Steel has very strong linkages with the economy. Steel products can be grouped under two broad categories, flat and long. Flat products are used in automobiles, appliances, pipelines, etc., whereas long products are used mainly in the infrastructure and construction sectors. Given this wide spectrum of use, steel has a bearing on the performance of the economy and there is strong correlation between steel consumption and economic growth.
Raw materials and logistics are two very important cost drivers in the steel industry. For an integrated steel player, raw material costs can be as high as 60-65 per cent of the overall cost of production. Steel prices are inherently cyclical and follow a typical boom-bust commodity cycle. Though steel demand is influenced by local conditions, its price is influenced by international trends.
Performance during the past decade
During the past decade, global steel production has grown at a compound annual growth rate (CAGR) of roughly 2.2 per cent. However, China’s production has grown at double the average rate and it alone accounts for over 90 per cent of the incremental global steel production in the past 10 years. As a result, today China accounts for almost 50 per cent of international steel production as well as demand. Steel production in India has also grown at a CAGR of 6.5 per cent; however, the installed capacity of 130 million tonnes (mt) is quite small in comparison to China’s 800 mt capacity. Interestingly, steel production in Europe and the US has decreased at a rate of 2.1 per cent over the past decade.
Apart from steel, China is also a major producer of iron ore and coking coal, which are two important raw materials for steel production. The country accounted for around 70 per cent of the international trade in iron ore and 20 per cent of coal. Given China’s dominance in steel production, its actions are bound to have a strong bearing on international price trends.
Since the beginning of 2013, steel prices have remained weak; however, this decline actually spiralled further, beginning 2015. By the beginning of 2016, international steel prices plunged to a low of $260 per mt. Thereafter, prices started picking up and barring a few blips, they have been increasing. At present, steel prices have almost doubled to $578 per tonne.
In the Indian context, steel prices hovered at around Rs 25,563 per tonne in January 2016. Thereafter, domestic prices rose in line with internationally prevalent prices. Further, various trade protection measures taken by the Indian government such as higher import duty, safeguard duty, etc. led to a significant increase in steel prices. As of October 2017, domestic steel prices stood at Rs 40,625 per tonne.
Reasons behind the rising prices
In China, the real estate and property market alone accounts for around 45 per cent of the overall steel demand. In 2014, the growth rate of the property market fell to 10 per cent and in 2015, it witnessed a further decrease to almost 1 per cent. As a result, in 2015, the decline in steel prices was the sharpest. Thereafter, investment in the property market picked up on account of several policy measures taken by the Chinese authorities and reached almost 7 per cent by the end of 2016. However, during the first half of 2017, China witnessed lacklustre growth and it was only during the second half of the year that prices went up at a sharper rate.
Meanwhile, Chinese authorities plan to shut down around 150 mt of steel production capacity by 2020 in order to curb pollution. They have already cut around 115 mt of capacity and another 35 mt is expected to be cut in the coming years. In addition, China also eliminated 140 mt of low quality steel products produced from medium frequency induction furnaces. Therefore, altogether a huge chunk of surplus capacity in China has either been closed down or is in the process of being closed down. As a result, the surplus which was being exported by China reduced by almost 30 per cent in 2017. This further strengthened the increase in international steel prices.
Trends in raw material prices
Till around August 2016, coking coal prices were benign and were in the range of $80-$85 per tonne. At that point in time, the Chinese government reduced the working days for the mining sector in the country from 330 to 270. Naturally, Chinese steel players started importing coking coal and the suppliers were caught by surprise. Therefore, within a span of three and a half months, prices nearly quadrupled from almost $80 per tonne to $300 per tonne in December 2016. Subsequently, in the beginning of 2017, prices corrected to $160-$170 per tonne.
However, in March 2017, Cyclone Debbie in Australia raised concerns about coal supply disruptions and prices doubled within a fortnight and crashed thereafter. Coking coal prices have thus witnessed unprecedented volatility. As a result of this volatility, the contract market for coking coal disappeared from the second quarter of 2017. However, recently, coking coal prices rose on account of congestion at Queensland port, prediction of La Nina during January-March 2018, and restocking by Chinese steel mills ahead of restarting operations from mid-March 2018 after the withdrawal of production restrictions. At present, coking coal prices have been hovering at $260-$270 per tonne, which are expected to be corrected to more predictable levels of around $150 per tonne. Further, the Chinese government has relaxed the norm for reduction in the number of working hours of the mining sector, as a result of which Chinese coal production has started gathering pace.
Iron ore prices have followed a similar trend, reaching a low of less than $40 per tonne by the end of 2015. Thereafter, prices more than doubled and reached a peak of almost $95 per tonne in 2017. Since then, prices have corrected to more normal levels and are at present hovering in the range of $60-$75 per tonne. Just like coking coal, iron ore prices are also expected to reach more manageable levels of below $60 per tonne and are likely to remain the same in 2019 as well.
India imports around 70 per cent of its coking coal requirement, and as a result, international price trends are reflected in the domestic prices. However, the situation is different with respect to iron ore where the country is an exporter. During 2014-15, India’s iron ore production hit a low of less than 130 mt. Various restrictions imposed by the central government at the time on mining companies adversely impacted mining operations in states such as Odisha, Goa and Karnataka. Subsequently, after the enactment of the Mines and Minerals (Development and Regulation) Act in 2015, most of the regulatory uncertainties surrounding the mining sector were removed and production started rising. In 2016-17, production crossed the 190 mt mark and is expected to rise above 200 mt in 2017-18.
As per the World Steel Association, global steel production is likely to grow at a reduced rate of 1.5 per cent in 2018, on account of lower input costs (resulting in lower steel prices) and expected stagnant demand growth in China. If the predictions turn out to be accurate, then input prices will drop, and steel players, without compromising on their profitability in terms of earnings before interest, taxes, depreciation and amortisation per tonne, will face lower prices. Nonetheless, if Chinese demand ends up surprising the rest of the world, steel prices could go anywhere one year down the line.
Based on a presentation by Jayanta Roy, Senior Vice-President and Group Head, Corporate Ratings, ICRA, at a recent India Infrastructure conference