month- to-month or even year-to-year movement of steel prices," Crandall says.

With full warehouses of their own and few new orders coming, steelmakers responded to the inventory buildup by curtailing production.

Page, at Wheeling-Pitt, says 32 blast furnaces were operating in the United States in June 2004; one year later, only 23 were still firing. That's the fewest since a nationwide steel strike in 1959, when only 19 furnaces were in operation.

"So the degree to which integrated producers cut back is really unprecedented," he says.

Though China had purchased massive amounts of U.S.-made steel in 2003, that buying didn't continue in 2004. Instead, the Chinese looked to Europe and other producers with lower costs as they supplemented their own rapidly growing industry.

Bob Jones, a marketing executive with Nucor, says no one anticipated the extent of the hoarding. Last summer, he says, automotive sales were flat, construction was "semi-sluggish" and even sales of home appliances were slowing.

"There was nothing to suggest through-the-roof consumption," he says, "yet we had through-the-roof buying."

While analysts say that consumption continued in the early part of 2005, several steel executives have said they believe the inventory is now being used up, and orders are likely to quicken in the fourth quarter.

Bradford, however, cautions against too much optimism.

The latest data from service centers show there was a reduction in inventory in June, "but it's still high by historical measures," he said. On average, service centers still held a 3.1-month supply in June, compared with the 2.7- or 2.8-month supply they normally have.

Orders now would be too late to affect the third-quarter performance, but Bradford and Parr agree the sudden jump in the price of scrap could bode well for the following quarter.

Source: Columbian

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