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Monday, Jun 10, 2002

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Steel price hike: Driven by supply cuts and speculation

A. S. Firoz

Good recovery in the steel sector worldwide has boosted prices, but the possibility of a further price rise does not seem very strong.

GLOBAL steel prices have risen after quite a long time. While the going seems good for the moment, there are reasons to believe that, despite many favourable factors, the current run may turn out to be short, as happened several times in the 1990s.

The steel price rise was expected, but the extent is surprising. The transacted export price of hot-rolled coils has touched $240 per tonne. Reports say that quotes for the third quarter stand higher, at about $260 per tonne, than the high-end mills. There must have been transactions at these prices too. The major increases, expectedly, have been in the US domestic market. The more enthusiastic sellers are asking for nearly $380-400 per tonne for the third quarter contract deliveries. How much of that they will actually get is anybody's guess, and only time will tell.

Why has this happened? Has global steel demand shot up to such an extent that there is a perception that shortages will follow soon? The global macro-economic data indicate the possibility of a real rise in steel consumption, and the observed feel-good factors in several major economies may have led to larger demand for stockholding and future consumption. The recovery so far is good enough — but anything beyond that may be excessively optimistic. Therefore, the possibility of a further price rise does not look as strong as some experts are trying to make us believe.

Steel demand, particularly for flat products, has risen largely on account of increased inventory holding. By December, 2001, the total stock of steel with the actual users, traders and service centres had grown to historic lows globally. The pressure was high on the producers, as they built up a lot of unwanted stock. They were ready to accept any price for these materials as there were no clear signals when the market would turn around.

The steel-makers around the world used well the opportunities emerging out of the US and the EU safeguard actions. While these two regions could isolate their markets from the global turmoil giving their domestic players a chance to raise tags, the resulting higher domestic prices came to become the standard for the rest of the world.

The steel-makers did everything possible in major markets such as the US to break contracts signed at lower prices, pulled the pricing power for themselves and started dominating the market that was for long at the mercy of the buyers. This was no uncommon business practice in steel but was fair game by all standards.

Supplies have also got a lot to do with the current price uptrend. Interestingly, the higher prices in the US and Europe were also backed by lower supplies. Crude steel production in the US in the first four months of the year dropped 5.3 per cent. The corresponding figure for the EU is 4.4 per cent.

Drops have not only been recorded for the first four months, but also for April, over the same month last year, and also over the previous month. In fact, these declining trends have been over the huge drops recorded in the second half of last year. Crude steel production has declined in the CIS ( -1.2 per cent ) as well as in South America ( -3.7 per cent ). This has happened because the doors are being closed to their steel-makers in most important markets.

Among major areas, steel output is up in Asia — by a huge 11.4 per cent in the first four months. Decline in steel output seen now is more a response to the worst the industry had seen in the latter part of last year. The question is: Will the industry continue in the same way in the months to come when the prices are high?

With barriers coming up everywhere, including China, it will be hard for many to sell. Therefore, the prices may not be of any business interest any more for many players. This will dissuade steel-makers from countries more affected by trade action from increasing output in response to rising prices.

On the other hand, opportunities are not totally dead in the world market. There will, therefore, be players who will take chances and increase output to the extent possible to take advantage of high prices, wherever they can command. For example, even when hit the most by barriers, the CIS producers, with their low costs, can corner a large share of the market not covered by safeguards by leading a limited price war. But they could face certain constraints here.

Today, with their domestic markets doing well, the Russian mills are diverting their output to the home market. Their potential to raise output to meet global quality demand may be limited without significant investment and cash flow into their industry. This will certainly not come about shortly. But an increase in the magnitude of a percentage point or two may not be difficult.

Asia can be a trouble spot. With the Chinese closing doors, after registering a massive 27 per cent growth in crude steel production, the region sees the possibility of a turmoil with a huge surplus of steel floating around in the market of the region. Although Japanese steel output is down, the same has not been the case for such other majors as Korea, India and Taiwan.

Overall, even on the upswing, the steel market does not look stable. The real test will be in the middle of the third quarter, when the negotiations will start for fourth-quarter deliveries. The demand-supply balance in the global market may change significantly by then. On top of that, speculation works, and well, in the steel mart. If some bit of speculation has driven up the prices, it is no great surprise if the same forces drag them down as well, when the stock building activities of the users, traders and service centres are over.

It will be interesting to see if the domestic steel markets of individual countries remain isolated from the global trends. Till now, reports indicate that domestic steel prices have shot up everywhere, and that too in a greater proportion than the international export prices. This is good news because, in the downturn, unlike in the past, domestic prices may not collapse. This is the direct result of growing protectionism worldwide. As nations have learnt to protect their steel industry by every means and have also shown actions on the ground, the international steel market will lose much of its punch.

(The author is Chief Economist at the Economic Research Unit of the Steel Ministry. The views are personal )

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