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Steel's tale of woes

A. S. Firoz

THE WORLD steel market is in a deep slump. The international prices of steel have crashed below the production costs of even the above-average mills in terms of efficiency. While the global commodity markets have remained weak, the steel prices have witn essed volatility unlike any other. The turbulence has surprised even the experts in the business.

The current trends in the steel market are not the fallout of some temporary or immediate problem that can be sorted out quickly. In fact, the root cause of much of the problems lies in the global developments in the industry since the mid-1990s.

It is common knowledge that the steel industry lacks an efficient system that adjusts supply quickly enough to meet the demand. This causes wild price fluctuations. But a number of other significant factors, too, have contributed to making the situation more complex.

The catastrophic changes in the erstwhile USSR did have a major impact on the global steel market in the 1990s. Steel consumption in the region fell from 116.6 million tonnes in 1990 to 28.8 million tonnes in 1998 and recovered to 40.7 million tonnes in 2000. Likewise, the production of crude steel dropped sharply from 154.4 million tonnes in 1990 to 98.6 million tonnes in 2000. The bigger fall in consumption was the root cause for the turmoil the followed in the world steel market. The notional surplus (production minus consumption) of finished steel rose from 18.5 million tonnes in 1990 to 45.6 million tonnes in 2000.

These former non-market economies dumped steel into the world market at prices far lower than in other countries. Further, the large-scale devaluation of their currencies and the highly depreciated plants and machinery, built during the socialist regime at low costs, resulted in their cash costs being abysmally low. Today, the CIS exports more than 46 million tonnes of steel, accounting for 30 per cent of the global extra-regional trade, at prices 10-20 per cent lower than those of their nearest rivals.

While one may question the capability of these steel makers to continue their current pricing strategy, what is indisputable is that under no circumstances will their competitive position depreciate. On the contrary, going by the new investments, the ren ewed efforts to open up mothballed capacities and the importance given by their governments to further develop the industry, the share of these countries in the global production is only likely to rise.

The 1990s also saw a dream run for the US economy. The greenback made huge gains against almost all other currencies. The dollar denominated prices are low today because of the weakening of the currencies in most of the major steel-producing countries an d regions, such as South-East Asia, Latin America, the EU, India and Japan. In fact, the domestic prices of steel in most countries, adjusted for inflation, did not drop as much.

The regular ups and downs notwithstanding, steel prices remained fairly stable in the first half of the 1990s. While the prices of long products had touched a valley -- and there was no noise about it -- uncertainly and speculation ruled over flats' pric es.

The rising trends in the consumption of flat-steel products in the early 1990s sent confusing signals to the industry, which saw in this market its future. Prices of flats in the first-half of the 1990s were high enough to justify profitable capital inve stments in new capacity. This popular perception gained weight when HR coils prices zoomed to $430-440 per tonne in 1995, but only to fall by over $100 within months. Rather that seeing the rise as the aberration, the fall was taken as a temporary adjust ment in the market. Major steel business research organisations such as the World Steel Dynamics predicted short- and longer-term `volcanic' eruptions in HR coil prices, as they feared that production capacity worldwide was falling short of the expected demand. This was the beginning of an investment surge in an industry which was already ridden with excess capacity.

Although estimates vary, at times by huge margins, the most widely accepted figure of global over-capacity is about 150 million tonnes. This capacity includes even that of inefficient plants which are incapable of delivering quickly and as per the qualit y standards of the international market. The effective excess capacity that has relevance to international trade would, therefore, be only nearer to 100 million tonnes.

Much of this excess capacity is sustained because of government support in various forms. This may not last long though, as the global market of such mills is getting chocked because of mounting trade cases. But excess capacity does not exist only in obs olete plants. The misguided investment surge in the 1990s added some state-of-the-art capacities. These are turning out to be white elephants for many now.

It is argued that low steel prices in the international market resulted also from a combination of factors such as the desperate bid by many financially weaker steel mills, for whom maintenance of cash flows became a priority, to survive. Many of them re sorted to major cost cuts, as they were not strong enough to withstand the pressure on prices. But this contributed to a further weakening of the prices. It is, however, a matter of debate whether such mills could have acted differently, as many would li ke to argue that ultimately they were only price takers in the global market. They were mere puppets in the `invisible hand' of the market economy.

A striking development of the global steel market towards the end of the 1990s was that it turned extremely unpredictable, volatile and speculative. The three-year steel business cycles were replaced by one-to-one and half-year duration cycles. Steel pri ces have been on the lower side of the cycle for a longer duration in the past 10 years. That is, the high-price periods have been short-lived. The current market is best described by World Steel Dynamics as the ``Death Valley''.

The expansion of the global market, per se, has not been the problem. The fundamental problem today is a combination of factors such as excess production, increased speculative trading, new-technology-driven low-cost production and unwillingness of steel companies to unilaterally pull out of production at the right time. For any steel company, the risk element involved with a larger exposure to the global market is much higher at present.

The following depict the state of the global steel market in the last decade and thereafter:

* The prices are much lower now than 22 years back. For example, the average price of HR coils dropped from $315 a tonne in 1979 to $210 in 2000. And it is less than $180.

* Consumption growth has fallen short of capacity growth.

* Idling large capacity makes no sense either. There has been a reluctance (to some extent inability) to reduce production quickly and sufficiently. In the past five years, production has outstripped consumption.

* Buyers today manage inventory better. Excessive stocks with producers have caused price volatility with unpredictable and unreasonable swings.

* Low prices have resulted in low returns on investments. In the past 20 years, the returns have been around 4 per cent.

* Low returns have weakened the financial viability of steel companies. In addition, the frequent price declines have ruined the finances of most steel makers. There is growing indebtedness and bankruptcy in the industry, especially for those players who made huge investments recently.

* Fighting for survival, steel mills have sought protection from import competition. This has led to increased trade disputes.

The happenings in the 1990s cannot be undone. And the crisis looks like continuing for the time being at least.

(The author is Chief Economist with the Economic Research Unit, Joint Plants Committee. The views expressed are personal.)