SMU Outlines Two Scenarios for Steel Price Cycle Change

Written by John Packard

“U.S. Steel Sinks as Another Wave of Cheap Imports Predicted” was the headline in Bloomberg on Friday morning. The article cites Axiom Capital Research analyst Gordon Johnson who wrote to his clients, “A boat load of imports are likely on the way.”  This opinion permeates the financial community and the pessimism is, in our opinion, a little over blown.

Sure, at some point in the future the domestic mills will probably have to deal with foreign steel imports coming in at higher numbers than the 2.2 to 2.5 million tons a month level we are seeing right now. But, in our opinion not today.

With the U.S. Department of Commerce set to release antidumping and countervailing duty Final Determinations regarding cold rolled and corrosion resistant steels over the next two weeks the idea of foreign countries loading up the boats destined for the United States is a bit far-fetched.

This is not to say there won’t be foreign steel coming into this country over the coming months. But, as we listened to a trading company explain at the Metals Industry Boy Scout Dinner in Chicago on Thursday, countries like Vietnam will continue to ship but they will not be able to come close to filling the void left behind by the countries associated with the antidumping (Japan/China) and countervailing duty trade suits (China).

With the steep rise in domestic prices, longer lead times and allocation/controlled order entry the domestic steel mills are pushing the “risk” of buying foreign steel lower. For example, we heard at the Boy Scout Dinner of a foreign cold rolled offer at $33.50/cwt DDP Gulf ($670 per ton) for October/November delivery. With the domestic mills at $800 per ton ($40.00/cwt) and threatening to go higher (we are hearing of quotes at $880 per ton or $44.00/cwt), the spread becomes too wide to ignore. Even if domestic prices drop by $100 per ton in September and into October, the foreign number will still be good when the steel arrives.

The hysteria within the financial community is related to China and the drop in iron ore and steel prices over the past few weeks. Granted, the run up in iron ore and steel earlier this year may have been fueled by a loose money policy and speculation. But, we are still are far way away from disaster because the U.S. steel mills, through the use of antidumping and countervailing duty trade suits, have managed to insulate themselves from a flood of Chinese material for a number of years (and U.S. Steel section 337 filing may make it very hard for the Chinese to get back into the U.S. market).

The Chinese mills were a major force and price factor in the United States prior to the trade suits being filed. These kinds of trade suits are being filed against Chinese steel around the world. In Europe, Australia, Mexico, Canada, India and many other countries the idea of the Chinese being able to dump their unemployment (which is what they are doing) on the importing country is no longer acceptable. The Chinese government is being forced to consider shuttering excess capacity which we calculate to be in excess of 300 to 400 million metric tons, much higher than the 100-150 million metric tons China has “promised’ to shut within the next 5 years.

SMU Opinion – Two Scenarios: This is what we believe will happen over the next 6-9 months:

Scenario #1 – Chinese bubble bursts showering the world with cheap steel

The Chinese speculation “bubble” on both iron ore and steel will collapse but reset at higher numbers than where they were during the low point of the last cycle.

The first item to watch will be billet sales to Turkey and what impact that has on ferrous scrap prices into Turkey from the east coast of the United States. As billet prices drop so will scrap prices in order to compete against billet sales into Turkey.

At “X” point in time Turkey will be able to buy scrap cheaper from non-USA sources and the scrap being collected for export will be pushed into the domestic market. This will exacerbate lower domestic scrap prices just as flows of scrap increase into the yards due to seasonal factors and the higher buy pricing being offered.

The spread between U.S. domestic steel pricing and that of the rest of the world will attract more steel to the U.S. but it will most likely come from smaller producers such as South Africa, Pakistan, UAE and others. Depending on the European domestic markets we will most likely see an increase in exports from Europe to the U.S. as well as South America.

Deliveries on these orders will be, at best, late 4th Quarter or into early 1st Quarter 2016.

North American customers will slow their orders to the domestic mills during the 4th Quarter 2016.

Sometime from September to November 2016, lead times will start to come back and discounting by the domestic mills will become more apparent.

We don’t think the disruption will begin during the summer months 2016 (July, August) because there are a large number of maintenance outages planned by the domestic steel mills. This should offset the traditional slowdown in automotive due to summer shutdowns.

SMU Scenario #2 – Domestic Mills Implode Due to Weakening Demand

The more likely scenario regarding the change in the price cycle is related to the domestic mills’ ability to control their order book and salespeople. Over the past few weeks the domestic mills have done a good job of keeping lead times extended and limiting price negotiations to basically nothing. The domestic mills have also been working on controlled order entry or allocation depending on your viewpoint.

The question is has demand improve at all over the past six months? If demand is tepid and not growing and inventories are either balanced or becoming top heavy at the end users then there will be a disruption to the order cycle. In other words as salespeople are unable to sell out their “allocated tons” they will resort to putting them on the street to other customers or, offering to sell them at a discount.

When we were at the Boy Scout Dinner in Chicago this past week we heard one mill salesman say he was not able to sell all of the allocated tons he had to sell. One small dent but, something to watch and listen for out of other salespeople and mills.

SMU also heard from a service center that their customers were resisting buying all of the tons they had available to sell at the new higher prices.

We are aware of spot tons being offered by US Steel and ArcelorMittal. US Steel had been a minor player in the spot markets for a number of months.

We will need to watch for cracks in the foundation at the domestic mills to see if offers are “quietly” being made to their “key” customers first, and then to the smaller accounts. At that point price negotiations are in full force and the cycle will have been broken.

Unlike the foreign steel scenario above, this scenario can happen at any time and change the cycle much faster than growing foreign imports. We will need to watch automotive shut-downs, the construction industry and if there is any stirring of life in the energy and agriculture market segments.

There is a flip-side to scenario #2, if demand picks up quicker or stronger than what is anticipated we could end up with a short term shortage situation…

Our assumptions are based on USS Granite City and AK Steel Ashland steelmaking operations remaining offline. Should either facility come back online we then think scenario #2 will have a better chance due to higher production numbers.

We will get a glimpse into the world of the flat rolled service centers this week as the MSCI releases their April inventory and shipment data. We believe April flat rolled steel receipts will be similar to March. When comparing shipments to the prior month we are expecting April shipments to have been better than what was seen in March. If so, this would be supportive of dropping inventories, continued long lead times and price strength in favor of the domestic mills. We will report on the MSCI data on Tuesday evening and our Premium customers will get the results of our inventory analysis and a new service center inventory apparent excess/deficit and price forecast on Wednesday of this week.

SMU Price Momentum Indicator continues to point toward higher steel prices over the next 30-60 days.

That is our opinion – we welcome yours:

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