Friday, September 05, 2008

Will steel companies cut production to protect prices?

Despite continuing bullish talk by steel producers, falling car sales around the world, reduced construction and the general slowdown in economic activity is having an impact on steel sales and putting downward pressure on prices. In the past such fluctuations in supply and demand have lead to the price of steel continuously surging and collapsing with the market cycle.

In more recent times (particularly in Europe), the steelmakers have responded to the threat of falling prices by reducing production to keep supply more in line with demand and avoid the dramatic price collapses that had been experienced in the past. This year however we have seen the largest and most consistent price increases around the world, driven partly by demand but also by unprecedented cost increases in iron ore, utilities and fuel. Not only did the steel companies pass on this cost fully to their customers, but they took advantage of the situation to drive prices to historically high levels and increase their profitability. This has come at a high cost to their customers many who were unable to pass on this increase, and are now either significantly weakened or no longer in business.

The high profitability of the steel industry this year has seen share prices soar, and acquisitions mergers and expansions at an all time high.

Against this backdrop, how are the steel companies likely to react to the current market situation?

Well it is certain that some will cut back production and indeed ArcelorMittal have said as much.

Firstly, even though ArcelorMittal depends on the spot market for around 80.0% of its steel sales, the company says it plans to maintain prices by pulling back on production. Therefore while demand may suffer from the slowdown, the global economy steelmakers are likely to maintain their pricing power. "Steel companies are prepared for this situation and are ready to adapt a price before volume policy," says Hermann Reith, an analyst at BHF Bank.

Source Forbes

In the past couple of years they have also switched sales toward the growing economies of the east (particularly China and India), but current forecasts show demand falling in those geographic sectors too with China likely to become a net exporter again, so this tactic may not be as effective as in the recent times. As production can only be cut back so far (as the cost per ton is closely related to operating at optimum levels), and they are unable to effect the demand side of the equation, prices will inevitably have to fall.

Whilst we are not expecting the price crashes experienced in past cycles, all the bullish talk of the steel companies is not going to protect them from economic reality, and the last nine months have forced steel buyers to explore supply possibilities more critically, ensuring that competition for business is going to be more open than in the past, in a more global and open market.

To conclude: Will steel companies reduce production? In Europe it is almost certain.

Will it stop the price of steel sliding? Inevitably it will reduce the impact, but stop prices falling, I think not.


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