Steel: Driving Forces & Challenges

BMI View: The global steel industry will continue to suffer as a result of significant overcapacity in China, as cheap exports from the country will remain a key drag on global steel prices over the medium term. While steelmakers in countries such as the US, Turkey and India are set for improving fortunes, the sustainability of high-cost producers in these and other countries remains vulnerable to both domestic and external headwinds. In many cases, the improvement of smelter margins as a result of falling input prices will provide only limited respite due to persistently low output prices.

Despite improving demand and the removal of some older steelmaking capacity in 2013, we believe the steel sector will remain gripped by persistent challenges over the coming quarters. Steelmaker margins in many countries will stay wafer-thin as sales remain pressurised by sluggish demand growth in domestic consumption and cheap Chinese supply in the seaborne market. Indeed, significant overcapacity in China's bloated steel sector will be hard to digest in some countries as efforts to rationalise production run into political headwinds.

Furthermore, several downside risks will continue to linger and challenge the sustainability of high-cost producers. We believe the improvement of smelter margins as a result of falling iron ore prices and subdued prices for coking coal, will be insufficient to combat the overall weakness in the steel industry.

China's Outsized Dominance
Global Steel - Production (LHS) & Consumption (RHS), 2012

Steel: Driving Forces & Challenges

BMI View: The global steel industry will continue to suffer as a result of significant overcapacity in China, as cheap exports from the country will remain a key drag on global steel prices over the medium term. While steelmakers in countries such as the US, Turkey and India are set for improving fortunes, the sustainability of high-cost producers in these and other countries remains vulnerable to both domestic and external headwinds. In many cases, the improvement of smelter margins as a result of falling input prices will provide only limited respite due to persistently low output prices.

Despite improving demand and the removal of some older steelmaking capacity in 2013, we believe the steel sector will remain gripped by persistent challenges over the coming quarters. Steelmaker margins in many countries will stay wafer-thin as sales remain pressurised by sluggish demand growth in domestic consumption and cheap Chinese supply in the seaborne market. Indeed, significant overcapacity in China's bloated steel sector will be hard to digest in some countries as efforts to rationalise production run into political headwinds.

Furthermore, several downside risks will continue to linger and challenge the sustainability of high-cost producers. We believe the improvement of smelter margins as a result of falling iron ore prices and subdued prices for coking coal, will be insufficient to combat the overall weakness in the steel industry.

China's Outsized Dominance
Global Steel - Production (LHS) & Consumption (RHS), 2012

A bright spot however, is that steelmakers operating in the US, Turkey and India will be on a relatively firmer footing over the coming quarters. For instance, demand for steel products will continue to improve as the US economy continues to gain traction, while infrastructure projects in Turkey and India boost steel consumption.

Mixed Outlook
Global - Steel Production By Company (mnt, 2012)

Key Themes In Global Steel Sector

  • The weight of excess supply from China will remain a key drag on steel prices. We forecast the MEPS global carbon steel price to average US$695/tonne in 2014, compared with an average of US$708/tonne in 2013.

  • Protectionist measures, in the form of punitive duties on imported steel products, could proliferate over the coming quarters.

  • Chinese steelmakers, in particular, will feel the heat of tighter environmental regulations. This should accentuate a gradual shift towards EAF-based steel production in the country.

  • Vertical integration could gain traction as steelmakers seek to secure stable supplies of coal and iron ore, while hedging themselves against price volatility.

  • Entrenched government policies that shield loss-making steelmakers from market forces to differing degrees will continue to delay the much-needed production discipline in the steel sector. This includes steelmakers operating in countries such as China, France and Belgium.

Steel Trap
MEPS Carbon Steel Product Composite Price (US$/tonne)

China: Consolidating...Gradually

As spotlighted by the demise of Suntech Power Holdings, the world's largest solar manufacturer, in 2013, we are starting to see signs of a broader realisation on the part of Beijing that the previous government's state investment-led policies were inherently unsustainable. With a raft of precarious fundamentals weighing heavily on the Chinese steel industry, we believe the decades of blind expansion and government support are fast catching up with the sector ( see 'Steel: Bloated Sector Running Out Of Luck', August 12, 2013).

Waning Fortunes
Select Chinese Steelmakers - Profit Margin (%)

Chinese steelmakers will be forced to increasingly rationalise production over the coming quarters as the Chinese government steps up its fight against air pollution. The provincial government of Hebei has orchestrated a string of furnace shutdowns in recent months due to heavy pollution in the region. Hebei has been ordered to retire 60mn tonnes (mnt) of capacity, or a quarter of the province's steel capacity and 75% of the nationwide target, over the next five years. According to the Ministry of Environmental Protection, seven of China's 10 most polluted cities are located in Hebei, where visibility levels in the southern areas are the worst nationwide. Indeed, steel production in Hebei, China's largest steel-producing region, plunged 16% between February and November 2013, compared with a rise of around 10% for the rest of China.

