Steel Industry Trends & Prices
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eFFECTS OF THE cORONAvIRUS ON THE sTEEL iNDUSTRY Updated June 11, 2020
- Production Levels Declining: Industrial metal production is considered an essential industry nationwide, insulating it from shut down orders. Despite this, concerns about over supply in the marketplace have triggered production reductions. U.S. steel mill shipments for April 2020 (reported in early June) were off 29.9 percent from March 2020. U.S. steel mill capacity utilization declined to 52.8 percent in April, down from 72.5 percent in March 2020 and down from 79.2 percent in April 2019.
- Specific Capacity Cuts: U.S. Steel idled its Blast Furnaces #4, #6 and #8 at Gary Works; Blast Furnace A at Granite City Works; Blast Furnace #1 at Mon Valley Works; all of its Lone Star Tubular Operations; a significant portion of its of Lorain Tubular Operations; and its Keetac Iron Ore Operations. As of early June 2020, none of these facilities had been reported to have been re-opened. ArcelorMittal also idled two blast furnaces indefinitely in early April, one in Indiana and one in Canada. In addition, ArcelorMittal closed its iron mine in the Minnesota iron range as of May 3, 2020. Cleveland-Cliffs is also closing its Northshore Mining operations in Babbitt and Silver Bay, while AK steel, which was recently acquired by Cleveland Cliffs, is scheduled to close its hot strip mill and the related annealing and tempering operations at its Dearborn Works plant in Michigan on July 5, 2020.
- Pricing Metrics: Hot rolled prices reached a low in early May 2020 but recovered in mid to late May and into early June by about 11 percent through June 11, 2020. Prices are still off about 15 percent from the January 2020 average, and are at levels that are unprofitable for many major steel mills. While pricing was trending up, demand from the automotive sector was still weak, and many brokers were noting volumes were better but still at about 50 percent of normal, and it was reported to be a buyer’s market. Not all the production for June 2020 was spoken for and orders for July, while ticking up slightly, were competitive. Plate volumes were reported to be off by 40 percent and were similarly weak but slightly improving. Hot dipped galvanized pricing was better relative to hot rolled with some indication of recovery from HVAC manufactures and the construction, sector, but demand from the automotive sector was still well below normal.
- Valuation Metrics: Gordon Brothers would expect a decline in inventory appraisal values based on pricing direction, a reduced order book going forward, as well as delayed and cancelled orders. Uncertainty and dim market sentiment will also weigh down values.
Date April 2020
- The coronavirus pandemic has made a dramatic impact on the marketplace with hot rolled coil prices dropping 18.6 percent from highs seen in January 2020, following already weak conditions in the market and causing a drop of approximately 35 percent over the past 12 months
- Industrial production in North America and throughout the world is contracting sharply due to significant curtailment in production
- The steel industry will see significantly reduced demand from the oil and gas sector in 2020
- Multiple new expansion projects coming online in 2020 will add capacity
- The North American market consolidated further with recent completion of the Cleveland Cliffs and AK Steel merger, which closed on March 13, 2020
- In February 2020, the Trump administration announced plans to expand existing Section 232 tariffs to products made from aluminum and steel, including nails, tacks, cables, wire, bumpers, and other tractor and car parts
- The collapse of oil prices due to COVID-19 combined with a price war that has broken out between Saudi Arabia and Russia has brought oil prices to lows not seen for decades
Approximate net recovery on cost
Coronavirus concerns: It is unusual that an insight on steel would focus on the dramatic impact of a novel virus that was unknown to the world until December of 2019, but here we are. Supply chains around the world including the steel industry, have slowed or shut down in an effort to contain the coronavirus pandemic and the spreading COVID-19 disease. A supply chain slowdown that began in early February 2020 with major Chinese factories shutting down has spread across the globe. The shutdowns are contributing to the growing conviction that the world has slipped into its first recession since the “Great Recession” more than a decade ago. “This is kind of a rolling natural disaster,” said Ethan Harris, head of global economic research at Bank of America on March 20, 2020. “In terms of the impact on global production, the shutdown outside of China will likely become bigger than the impact from China.” The shock to supply chains, Harris said, is deeper and more sprawling than the trade wars of the past two years and likely to be more prolonged than the storms, earthquakes, or floods that have been a source of stress for major industries in the past. He expects factory shutdowns will last into May and possibly longer. Compounding the blow for companies, the initial supply shock has been interwoven with a demand crisis in Europe, the United States, and other major economies, as workers and consumers are ordered to shelter in place. How this plays out is open to debate and there are a range of outcomes being discussed. The balance of this outlook discusses the current situation on or about April 8, 2020.
