1. GLOBAL INSIGHT STEEL OUTLOOK
Supply Chain Blues: Resurgent Steel Prices
Erode Manufacturers' Margins
John Anton
Director, Global Insight Steel Service (202)

2. The Squeeze on Steel Consumers
Steel product prices increased between 100% and 280% in 2004
Prior to 2004, approximately 45% of a fabrication was steel, 45% labor, and 10% energy and overhead
As steel costs doubled, fabrication prices should have risen 20%
Yet fabricated metal prices rose only 9%
The difference comes straight out of profits
Copyright © 2005 Global Insight, Inc.
2005Q1

3. What Do The Next Few Years Hold?
Auto parts makers are paying premiums for steel and other commodities
Yet, car makers are unwilling to pay more for parts
Ford, GM show lackluster sales
Raising prices (cutting incentives) causes falling sales
If parts makers agree to contracts that are comparable to 2003, they will not be able to stay in business
After several parts suppliers go bankrupt, the remainder will win cost increases from car makers
Copyright © 2005 Global Insight, Inc.
2005Q1

4. Motor Vehicles and Demand Destruction
If steel prices stay high, alternate materials are considered
Aluminum
Plastic
If domestic steel costs more than overseas, fear of more outsourcing (Section 201, exchange rates)
Countervailing forces
Just-in-time inventory
Transportation
Quality
If the industry loses an application, it may never come back
Demand destruction fear could easily be overblown
Iron ore is plentiful, petroleum (for plastic) is not
More Fe ore than bauxite
Outsourcing limited by the countervailing forces
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2005Q1

5. Outline of the Steel Forecast
Demand is firm, but there is less upward momentum
Much of the recovery already took place in 2004
China remains the big driver
U.S. supply has loosened, globe is tight
High production and imports replenished inventory
U.S. consumption caused less availability elsewhere
Raw materials additions are the key to relief
Prices will continue to ease
High input costs and weak dollar prevent collapse
More supply means lower prices
Copyright © 2005 Global Insight, Inc.
2005Q1

6. Good News/Bad News for Buyers
Prices are declining, will continue to ease
Supply is sufficient to meet demand
Tumble in prime scrap costs undercuts surcharges
End market demand will be strong in 2005
Prices will be permanently higher than in 1998–2003
Capacity utilization is so high that any outage would be disruptive
Raw materials remain tight, cost of making steel rises
Demand outlook for 2006 is getting worrisome
Copyright © 2005 Global Insight, Inc.
2005Q1

7. Summary of Forecast Assumptions
U.S. demand grows slower in 2005, plateaus in 2006
China demand continues to grow strongly for first half of 2005, but the breakneck pace will then moderate
Western Europe and Japan are in danger of stagnating again, Central and Eastern Europe are looking strong
Apparent supply in the U.S. was too strong, and inventory tightness became inventory surplus
High prices are spurring raw material investment such that global supply will improve as time passes
The dollar continues declining until 2007, then stays low
Copyright © 2005 Global Insight, Inc.
2005Q1

8. Steel: 2002 Started A Reversal of Fortune
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2005Q1

9. United States — The Fundamentals have Shifted
Consolidation means fewer sellers with more power
More consolidation yet to come
A weaker dollar changes the trade in finished steel
Imports are choice of last resort, exports are a viable market
Dependence on imports may be untenable in the future
New labor contracts
Integrateds’ costs are lower
Narrows gap with electric mills
Raw materials will cost more
Weak dollar
Imported ore and coke more expensive
Also makes scrap exports more lucrative
Energy prices feel same pinch
Competing with China for scarce inputs
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2005Q1

10. 2004 Was The Strongest Growth Year for USA Steel Endmarkets
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2005Q1

11. Demand in the U.S. Needs Until 2008 to Regain Peak
Rising from 2003q2 trough
But below 2000q2 peak
Demand fell 14%, has risen only 6.8% through 2004q4
Without consumer goods (autos and appliances), there would have been a complete rout
Now business investment is strong, and consumer side is starting to weaken
30% Real Nonres. Construction
30% Motor Vehicles & Parts
20% Fabricated Metal Product
10% Elect. Eqpt., Appliance, & Comp.
5% Machinery
5% Oil & Gas Extraction
Copyright © 2005 Global Insight, Inc.
2005Q1

12. Demand Sectors — Construction
Residential
Sustained the downturn as low interest rates made home payments affordable
Likely to weaken on higher interest rates, price hikes, and satisfied demand
Steel impact via pipes, appliances, utensils, and tools
Nonresidential — much more important for steel
Suffered greatly in the downturn
Fell 25% between 2000:4 and 2002:4
Recovering slowly with the overall economy
Rebounded late in 2004, all of 2005, then slows in 2006
Will need years to regain old peak level
Copyright © 2005 Global Insight, Inc.
2005Q1

13. Demand — Light Vehicles
Held up remarkably in recent years
Low rates, incentives
Sales are mediocre
Market saturation
Higher gasoline prices
Detroit bet on SUVs
Sales will recover as new models entice buyers
Parts makers are squeezed by steel prices
Copyright © 2005 Global Insight, Inc.
2005Q1

14. The Steel Market Must Be Viewed Globally
U.S. apparent consumption is only 13% of global total
China is 3 times larger in production and consumption
The U.S. does not have enough capacity to fulfill domestic demand and must import 20% to 30% of tonnage
While domestically focused international factors cannot be ignored, and often predominate
WHY IS IT REALLY IMPORTANT? If China usurps iron ore/scrap/coke, those materials are not available to us
Copyright © 2005 Global Insight, Inc.
2005Q1

