For employees at Scotland’s last two steelworks, the timing of the Chinese president’s visit to Britain will have left a bitter taste.
On the day that Xi Jinping paraded through central London amid much pomp and pageantry, Tata Steel confirmed it would mothball the 130-year-old plate mills, south of Glasgow, that it owns — with the loss of 270 jobs.
Tata blamed the latest in a spate of UK steel closures on a strong pound, high electricity costs and a “flood” of cheap imports, mainly from China.
However, while Britain’s remaining steel industry gasps for survival, a supply glut is casting a shadow over companies all round the world.
Sales have come under pressure at US Steel, Luxembourg-based ArcelorMittal and South Korea’s Posco from a 25 per cent fall in prices that has made the metal cheaper than at any time in the past decade. And, with world demand for steel now set to contract for the first time since 2009, the risks to earnings are set to sharpen.
Carsten Riek, analyst at UBS, says: “It’s a pretty unhealthy environment, one of the most challenging over the past 20 years. Companies might be forced to go out of business.”
For many steelmakers, how they navigate through this tough landscape will depend upon four factors: import prices, profit margins, product mix and plant capacity.
Prices
The recent price plunge has been driven by China, the world’s biggest consumer, producer and net exporter of steel.
Since 2000, its annual production has expanded nearly sevenfold, reaching 858m tonnes in 2014, according to consultants at CRU — around half of the worldwide total.
However, while China’s output used to be for domestic consumption, its appetite for steel shrank for the first time last year — resulting in its producers pushing their output into other markets. Exports are expected to surpass 100m tonnes this year, after jumping by more than 50 per cent to 93m tonnes in 2014.
China responds to accusations of “dumping” cheap steel by claiming it can simply make the metal more cost effectively than western plants — even though most of its own plants are lossmaking. Earlier this month, Sinosteel narrowly averted default on a bond payment.
Still, Xu Zhongbo, of Beijing Metal Consulting, insists: “With falling iron ore prices, Chinese steel is more competitive. European labour costs are high.”
By undercutting European costs, Chinese imports are finding buyers around the world.
Although US customers buy more steel from Canada, Brazil, South Korea and Turkey, an increase in the level of purchases from China mean overall imports are set to achieve a 30 per cent market share, according to Tom Gibson, president of the American Iron and Steel Institute.
US Steel, the country’s second-largest steel company by production, has been one of the worst affected by the imports and resulting price pressure. Its shares have fallen 69 per cent in the past 12 months and, after cutting 3,000 jobs from its North American workforce in 2014, it has warned of thousands more redundancies.
Margins
Margins at global steelmaking groups have inevitably contracted as prices have started falling faster than raw materials.
Steel prices normally track iron ore, the metal’s main ingredient. But the sharper pace of the steel price decline is squeezing the ‘spread’ that producers earn, explains Seth Rosenfeld, analyst at Jefferies.
“You could see further margin contraction as steel prices continue to plummet relative to raw material prices,” he says.
Even some producers that should be enjoying a boon from weaker currencies are hurting. A tumble in the rouble helped Russian steel export volume rise by 9.6 per cent in the first eight months of 2015.
But low prices mean that shipments are now “barely profitable for the first time in more than a decade”, says Kirill Chuyko, analyst at brokerage BCS.
“The [Russian] steel sector is descending into the abyss with every company lossmaking by 2017 on net income basis,” he adds.
Product mix
Not all steelmakers are in the doldrums just yet, though.
South Koreas's Posco, the world’s fifth-biggest steelmaker, reported quarterly sales down 14 per cent at its core South Korean steel unit last week but said operating profit was flat and its operating margin improved a little.
This was partly because of the company’s advanced technology and the large proportion of high-end steel in its sales mix, says Chung Sung-yop, an analyst at Daiwa.
He, and others, suggest that companies focusing on higher-value steel in smaller volumes are better placed to weather the influx of typically lower-grade and commoditised steel from emerging markets. Such “differentiated” products — which include high-strength and alloyed steels used in the aerospace and automotive industries — are less vulnerable to price declines.
This has shielded producers in Japan, the world’s second-biggest producer of steel, where there have been no job cuts or plant closures so far. Although large companies such as Nippon Steel & Sumitomo Metal and JFE Holdings have seen their profit margins affected by imports, the effect has been muted, helped by a weaker yen and cost cutting.
Even so, analysts warn that the trend in bulk steel prices could soon exert downward price pressure across the board. In Europe, Thorsten Zimmermann, analyst at HSBC, says this trend is already affecting profitability as measured by the industry’s preferred metric of earnings before interest, taxes, depreciation and amortisation (ebitda) per tonne.
“Six months ago it looked like ebitda per tonne would improve by €10-€15 but that’s no longer the case," says Mr Zimmermann. "What’s changed is imports.”
On Tuesday, Moody’s gave a stable outlook on Europe’s steel industries, due to demand from the car, construction and consumer goods sectors.
However, companies that are most exposed are those with a large proportion of sales in the spot market — such as ArcelorMittal and SSAB of Sweden, which reported quarterly ebitda 20 per cent below consensus forecasts last week.
European companies argue their competitiveness is also hampered by the additional burdens of environmental taxes and high electricity costs that are not faced by rivals in other regions. Such factors were cited in the collapse of Britain’s second-biggest steelmaker, SSI UK, last month.
Capacity
For steelmakers, the level of capacity being utilised becomes important, as high fixed costs mean that if they are running at less than 80 per cent capacity, plants use raw materials less efficiently and producers lose pricing power.
This requires the permanent shutdown of excess global capacity, which is expected to widen to around 645m tonnes above demand this year and was identified by the OECD as one of the main challenges facing the sector.
However, the potential loss of market share, the high costs of setting up a new steel plant — and the expense of redundancies in countries with strong labour laws — mean few companies are willing to grasp the nettle.
ArcelorMittal, the world’s biggest steel company, has led the way on the thorny issue and some analysts take comfort from restructurings under way in Europe and more to come in the US. But as a volume producer with a large emerging market exposure, it faces headwinds in countries such as Brazil and South Africa.
“Arcelor remains challenged in all key end markets,” wrote Deutsche Bank analysts in a recent note to investors, as they forecast a 25 per cent year-on-year drop in ebitda in the third quarter to £1.43bn.
Ultimately, much will turn on China, which some analysts believe needs to reduce capacity by 20 to 30 per cent. Yet this will be difficult as long as banks and local governments roll over steel mills’ debt to avoid the pain and political implications of bankruptcy in a sector where state-owned enterprises account for 40 per cent of output.
As Mr Riek of UBS says: “Every other nation historically went through 10 years of pain to get their capacities in order. China hasn’t done this yet.”
Source: http://www.ft.com/