Intense Cutbacks In Hebei
China - % Share of Total Steel Production By Region (2012)

That said, we are aware that efforts aimed at consolidating the Chinese steel industry are susceptible to several roadblocks. Anecdotal evidence suggests that local governments, reliant on steel revenues, often idle furnaces only for a period of time long enough to escape the central government's attention. Additionally, some of the furnaces that were torn down in Hebei had in fact been sitting idle for some time. Most importantly, it is estimated that the potential job losses stemming from all state-required capacity cuts could reach as high as 200,000, a figure that could trigger widespread social unrest amidst the slowdown of the Chinese economy.

Chinese Steel To Slow, But Still Driving Global Glut
Steel Production - Average Annual Growth (% chg y-o-y, LHS) & % Share of Global Production (RHS)

As concerns over environmental pollution continue to dominate the headlines, Chinese steelmakers, and by extension, other steel-producing countries, could potentially move away from a reliance on the more iron ore intensive Basic Oxygen Furnaces (BOFs) and toward the greener Electric Arc Furnaces (EAFs).

EAFs To Gain Traction
Select Countries - % Total Crude Steel Production By Type of Furnace (2012)

Japan: A Minor Push From Olympics Win

We expect Japan's victorious bid to host the 2020 summer Olympics to provide only a slight boost to the domestic steel industry. Despite the increased opportunity for reforms to be implemented, several factors warrant us to keep our downbeat outlook for both the country's economy and construction sector. In particular, we highlight:

  • Japan already boasts good infrastructure, which suggests a less intensive build-up than other less-developed countries that have held the Olympics, such as Brazil.

  • Cost overruns and other risks suggest that the metropolitan government may need additional funding from the central government, which itself faces risks stemming from its large stock of domestic debt. As such, the risks of delays and forced cutbacks in spending for the construction sector remain very much intact.

A Modest Boost From Olympics
Japan - Construction Industry Forecast

We forecast Japan's steel production to expand by a modest clip of 1.5% per annum between 2014 and 2017, compared with 0.5% over the past decade. Apart from the aforementioned factors, a spate of challenges will continue to limit the fortunes of the country's steel industry. Specifically, demand for steel products from the autos and shipbuilding industries is likely to remain lacklustre over the coming years. Japanese automakers, the largest buyer of high-margin specialty steel products, have been shifting their production bases overseas in recent years. Domestic shipbuilders are also reducing capacity in light of shrinking orders and competition from Chinese and Korean shipyards.

Under Pressure
Japan - Domestic Steel Demand By Sector (2011)

Furthermore, Japanese steelmakers, sitting at the high-end of the global cost curve, are gradually losing their technological edge as foreign producers seek to close the quality gap. According to the Japan Fair Trade Commission, steel products from South Korea are being viewed in a similar light from a quality perspective with those of Japanese blast furnace steelmakers. In a key vote of confidence, Toyota added Korean steel producer POSCO to its list of top suppliers in 2013.

South Korea: Outlook Brightening

We believe South Korean President Park Geun-hye's three-year economic revitalisation plan will provide much-needed respite to the country's steel sector, which has seen output growth wane in recent years. Under a three-year 'economic innovation plan', Park plans to achieve three core objectives: a complete public sector revamp, the creation of a 'creative economy', and to boost domestic demand. In our view, Park's three-year plan is a step in the right direction for the economy and would serve to address some of the structural problems that we believe are likely to impede South Korea's long-term economic growth.

Mixed Outlook
Select Countries - Real GDP (% y-o-y)

However, we caution that South Korea's economy remains vulnerable to several headwinds in the coming year ( see 'Headwinds Remain Despite Resurgent Trade', January 03, 2014). As China continues to iron out its structural deficiencies and rebalances it economy towards private consumption, we expect neighbouring economies, including South Korea, to be adversely affected by China's waning appetite for imports of goods and services. Additionally, the depreciation of the Japanese yen would undermine the export competitiveness of Korean exporters in the all-important shipbuilding, electronics, steelmaking and automobile sectors.

India: Steeled For Growth, But Challenges Persist

With more than US$1tn in infrastructure planned outlay between 2012 and 2017, we believe India's steel sector is geared to expand at a healthy rate of 6.3% per annum over the coming years. Demand from the construction and infrastructure industries should continue to accelerate, while the growing affluence of the country's population spurs spending on housing and white goods. According to the World Steel Association, per capita steel consumption in India stood at 61kg in 2012, compared with the global average of 238kg and more than 500kg in the mature economies of Japan and South Korea.