Coronavirus brings recession fears: The world is transitioning in most areas from social distancing to widespread shutdowns in an attempt to control the spread of the novel coronavirus. Countries hit early as measured by the date of first reported death include China (1/23), France (2/15), Italy (2/21), South Korea (2/20), and Japan (2/13). All of these countries have instituted some or all of the following measures either on a national or regional basis: quarantines, stay-at-home orders, non-essential business closures, social distancing rules, contact tracing, among others in order to mitigate the spread of the virus. Countries and regions affected after these early waves include the United States (2/29), Canada (3/9), the balance of Europe (first to second week of March), India (3/11), Turkey (3/17), Brazil (3/17), Indonesia (3/11), and many other nations.
In the United States, stay-at-home orders, non-essential business orders, and other measures have roiled through the economy first in the Pacific Northwest in early March, then in California and New York, and have now spread throughout almost every state. While multiple types of consumer and industrial activity have been deemed a part of the “essential infrastructure” of the United States, this has not stopped a large contraction in economic activity throughout North America, with broader measures such as unemployment, purchasing manager sentiment, and forecasted gross domestic product plunging in March.
Key industry impacts: According to the American Iron and Steel Institute (AISI), construction accounted for an estimated 44 percent of total domestic steel shipments, followed by transportation (predominantly automotive), 28 percent; machinery and equipment, 9 percent; energy, 6 percent; appliances, 5 percent; and other applications, 8 percent, in 2019. Of most concern to the steel industry, the spread of COVID-19 has caused large reductions in automotive production, has slowed construction activity, and has caused a sharp decline in oil and gas drilling activity, although it is likely that all major sectors utilizing steel in their products will be impacted by the virus eventually.
Automotive manufacturers throughout the world and in particular in North America have been closing plants and curtailing production in reaction to COVID-19 safety concerns as well as demand forecasts and/or supply chain issues. In North America, the Big 3 automakers and others closed their North American assembly plants for two weeks starting in March. To date, both Ford and Toyota have announced an extension of their closures through mid-April. The latest projections from Edmunds estimates that annual sales levels in North America will decline by 35.5 percent in 2020, and they noted that sales in the third week of March 2020 had fallen by 80 percent from 2019 levels.
Construction activity is also expected to slow due to COVID-19, although no exact statistics measuring the drop have been published to date. As of March 25, 2020, construction was considered an essential service in approximately 45 of 50 states, but labor, travel, and supply issues have slowed activity in the sector. A survey released by the Associated General Contractors of America on March 22, 2020 in response to the outbreak noted that 28 percent of member firms in the United States had already halted or delayed work on projects due to COVID-19, with 11 percent of respondents noting possible delays in jobs scheduled to start in April and beyond. The cause of the delay was related to a shortage of government inspectors and lack of job supplies and equipment including personal protective equipment, labor shortages, and other factors. The number of delayed projects was expected to increase in April.
On a year-to-date basis, as of April 3, 2020, the active drilling rig count as reported by Baker Hughes had dropped by 22 percent and West Texas Intermediate (WTI) crude oil had dropped to below $20/barrel before recovering late in the week. At $20 per barrel, this represents over a 66-percent drop from January 2020 highs. This precipitous collapse was due to the combined impacts of the spread of COVID-19 as well as a price war that has broken out between members of the Organization of the Petroleum Exporting Countries (OPEC) and Russia. The dispute, which is primarily between Russia and Saudi Arabia is over the level of production each country will maintain. When talks broke down between the two parties at the end of the week of March 2, 2020, oil fell from the already depressed level of $45 per barrel to $30 per barrel immediately and then to the $20-per-barrel range by March 18 and $14.10 per barrel on March 30. As the dispute was recognized globally to be a full price war, outlook dimmed based on a further understanding of what COVID-19 was going to do to the global economy.
Although there is ongoing discussion of a political solution or government intervention, based on the current level in the drop in demand for oil of 20 to 30 percent, and the high level of global inventories (estimated to reach global capacity by May 1, 2020), it is likely that oil prices will be significantly below profitable drilling levels for the remainder of 2020. Upon the announcement of a meeting between OPEC members and Saudi Arabia scheduled for April 9th, 2020, the price of oil shot up, with WTI futures trading around $26 per barrel on April 6th. If oil prices average out the balance of the year in a range of $25 to $30 per barrel or below, U.S. exploration and production activity will be curtailed heavily.
Most major oil companies have announced reductions to their capital expenditure budgets for 2020 of 30 to 40 percent from where they had been pre-COVID-19. Given the current market dynamics in the oil and gas space, the industries’ consumption of steel will be materially negatively impacted and will cause trickle down effects in other sectors that are important to the steel industry, including transportation demand and equipment production.
