Date May 2017
Approximate net recovery on cost
- Scrap steel prices have increased approximately 30 percent for the year ended April 2017
- U.S. steel imports jumped over 30 percent in April of 2017 compared to 2016 on all steel types
- Despite price increases, U.S. raw steel production operated at approximately 74 percent of mill capacity as of May 2017
- China’s steel Purchasing Managers’ Index (“PMI”) reached a 12-month high in May of 2017; increased orders from purchasers in China as well as lower inventory levels drove the increase, following two months of declines in March and April
Steel sales shape global market: American steelmakers have warned the U.S. government that there is a global overcapacity crisis in the steel market, describing cheap imports from China and other countries with state-supported industries as a threat to national security. At the same time, American steel producers have seen a boost in the last year from trade cases, including U.S. Steel, which is expecting to turn a profit in 2017 for the first time since 2014.
Both chambers of the Texas legislature have passed the “Buy American” Bill, which will go to the governor before being signed into law. The “Buy American” Bill would require state infrastructure projects to purchase both iron and steel material from American suppliers, as long as the cost does not exceed the price of imported material by 20 percent. This bill, if passed, would provide a significant boost to both Texas and domestic steel and iron production facilities. However, there is also concern that the bill could harm the Texas-Canada trade relationship, which represented more than $12 billion in 2016, although Canada purchases more steel from Texas than it sells.
Categories drive value: For U.S. imports of steel mill products, many categories have seen increases in tonnage imported for the four months ended April 2017, compared to the same four-month period in 2016. The biggest change was in the quantity of oil country goods imported, representing a 551.1 percent increase, from 47,686 tons to 310,468 tons. Hot-dipped galvanized product also saw significant increases (36.9 percent increase, from 218,189 tons to 298,692 tons). A few categories saw year-over-year decreases in imports, such as hot-rolled sheet, reinforcing bar, and line pipe, but those were the only three categories showing a year-over-year decline. Overall, the level of U.S. imports of steel mill products increased to a total of 3,006,962 tons, a 33.5 percent increase compared to the 2,253,069 tons imported for the same period in 2016.
Mills have domestically produced 32.9 net tons of raw steel, up 2.2 percent over May 2016. Mill capacity in the U.S. increased from 71 percent in January 2017 to 74.1 percent as of May 2017. Globally, steel demand is expected to grow by 1.3 percent in 2017 to 1.535 billion tons and a further 0.9 percent in 2018, due to accelerating growth in most developing countries. While China’s steel demand is expected to remain flat, India’s recovery from demonetization, as well as increased demand in Russia and Brazil, means that, excluding China, emerging and developing economies are expected to increase their steel demand by 4 percent. Steel prices have also risen by 45 percent since December 2015, due to rising demand and Chinese anti-dumping measures.
Section 232 review: U.S. steel manufacturing facilities in operation are waiting on the Section 232 investigation into steel and aluminum imports. The investigation is looking into the Trade Expansion Act of 1962, where Section 232 allows the President to penalize imports if he/she decides that they pose a threat to national security. Once the report is completed in June 2017, the President will have 90 days to assess the results. Import limitations could include tariffs, volume quotas, or a combination of both, which would ultimately affect the global market.
Collateral values taking a hit: Any company with large steel inventories will likely be materially affected by current conditions as these assets were previously losing value, but as market prices continue to rise, could see values improving. Slow-turning inventory that was previously at high risk of being overvalued is less at risk as steel pricing is rising. The need to reappraise is important to understand current market values as they relate to prior market prices when the inventory was purchased, as well as inventory costs. Exit strategies are limited as the cost to relocate large inventories is not practical given these market conditions. In some cases, strategies may include holding inventory for longer periods in the hope of some market recovery.
Certifications important: In order to achieve maximum value for inventory collateral, each item must have current and up-to-date material certifications from the appropriate vendor. The documentation specifies all relevant certifications including grade, alloy, ASTM, SAE, or UNS specification, size, mill of origin, heat number, and other information that would be required by a potential buyer. Without those certifications, the value of the inventory would be lower as fewer customers would purchase the material and the inventory would become secondary-grade material. Lenders should ensure that record keeping related to certifications is being maintained and audit this paper trail in the same fashion that proof of deliveries are checked for accounts receivable.
Inventory Costing and Mark-to-Market Reserves: When a company’s inventory contains commodity-type items, like steel, which are subject to frequent price fluctuations, it is imperative to understand the company’s inventory costing methodology. A standard cost approach includes updating inventory costs periodically and, depending on the frequency of the update, can result in the company’s reported cost varying from the market in an inflationary or deflationary environment. A rolling weighted cost approach utilizes an average weighted cost for each purchased item that equates to a rolling perpetual average. This methodology is useful for commodity-type items as a company’s reported cost will remain closer in line with the market, although they will still trail market prices by a set period. Given the volatility in the steel market, lenders should be aware of the target company’s costing methods and should consider incorporating a mark-to-market or lower of cost or market reserve. A mark-to-market reserve account will adjust the cost basis to market and ensure that an advance rate based on a percentage of cost remains relevant even in a volatile market.