Wednesday, August 24, 2005

Who Drives Steel Prices?

For a number of years now there have effectively been two completely separate pricing schedules for steel. It is a subject that I and others have touched upon in the past. The large volume OEM’s and particularly automotive manufacturers have used their purchasing power to negotiate favourable prices fixed forward for long periods of time. In the UK it was often referred to as “Automotive sector rebate”, and was available to most tier one suppliers.I was very interested therefore to discover the following article published over at MEPS which addresses this issue and why things may now be changing:-

Contract Buyers are not the key Driver for Steel Prices anymoreBuying just four times a year, as do many major steel mill customers, can be extremely beneficial to consumers when the market is trending upwards. In contrast, it can be detrimental in the downturn.This extra information is in response to clients’ requests to understand more fully the implication of steel price movements as they apply to major steel mill customers who purchase, normally, on a quarterly basis. Buying just four times a year can be extremely beneficial to consumers when the market is trending upwards. In contrast, it can be detrimental in the downturn.Due to their substantial steel requirements, large OEM’s are required to negotiate early with the steel makers to agree production schedules. Deals are usually made two months prior to the start of the delivery trimester. This gave an advantage to contract purchasers of cold rolled through 2004 because, at the time of agreements, the mills had available capacity. In 2005, these contract buyers had completed their negotiations before the steel makers’ order book shortfall had become apparent and subsequently discounts were given at a later date to the smaller purchasers.With up to 50 percent of the steel producers’ total sales of cold rolled coil sold to major contract customers; it is clear that the price agreed is important to both parties. However, contract buyers are not the key drivers in market price trends. The OEM’s have reasonably stable requirements. They keep small inventories. Moreover, they usually buy from local suppliers to avoid irregular delivery patterns.It is usually the mid sized/smaller buyers and service centres that determine market price movements. They carry large inventories compared to total usage. For this reason they are able to purchase some of their needs from foreign sources - often at competitive rates because delivery is less critical. This category of buyer has more flexibility and can influence prices by cutting off orders or placing extra requirements based on internal demands or external leverage.Large contract buyers are fast losing influence in the steel market price scene. The days are long gone when OEM’s could demand substantial discounts because of the volume of business placed. Contract prices now follow the market. They do not lead it. Even the powerful automotive segments’ annual contracts are negotiated on the basis of the general market price tendencies. In Europe, the mills are cutting output to prop up prices. This is not the result of significantly lower order volumes from the large contract buyers. The mills are reacting to the regular monthly customers’ demands and these are based on inventory levels and the availability of imports.As prices continue to drift in the EU through the summer, large contract customers will see their purchasing power increase somewhat. However, if values continue to slide over time, early agreements will result in them paying more for steel over the full quarter, compared to a more flexible buyer who goes into the market on a more regular basis. It should be said that they had some of the benefit in the last upturn. But informing the mill of the blessing of placing substantial orders when it is overwhelmed with enquiries does not promote competitive offers.It is clear that the steel stockists and mid sized regular steel buyers have the greatest influence on the market. Large contract buyers are eventually required to follow the pattern already set by others.MEPS prices reflect those agreed by stockists and a great number of mid sized buyers on a monthly basis. The large OEM’s cannot stay aloof from their smaller counterparts. The power is in the hands of the purchasing majority.

It was not unusual in the past for the leading OEM manufacturers, particularly those involved in the automotive industry to have long (sometimes three years) fixed price deals. These deals offered them stability and were obviously advantageous at a time of rising prices. During a time of high demand however, large quantity business does not necessarily attract discounts, as producers realise that capacity can be sold at higher prices elsewhere.Ironically the automotive manufacturers have possibly the least flexibility in their purchasing options, despite their massive purchasing power. This is due to the fact that auto assembly plants are incredibly expensive to run and have a very complex supply infrastructure. Any plant downtime, due to supply issues can be disastrous and resultantly, they cannot rely on remote and inflexible steel plants for their strategic supplies. They therefore purchase raw material from Service Centres, who by maintaining high inventories combined with flexible processing facilities can offer the high level of service they require.This supply route extends beyond the automotive manufacturers to their key component manufactures that in turn need high levels of service, and have similar arrangements often “tied in” to the automotive manufacturers deal.By contrast the Service Centres hold high stock levels and are more able to order large quantities from worldwide sources. This enables them to take advantage of lower cost available in different geographical regions, as prices fluctuate. Smaller users order as they need the material and can benefit, particularly in a falling market, being unshackled by fixed prices.One Caveat I would add, is that many service Centres (particularly in the UK) are owned by the steel manufacturers. It would be na├»ve to think that the producers have no input in to price negotiations between the Service Centres and the large OEM’s. Indeed having worked for two large steel manufacturers I know that tri-partite negotiations are commonplace.If indeed the large buyers are losing their power to drive prices, maybe that’s a distortion that will not be missed in the industry. Maybe things are changing, and maybe that’s no bad thing.

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