Despite our generally upbeat view, we acknowledge that Indian steelmakers will continue to grapple with a fair share of problems. The shortage of high-quality iron ore, as a result of the ongoing mining ban in Goa and Karnataka, is forcing steelmakers including JSW Steel, Essar Steel, Prakash Industries and the Steel Authority of India (SAIL) to invest in plants that can process low-grade iron ore. A handful of small unlisted steelmakers are also constructing beneficiation plants that extract waste material from ore and increase its iron concentration.

Lagging Behind
Select Countries - Iron Ore Production (mnt)

Despite healthy seaborne supply for coal and iron ore, a failure by the rupee to recover to levels seen in recent years will increase the import bill for many steelmakers. Companies such as JSW Steel, Rashtriya Ispat Nigam Ltd (RINL) and Essar Steel will be most affected by the depreciating rupee due to their heavy dependence on coal imports. Furthermore, political paralysis is hurting the country's business climate and taking its toll on foreign investment. In July 2013, ArcelorMittal and POSCO scrapped plans to invest US$18bn in the construction of factories in Odisha and Karnataka due to the protracted process of land acquisition and uncertainties over iron ore supplies.

Russia: A Chalenging Picture

While we expect Russia to remain the largest steelmaker in Europe over our forecast period up to 2017, steel production growth in the country will only increase at an annual clip of 1.3% between 2014 and 2017. Russian steelmakers such as Evraz, Severstal and Mechel are feeling the pinch of depressed demand, weak prices and the rising threat of trade protectionism in the steel sector ( see 'Steeling Trade: Trade War Prospects & Implications', June 04, 2013).

Global - Steel Trade By Region (mnt, 2012)
Exporter
EU 27 Other Europe CIS NAFTA Other America Africa & Middle East China Japan Other Asia Oceania Total Imports
Importer
EU 27 101.8 4.5 17 0.6 1 0.6 3.9 0.4 3.6 0 133.3
Other Europe 10.3 0.7 5.4 0.1 0.1 0.1 0.5 0.6 0.5 0 18.3
CIS 1.9 0.8 9.5 0 0 0 2.1 0.2 0.6 0 15.1
NAFTA 7.1 1.7 2 19.4 4.6 0.3 3.1 3.5 8.3 0.3 50.2
Other America 2 1.3 0.8 2.6 3.5 0.1 5 1.1 1.6 0.1 18.2
Africa 8.2 3.6 3.2 0.2 0.1 1.4 3.2 0.7 1.5 0 22.1
Middle East 2.9 8.6 9 0.3 0.2 0.3 4.6 2 5.7 0.1 33.6
China 1.1 0.1 0.3 0.1 0 0 - 5.8 6.1 0 13.6
Japan 0.1 0 0 0 0 0 0.9 - 4.7 0 5.7
Other Asia 5.9 0.6 7.9 0.9 2 0.6 30.6 26.8 24 0.3 99.5
Oceania 0.4 0.1 0 0.1 0.1 0 1 0.4 2.6 0.3 4.9
Total Exports 141.5 21.9 55.1 24.4 11.5 3.5 54.8 41.5 59.2 1.1 414.5

ber of Russian steelmakers are betting on growing demand in the home market. We expect demand for construction steel to remain supported over the medium term as a pipeline of infrastructure projects begins in earnest ahead of big sports events such as the 2014 Sochi Olympics and the World Cup in 2018.

US: Slow Walk To Recovery

With the US economy on an increasingly even keel, we expect US steelmakers to continue bringing their production online over the coming quarters. Demand for steel products will be spurred by the brightening outlook in the housing and automobile sectors, which have continued to show signs of bouncing back to life in recent quarters. The country's status as a low-cost steel producer should provide some respite against depressed steel prices over the medium term. The growing popularity of EAF-based steel production has significantly helped to lower the energy bill for many US steelmakers. Due to the heavy usage of ferrous scrap, it is estimated that EAF steel production consumes 75% less energy per tonne of steel produced than ore-based production.

Europe: Set For Diverging Trends

We expect Europe's steel sector to undergo a series of diverging trends over the coming years, with countries such as Turkey and Ukraine benefitting from greater domestic demand and a pipeline of new projects into steelmaking. In contrast, steelmakers operating in Spain, France and Italy will remain under pressure from cheap imports, weak growth in domestic consumption and a lack of steel production plans on the horizon ( see 'Europe Steel: Challenges To Persist, Look East For Growth', December 17, 2013).

