Last week in our blog post, China and its impact in iron ore prices we addressed the problems that the mining of iron ore is experiencing due the shrinking Chinese economy. This time, I wanted to expand on how this is also affecting the downstream product—steel.
Currently the steel market is not in the best of shape, and it is hampered by overcapacity due low demand, threats of nationalization, lower profitability and lack of industry consolidation.
As explained in the Wall street journal article, Global Steel Industry Faces Capacity Glut, there is overcapacity in the current steel mills. This year, steel mills around the world have a cumulative production capacity of 1.8-billion tons. Cumulative demand is around 15-billion tons. The big problem is that instead of consolidating and becoming more efficient, the industry is building more capacity. By 2016, an estimated 100 new mills, with total estimated supply capacity of 350 million tons, are expected to come on stream, according to industry executives and consultants.
But why are these mills continuing to be built that are not currently needed? The reality is that steel mills are a source of jobs and governments are prone to finance them even when the value is questionable in order to secure jobs. One case is France seeking to nationalize the steel industry.
Meanwhile, governments around the world continue to subsidize mills, despite weakening demand, to maintain jobs and sustain local economies. Currently, companies in Vietnam, Argentina, Ecuador, Peru and Bolivia, all backed in some way by their respective governments, are building or planning new mills.
In addition, the steelmakers are seeing an increase in price in raw materials because suppliers because of a change from long-term pricing for iron ore to selling at spot prices that tend to average higher over the long term. This change benefits the suppliers over the buyers. Steelmakers now have higher raw material costs from making a ton of steel. Inversely, mining companies have seen greater profitability. For example, the profit percentage from one ton of steel for a ton of hot-rolled coil in Europe has dropped to 17% this year from 76% in 2006. For iron-ore miners, profitability has increased to 50% from 11%.
The article concludes noting that in order to avoid overproduction and make the industry more efficient, steel companies need to consolidate in order to align production with demand and start closing inefficient facilities. But steel companies will have also to rely on other methods to stay healthy. These include developing better high-margin, high-tech, light-steel products for the auto sector, cutting costs, and selling more in emerging markets.
In my opinion, consolidation of steel companies might take a while but in the short term, they can improve in profitability by investing in efficiency-producing projects and programs in their production operations. For example, technologies that support predictive maintenance in reliability programs can reduce maintenance cost and unplanned production down time. Technologies that provide better process control and allow them to reduce energy consumption.
There is no doubt that the steel industry will continue to be in for a wild ride, and only those with nerves of steel will remain successful in this industry.