The Hindu Business Line : Steel bends under slowdown pressure

While the Indian scene looks a little more optimistic than the global one, sustained recovery by the industry will, to a large extent, depend on the infrastructure development drive of the Government from here on.

Adarsh Gopalakrishnan

The recent bull run in the commodities markets has seen the Reuters CRB Metals index rebound by 60 per cent from its December lows. However, steel is one commodity which appears to have missed the bus, with prices hovering at just 10 per cent higher than the December lows.

Steel consumption has been battered by the economic crisis, with global prices dropping 45 per cent from their June 2008 peak. The decline in global demand for steel has reflected in production cuts by steel producers and rapid drops in prices of raw material such as iron ore and metallurgical coal.

Deep production cuts

Steel is a vital commodity input for the automobiles, infrastructure and machinery. With the credit markets freezing and consumer confidence taking a beating, demand for steel has dropped rapidly. Global steel production hit a peak of 119 million tonnes in May-June 2008, which was a 25-year high. Since then, the decline has been rapid.

Global steel production for the first four months of 2009 stood at 354 million tonnes, a 23 per cent drop over the same period last year. This drop has been attributed to rapid de-stocking, the process of players clearing out the inventory rapidly while cutting production.

If China, which produces 48 per cent of the world’s steel is excluded, the drop in output was even higher at 36 per cent. Crude steel production in several developing economies such as Brazil and Russia registered huge falls in production by 46 and 31 per cent respectively.

Chinese production remained flat at 170 million tonnes. By its sheer magnitude, this buffered the rapidly dwindling output in advanced markets such as US and Europe, which saw production nearly halve in this period.

Demand still uncertain

The pace at which steel production has dropped has certainly been sharp when compared to how global industrial activity has contracted over this period. While world GDP contracted by 2.5 per cent according to the IMF, steel saw a 24 per cent decline in output. This could indicate that the process of de-stocking has been more severe than warranted by the slowdown and that the worst could, therefore, be behind us.

However, despite all the talk of green shoots, the global demand for steel continues to look far from rosy, with the glimmer of hope being demand for steel driven mainly by China and India. China’s heavy infrastructure spending has fuelled domestic steel production there.

A strengthening of steel prices from here appears to depend mainly on how several factors such as government stimulus spending across key economies pan out and the pace and direction of such spending.

One factor that has played a role in price trends for steel is the sector’s relative fragmentation. The top ten steel producers in the world produce slightly more than 30 per cent of the world’s steel. While various types of steel are produced, and several value-added processes exist, the scope for differentiation is limited, making steel a commoditised product. This leaves limited scope for pricing power except in niche products such as high alloy steel for machinery, etc.

In contrast, iron ore, a key input to steel is an industry dominated by a few, with the top three iron ore producers in the world controlling 70 per cent of the world’s seaborne iron ore. Consolidation has been the buzzword among the mining majors with BHP Billiton and Rio Tinto merging their Western Australia iron ore mines.

The latter is an effort to regain a semblance of control over raw material prices which have collapsed since late 2008. Global coal prices are down between 55 per cent and 65 per cent from the peaks in July 2008. Iron ore prices are down 60 per cent from the peaks of April-May 2008. The lower raw material prices have eased the pressure on steel producers who had a low degree of backward integration.

The Indian scene

The Indian scenario for steel looks a little more optimistic than the global situation. Domestic HR coil prices declined just 26 per cent from their peak in June 2008 to their trough in February 2008. The domestic market has exhibited some early signs of recovery with several steel producers hiking or contemplating a hike of between 2 and 5 per cent.

Even as international prices have weakened, domestic steel prices have been supported by shortfall in supply, after accounting for exports. The past year saw domestic output of 55.2 million tonnes against consumption of 52.6 million tonnes. India exported 6.6 million tonnes of steel and imported 7.7 million tonnes.

Growth in output in recent years has been slow, with finished steel output growing by just 6.2 per cent in 2007-08 and remaining almost flat (0.2 per cent growth) in 2008-09. Greenfield additions to steel capacity have been hampered by limitations in infrastructure such as ports, railways and roads and problems in land acquisition. India’s compounded growth rate in consumption has hovered at 8.5 per cent in recent years.

To bridge the shortfall between the current capacity of 56 million tonnes and future requirements, the Ministry of Steel has set an ambitious target of 110 million tonnes to be achieved by 2010-11 and 240 million tonnes by 2020.

Brownfield expansion, that is, expansion of existing capacity, is expected to add 60 per cent to existing capacity at 40 million tonnes. Greenfield expansions, are expected to fill in the remaining 40 per cent.

Steel products are used by infrastructure companies and demand has remained steady, though not robust, helped by the three instalments of infrastructure stimulus that have been pushed through in the past six months. There are also several proverbial ‘green shoots’ in the residential real estate market, as evidenced by a slew of launches by regional and national real estate players.

The commercial real estate market which went into overdrive between 2006 and 2007 led to massive over supply, this sector has yet to show any clear signs of a revival. The conflicting signs lead to mixed expected demand from real estate.

In light of the above, the promised land for steel players will be at hand only if the elusive infrastructure development drive by the Government makes rapid strides from here on. Ports, airports, railways, roads, and bridges all require long, flat and other variants of steel.

The potential upside to steel companies from government spending would be high, but to put a number to it would be difficult given that the pace of implementation of public projects on infrastructure has been quite inconsistent.

Suffice to say, long-term growth in demand for steel will outpace the long-term growth of the general economy, solely because of the widespread need for the metal. Sectors such as shipping and automobiles however show decisive signs of revival and hold good potential for steel producers.

Budget hopes

Infrastructure spending apart, the steel sector is also hoping for higher barriers of protection against imports and curbs on the export of iron ore from the forthcoming Budget. With India currently exporting 60 per cent of its iron ore, an export levy could expand domestic supplies and curb prices.

On imports, the industry is looking to a levy to narrow the price gap. With global demand being as weak as it is, steel producers in Korea and Russia, where steel prices are lower than in India, would find India to be a desirable market, while China too provides tax rebates to steel exporters.

However, more than measures such as the above, it is the Government’s much awaited agenda on infrastructure spending that can deliver a demand push for steel. Indian steel companies are among the most cost effective in the world with linkages to raw materials and access to cost effective labour. All it will take is a little push by the Government to set them back on the growth path.