Enjoy it while it lasts

Mar 4th 2005
From The Economist Global Agenda

Last year was one of the best on record for the world’s steelmakers. But a huge rise in the price of iron ore seems likely to squeeze their profits this year. And China’s booming steel output could yet propel the rest of the world’s producers back into the doldrums

AS RECENTLY as 2002, steelmakers were lamenting that overcapacity had driven down the prices of their products to the lowest for 20 years. But, such has been the surge in demand from a fast-growing China that the world steel industry has since enjoyed a spectacular turnaround in its fortunes. After years of losses and retrenchment, 2004 was one of soaring prices and bumper profits. Mittal Steel, a London-based multinational which is in the middle of a merger that will make it the world’s largest producer, recently announced that its profits had almost quadrupled in 2004, to $4.7 billion.

But for how long will the steel firms’ good times roll? The world’s iron-ore producers—ie, the providers of the steelmakers’ main raw material—have become determined to share in their customers’ good fortunes, and are seeking to impose hefty price rises on the steel firms. Between them, the world’s three largest iron-ore producers—CVRD, BHP Billiton and Rio Tinto—have a 70% market share, which gives them considerable pricing muscle. Last month, the big ore miners shocked the steel industry by demanding a 71.5% price rise in initial negotiations with Japan’s steelmakers.

In previous years, these talks have set a benchmark for the rest of the world. This time, the world’s steel giants argued that the big price hikes imposed on Japan’s steel firms were unlikely to be repeated across the whole industry, since Japan’s steel firms were relatively small and thus lacked negotiating clout. However, on Thursday March 3rd, Arcelor, a Luxembourg-based giant which until Mittal’s merger announcement was the world’s largest steelmaker, announced that it had agreed to accept the same hefty price rise from CVRD, the Brazilian giant that is the largest of the big three ore miners.

The rise agreed by Arcelor for this year comes on top of price increases of 19% last year and makes it highly likely that other steelmakers will be arm-twisted by the ore miners into accepting similar hikes. And this is not the only price pressure facing the industry. In December, steelmakers suffered the doubling of the benchmark price of coking coal, which fuels the blast furnaces that turn iron into steel. The steelmakers insist they will have to pass on these cost rises to their customers. If so, the price of hot-rolled coil—one of the most common steel products—could rise by as much as 15%, on top of the sharp spike in prices seen since 2002 (see chart). Carmakers, among the biggest consumers of steel, have warned that added costs will hit profits this year and have appealed to steelmakers to “share the pain”.

Even if steel companies succeed in passing on all these added costs to customers, they could face a bigger threat to their long-term profitability. The huge spike in demand has come about mainly as a result of China’s vast appetite for steel. But concerns that China’s economy was overheating led to action by the country’s government last year, to cool down a construction boom by squeezing credit. As a result, the growth in China’s steel consumption has moderated considerably. Between 2000 and 2003 it was growing at an average annual rate of 23%, according to the International Iron and Steel Institute. But the Organisation for Economic Co-operation and Development (a club of mainly rich countries) predicts that the growth in Chinese steel demand this year will be just 10.7%.

China’s soaring demand has encouraged a rapid expansion in its domestic steelmaking capacity. China's steel-industry body says its production grew by 23% in 2004. Further strong growth is expected this year. Such has been China's success in boosting home production that in November it (albeit briefly) became a net exporter of steel.

Surging capacity in China and elsewhere has prompted the North American Steel Trade Committee (comprising America, Canada and Mexico and their country’s steel firms) to estimate that the world’s total annual steelmaking capacity will rise by 250m tonnes over the next five years, an increase of 25% that threatens a return to glut, and thus plunging prices, especially if Chinese demand falters.

Recently, the world’s steel mills have been running at close to full capacity but getting there was a painful process, including bankruptcies, closures and huge job losses. In the 1990s, competition from developing countries with lower production costs (such as India and Brazil, as well as China) and the emergence of steel suppliers from the former Soviet Union led to gluts and deflated prices. Inept management, over-mighty unions and crippling pension costs were left unchecked for too long, as richer countries’ steel industries were protected behind tariff barriers. Now, at least, the rich world’s steel firms are in better shape to weather another bout of oversupply.

As long as global growth remains strong, world steel demand should hold up. Nevertheless, if China’s recent, breakneck growth is as unsustainable as many experts suspect, and its economy suffers a “hard landing”, then the country’s rapidly expanding steel producers may be tempted to dump their output on the world market. If so, the steel price could come crashing down as fast as it has recently been soaring. After a few glorious years, the industry could quickly find itself back in the mire.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.