Reduction in production due to COVID-19: Because of cratering demand, many steel mills have announced a variety of measures to adjust production levels to market demand. U.S. Steel idled tubular operations indefinitely at its facilities in Lone Star, Texas, and Lorain, Ohio, on March 24, 2020. Tenaris S.A. announced it will suspend operations at two plants in Koppel and Ambridge, Pennsylvania, affecting 560 workers. These facilities were producing various products, but had a heavy focus on oil country tubular goods.
U.S. Steel also plans to idle a blast furnace at its Granite City Works in Illinois for 60 days. ArcelorMittal is also idling two blast furnaces in Indiana and Canada indefinitely. For the week of March 28, 2020, U.S. steel mill estimated capacity utilization as reported by AISI was 71.6 percent, representing a 9.8 percent decline from the prior week and 12.7 percent from same week in 2019.
Additional capacity coming online: In reaction to the tariff protection offered by the Trump administration in 2018, a significant number of U.S. steel mills underwent new capital improvement projects on many facilities, which will result in additional efficiencies or production capacity coming online. Nucor completed a $200 million project in a new hot band galvanizing and pickling line at is sheet mill in Ghent, Kentucky, which ramped up production in late 2019. In addition, Nucor added a rebar micro mill near Kansas City, Missouri, capable of producing approximately 380,000 tons annually, which started in early 2020. Nucor is also adding 500,000 tons of merchant bar capacity at an existing mill in Bourbonnais, Illinois, which is scheduled to start up in the second quarter of 2020. In addition, Nucor is expected to open another new rebar micro mill capable of producing approximately 380,000 tons annually in Frostproof, Florida, which is expected to be operational in the second half of 2020. Nucor has several additional projects underway in the flat roll and plate spaces, but these projects are not expected to go into operation until 2021. Steel Dynamics invested in additional pickling capacity at its Butler, Indiana, plant in 2019 and has started construction of a new flat roll steel mill in Sinton, Texas, which will have an estimated 3.0 million tons of new steel production capacity expected to come online in mid-2021.
Some industry estimates put new flat-rolled steel capacity currently under construction that will come on line in 2020 or later at an additional 7 million to 8 million tons, or about 10 percent of 2019 total domestic production levels.
Marketplace consolidation: The marketplace has seen significant consolidation in recent years and the trend has continued in 2020. On March 13, 2020, AK Steel Corporation was acquired by Cleveland-Cliffs. The Cleveland, Ohio-headquartered Cleveland-Cliffs is a producer of iron ore and steel and holds a significant market share in the automotive industry. Also headquartered in Ohio, in the West Chester region, AK Steel manufactures a variety of steel products for the automotive industry, with sites in the United States, Canada, Mexico, and Western Europe. On March 18, 2020, British Steel completed the sale of its United Kingdom and Netherlands assets to Chinese steelmaker Jingye Group. British Steel had been in insolvency proceedings since mid-2019. Jingye Group, headquartered in Shenzhen, China, specializes predominantly in steel and iron production.
Ongoing Trade War: The Trump administration announced in February 2020 plans to expand the section 301 tariffs to products made from aluminum and steel, including nails, tacks, cables, wire, bumpers, and other tractor and car parts. The Section 232 tariffs, which were rolled out in 2018 because of executive action on the part of the Trump administration, are still in effect, although multiple exclusions have been granted on a country- and product-specific basis. The impact of tariffs is fully priced into the market at this point, although there has been concern in the marketplace among domestic U.S. producers that the section 232 tariffs may be rolled back at some point.
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 more in line with the market, although costs 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 reserve to 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 or a lower-of-cost-or-market reserve to adjust the balance sheet value of these inventories when their market values change.
Valuation outlook: In the short term, Gordon Brothers would expect a decline in inventory appraisal values based on current pricing direction, a reduced order book going forward, as well as delayed and cancelled orders. Additionally, higher per-pound logistics costs, uncertainty, and dim market sentiment will weigh down values as well.
Note: This publication is provided for informational marketing purposes only. The material contained herein should not be regarded as advice, nor relied upon to make financial, operational or other decisions; nor should it be used as a substitute for an asset appraisal. Actual recovery values may vary from transaction to transaction and the recovery values referenced herein are for representative transactions without regard to specific key factors. This material may be redistributed only in its entirety, including notice of copyright. All rights reserved. ©2020 Gordon Brothers, LLC.
Reference sources: FRED, BAKER HUGHES, NUCOR, U.S. GEOLOGICAL SURVEY, ICLG, MESABI DAILY NEWS, IHS MARKIT, JUST AUTO, KPMG, STEEL NEWS