15. Demand — China and Other Hot Spots
China is growing at an un-sustainable rate
The Chinese government is trying to cool the rate of growth
Restrictive lending
Denial of permits
Slows in 2005 and 2006, but still fast compared to rest of the world
If it doesn’t slow soon, it could crash later
India is poised to follow China into extreme growth
Massive population, living in near-poverty
Liberalizing governmental policies aiding expansion
Outsourcing
China and India insure strong global steel demand
China is the main driver
Largest in terms of size, and in terms of growth
We expect a soft landing: continued growth, but slower
Western Europe, Japan weak
Recovery foundering, barely better than stagnation
Asian crisis is finally behind us
Caused much of the low global steel prices of
Central and Eastern Europe booming
Entry into European Union allows outsourcing from Western Europe
Latin America is wild card
Good workers and resources, offset by high risk
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2005Q1

16. Chinese Consumption Still Has Room to Grow
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2005Q1

17. Copyright © 2005 Global Insight, Inc.
Production and Supply
Global steel production
Up by 40% since January 1995
Probably exceeded 1 billion metric tonnes in 2004
Growth rate of 2.1% from 1994 thru 2001
Growth rate of 9.0% from 2002 thru July 2004
Copyright © 2005 Global Insight, Inc.
2005Q1

18. Production and Supply — The Crunch
Global steel production is up by 40% since January 1995
But raw materials expansion did not keep pace
Lousy profits
Excess capacity
As long as there was a surplus, no one noticed
But furnace capacity eventually hit materials constraint
Which is why prices exploded
Line represents raw materials capacity (ore, coke, scrap, etc). The line is arbitrary and for illustration only. It is not to be taken as an empirically determined level.
Copyright © 2005 Global Insight, Inc.
2005Q1

19. Production — Raw Materials
Raw materials prices are sharply higher
Your supplier isn’t making it up
Early last year, metallurgical coke could not be obtained at any price
Chinese demand
Mine fire
Scrap is twice as expensive than in January 2003
New ore and metallurgical coal mines are being dug
But little relief until 2006 and 2007
Scrap supply cannot be increased easily, depends on junking of steel products sold 10–15 years ago
Copyright © 2005 Global Insight, Inc.
2005Q1

20. Production — China is the Key
China’s steel production was equivalent to U.S. and Japan in the early 1990’s
By 2003, China made 2.4 times more steel than the U.S., twice as much as Japan
China accounts for 59% of growth in global production since 1995
Tremendous acceleration for thru 2004
Copyright © 2005 Global Insight, Inc.
2005Q1

21. Copyright © 2005 Global Insight, Inc.
Raw Materials
Scrap supply is limited by rate of junking
Steel use 10 to 15 years in the past
Ore mines are being expanded in Australia, Brazil
Little relief before 2005 and 2007 before they really help
Coke is tight as mines have to be expanded
Can’t get enough miners in the United States
Ukraine, China want to retain coke for domestic mills
Help by 2007
Transportation
Ocean freight strained by China
Domestic rail will be tight as trains haul grain instead of steel supplies
Copyright © 2005 Global Insight, Inc.
2005Q1

22. Copyright © 2005 Global Insight, Inc.
Price — Outlook
Prices fell slightly in the fourth quarter of 2004, and continue easing through 2005
Down pressures
Imports
Inventory restocking
Global price lower than in U.S.
Up pressures
Shipping still expensive
China may rebound
Global supply of raw materials
Dollar
Significant declines in 2006 and 2007 as ore and coke become plentiful, uptrend in long term as demand keeps rising
Tide turned in late 2004
Many products peaked in September, others in October and November
Plate didn’t turn until February, SBQ still rising
Declining early in 2005 as inventory worked off
Continues to decline as input supply improves and global demand moderates
Only as raw materials expansions come online will significant drops be seen
Copyright © 2005 Global Insight, Inc.
2005Q1

23. Price — Rapid Rise, Slower Descent
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2005Q1

24. Risk — China Hard Landing
We believe China is slowing rate of expansion
But, growth could resume at breakneck pace
Prices stay near current levels
Chinese government would react by slamming on the brakes sometime in 2005
Global prices crash, then rebound once weak Chinese mills go out of business
Copyright © 2005 Global Insight, Inc.
2005Q1

25. Price — Causes for the Price Rise
Raw materials unavailability
Dollar
10% fall vs. the yen means Japanese steel makers must raise prices 10% or take hit to profit
Actual depreciation was 22% against the yen, 44% against the euro
Demand
U.S. and North America demand does NOT justify prices
But steel is global, and Chinese demand does justify
Supply
Mills operating flat out
Imports did not rise until May
Inventory was extremely lean
History
Downtrend since 1992
Each peak lower than the prior, each trough deeper
Bottomed just before LTV shut down
Price was below cost of production for integrateds, occasionally below cost for EAF
Current
Highest prices ever
In real terms, well below legendary spike of 1974
Doubled and tripled since last year
Copyright © 2005 Global Insight, Inc.
2005Q1

26. Copyright © 2005 Global Insight, Inc.
Implications
Other commodities face same pressure from China and under-investment
Petroleum, and petrochemicals (plastic)
Non-ferrous metals
Most commodities will be permanently above levels of recent years
This adds global inflationary pressure
Copyright © 2005 Global Insight, Inc.
2005Q1