Global steel capacity vs. supply vs. demand
Volatility of contract prices
Note: The quarterly contract came into effect from FY11 Q1
“Understanding the challenges in today’s steel market is crucial for the sector in order to explore new opportunities and means of growth.” Mike Elliott
Global Mining & Metals Leader,
Ernst & Young
Despite the demand growth witnessed during 2010 and 2011, growth in steelmaking capacity still exceeds steel demand. There is now significant over-capacity in the global steel sector which is putting pressure on operators’ profitability.
This has been exacerbated by the European sovereign debt crisis which reduced confidence in the marketplace in the latter half of 2011 on global economic growth, putting a halt on investments into large-scale infrastructure projects in Europe, and reduced availability of capital for growth.
The complexity of the issue is large, as growth in steelmaking capacity is expected to continue at pace and political issues are preventing a rationalization of the sector because governments are under pressure to protect jobs and the sector. The timeframe for rationalization will be driven by the political agenda. With over-capacity being the most significant challenge in the sector today, there are further related challenges facing the sector.
Significant challenges in today’s global steel sector
- A shift to emerging markets
Steel production is shifting from mature to emerging economies. There are fewer domestic growth prospects, as well as increased competitive threats for steel players with an established footprint in Europe and North America. Europe and the United States show a weakness in both GDP and industrial production as GDP is forecast to grow less than 2.0% in both 2011 and 2012, as opposed to an expected 9.0% and 7.5% growth in 2012 for China and India, respectively.1
The Indian steel sector is striving to put on more capacity to capitalize on that growth. In China, however, there is already significant excess steelmaking capacity. Chinese crude steel capacity is expected to amount to 840 million tonnes in 2012, which would be 22% in excess of the expected 688 million tonnes of consumption.2
- Growth in market volatility and margin pressure
For steelmakers, not only does the performance vary significantly across both emerging and developed markets, but a considerable cause of volatility is the cost of raw materials. The shortage of these supplies in the market has allowed suppliers of iron ore and metallurgical coal to rebuild the pricing mechanisms through the shift from annual to shorter-term price contracts.
This has created numerous challenges for steelmakers as they must now deal with volatility in raw material prices, as well as maintain margins with fluctuating demand. Over the past two years, any firmness in steel prices has given iron ore producers an opportunity to increase the prices in the next contract; however the reverse may not be true as steel companies cannot always pass on the rise in iron ore prices to end consumers due to the fragmented market.3
- Lack of operational agility
The very nature of steelmaking and large amounts of capital investment means that the sector does not find it easy to adjust quickly to changing circumstances. At the time of the global economic crisis of 2008–09, steel mills were operating at high capacity when demand fell off very suddenly. This caused an unexpected oversupply of steel in the market. There remains a lag between demand fluctuation and production adjustments as there is still structural overcapacity in certain product segments.
- A need for business models to evolve
For many decades, the greater margins were derived by the steel mills. The steel mills held both purchasing power over the raw materials supplies and set market prices for steel distributors and customers. In recent years, however, most of the pricing power switched to the suppliers and customers. In response to these changes, steelmakers need to change their business models by introducing greater operating flexibility and becoming more customer-focused in their product mix and more innovative in how they price their products.
1. World Economic Outlook: Slowing growth, Rising risks, IMF, September 2011.
2. “Chinese steel industry faces significant overcapacity in 2012 – CISA”, IHS Global Insight daily analysis, 6 January 2012.
3. “China steel sector,” Macquarie Research, 8 July 2011.