Diverse Forces At Work
Select Countries - Incremental Steel Production & Consumption, 2013-2017e (kt)

Specifically, we highlight that the share prices of Turkey's two largest steelmakers, Erdemir and Kardemir, could continue to outperform their peers over the coming quarters as they build on steady output growth achieved in 2013. The diversified nature of major steelmakers ArcelorMittal and ThyssenKrupp's operations should also provide pockets of resilience in the face of challenging dynamics in the steel industry. ArcelorMittal derives revenue from trading, distribution and mining, whereas ThyssenKrupp is slowly stepping away from its old staple steel business and pushing for expansion in other less volatile markets such as elevators and engineering.

Largest Five Countries - Steel Production & Consumption Forecasts (mnt)
2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f
Production
Global 1,236 1,432 1,582 1,612 1,695 1,765 1,827 1,879 1,929
% chg y-o-y -7.8 15.9 10.5 1.9 5.2 4.1 3.5 2.8 2.7
China 577 639 702 717 784 831 868 899 926
% chg y-o-y 12.6 10.7 9.9 2.1 9.4 6.0 4.5 3.5 3.0
Japan 87.5 110 108 107 110 111 113 115 117
% chg y-o-y -26.3 25.3 -1.8 -0.3 2.5 1.4 1.6 1.7 1.2
USA 58.2 80.5 86.4 88.6 90.2 91.5 92.5 91.8 92.7
% chg y-o-y -36.4 38.3 7.3 2.5 1.8 1.5 1.0 -0.8 1.0
Russia 60.0 67.0 68.7 70.6 68.9 69.3 70.0 71.1 72.5
% chg y-o-y -12.4 11.7 2.6 2.7 -2.4 0.5 1.1 1.6 1.9
India 63.5 69.0 73.5 77.6 80.7 85.2 90.5 96.3 103
% chg y-o-y 9.9 8.6 6.5 5.6 4.1 5.5 6.2 6.4 7.0
Consumption
Global 1,220 1,400 1,485 1,512 1,587 1,661 1,726 1,792 1,856
% chg y-o-y -7.6 14.8 6.1 1.8 5.0 4.7 3.9 3.8 3.6
China 574 612 668 688 746 795 834 872 907
% chg y-o-y 23.4 6.6 9.1 2.9 8.5 6.5 5.0 4.5 4.0
USA 62.4 87.0 96.4 102 103 104 105 105 106
% chg y-o-y -39.1 39.4 10.8 5.4 1.5 1.0 0.5 0.5 0.8
Japan 56.1 67.4 69.6 68.8 69.7 70.7 72.0 73.7 75.8
% chg y-o-y -32.6 20.1 3.3 -1.1 1.3 1.4 1.9 2.4 2.8
South Korea 47.3 54.6 58.7 56.3 57.6 58.8 59.9 61.0 62.0
% chg y-o-y -22.6 15.4 7.6 -4.1 2.2 2.2 1.8 1.8 1.7
India 64.4 69.2 75.9 77.0 79.4 84.5 90.6 97.8 107
% chg y-o-y 14.5 7.6 9.5 1.6 3.0 6.5 7.2 8.0 9.0
e/f = BMI estimate/forecast. Source: BMI, WBMS
Select Steel Companies - Key Financial Data
Company Country Market Cap (USDmn) Employees Revenue (USDmn) Net Income (USDmn) Profit Margin (%)
Nippon Steel & Sumitomo Metal Corp Japan 31,071 83,187 53,128 -1,508 -2.8
ArcelorMittal Luxembourg 27,967 239,000 84,213 -3,726 -4.4
POSCO South Korea 25,796 17,099 31,678 2,220 7.0
Nucor Corp US 16,849 22,200 19,429 505 2.6
JFE Holdings Inc Japan 13,938 57,044 38,596 479 1.2
ThyssenKrupp AG Germany 13,614 156,856 50,594 -1,832 -3.6
China Steel Corp Taiwan 13,380 9,800 7,007 197 2.8
Baoshan Iron & Steel Co Ltd China 10,288 32,598 30,304 1,646 5.4
Novolipetsk Steel OJSC Russia 9,958 47,953 12,157 596 4.9
Severstal OAO Russia 7,771 na 14,104 762 5.4
Hyundai Steel Co South Korea 6,325 9,288 12,549 703 5.6
Tata Steel Ltd India 6,081 80,534 24,772 -1,298 -5.2
Reliance Steel & Aluminum Co US 5,887 11,600 8,442 403 4.8
Inner Mongolian Baotou Steel Union Co Ltd China 5,699 29,512 5,827 41 0.7
Kobe Steel Ltd Japan 5,482 36,018 20,399 -326 -1.6
Steel Authority of India Ltd (SAIL) India 4,617 101,878 8,291 428 5.2
Eregli Demir ve Celik Fabrikalari TAS Turkey 4,314 12,687 5,317 236 4.4
Steel Dynamics Inc US 4,240 6,530 7,290 164 2.2
Note: Data based on latest financial year. na = not available.
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