Jayanta Roy, Group Head, Corporate Headings, ICRA
The steel industry is inherently cyclical and follows the typical “boom-bust” commodity cycle. For the industry, while demand is influenced by local conditions, prices are influenced largely by global conditions. In this article, domestic HRC (hot-rolled coil) and Chinese export HRC prices have been considered as representative for Indian and international steel prices, respectively, for illustration purposes.
Steel price trends: Historical perspective
China’s effective implementation of capacity cuts and improved domestic demand propped international steel prices post the 2015-16 collapse. As can be seen in Exhibit 1, Chinese HRC prices started slipping from the second half of the 2014 calendar year (CY) on account of sluggish domestic demand, which contracted by 3.3 per cent in CY 2014 and registered a de-growth for the first time since CY 2000. The downward trend continued throughout CY 2015 due to a further shrinkage in Chinese steel demand by 5.4 per cent, and prices touched a bottom of $258 per metric tonne in January 2016 as China’s steel exports flooded the international markets, creating a significant supply overhang globally. However, in January 2016, the Chinese government announced its plans to cut steel capacity by 150 million tonnes (mt) by CY 2020, which, along with its subsequent stimulus-driven economic growth, led to a sharp recovery in steel prices in CY 2016.
Effective implementation of the capacity cuts and the Chinese government’s clampdown in the first half of CY 2017 on low quality induction furnaces with a capacity of about 120 mt further spurred Chinese HRC prices during the second half of CY 2017. On the other hand, the increased trade protectionism in major steel-consuming countries and the rising domestic steel consumption within China led to a 31 per cent degrowth in Chinese steel exports in CY 2017. Consequently, the prices touched a high of $594 per metric tonne in June 2018 (touching five-year-ago levels). While healthy demand in China kept steel prices buoyant during CY 2018, relatively lenient pollution control norms and moderation in demand from the real estate and automotive sectors exerted some pressure on Chinese HRC prices in the fourth quarter of CY 2018. While the prices recovered subsequently to about $530 per metric tonne in March 2019 in response to an increase in iron ore prices due to supply disruptions in Brazil, ICRA believes that going forward steel prices would remain sensitive to China’s commitment towards infrastructure spending.
Indian steel prices mirrored international trends and were further supported by trade protection measures taken by the government
As Exhibit 2 depicts, domestic HRC prices reached a bottom of Rs 25,500 per metric tonne in January 2016 in line with international price trends. However, they recovered subsequently on the back of the minimum import price (MIP) imposed by the government in February 2016 to protect domestic steelmakers from a surge in cheaper steel imports. Indian HRC prices strengthened further in the second half of financial year 2017, following international cues. In August 2016, provisional anti-dumping duties (ADD) were imposed, which eventually replaced the MIP in the form of a definitive ADD in May 2017, with validity till August 2021. With healthy growth in domestic steel consumption of 7.9 per cent and 7.5 per cent in 2017-18 and 2018-19 respectively, domestic HRC prices remained elevated during these two years, notwithstanding intermittent fluctuations that are typical of commodity prices. However, they have softened in the past few months and were around Rs 40,750 per metric tonne in the first week of May 2019, following a slowdown in demand from the automotive sector, and increasing concerns on consumption demand.
Domestic HRC prices are currently trading at a 6 per cent discount to imported prices due to the moderation in demand from the automotive sector, which has been witnessing pressures since the liquidity crisis in the second half of 2018-19. While there is scope for a price hike if international prices are sustained at the current levels, ICRA expects that any meaningful price improvement may happen only in the second half of 2019-20, when the automotive sector is expected to do well on the back of pre-buying ahead of the BS-VI roll-out.
Raw material price trends
Steelmaking remains a highly raw material-intensive process with 1 metric tonne of steel requiring around 3 metric tonnes of raw materials. Iron ore, coal (both coking coal and thermal coal), ferro alloys and fluxes remain the key raw materials used in making steel. In India, many of the larger integrated steel mills produce steel through the blast furnace-basic oxygen furnace route using iron ore and coking coal. These two elements cumulatively contribute around 60 per cent to the total steelmaking cost for domestic blast furnace operators. While India has abundant reserves of iron ore spread across the states of Odisha, Chhattisgarh, Karnataka, Jharkhand and Goa (currently non-operational), domestic reserves of coking coal remain scarce. Consequently, domestic steel mills remain dependent on coking coal imports from countries such as Australia, the US and Canada to meet over two-thirds of their requirement, exposing their profitability to the volatilities in seaborne coking coal prices. The following sections take a closer look at some of the key trends that could have a bearing on raw material prices for domestic mills going forward.
Cost savings of domestic mills from low iron ore prices largely eroded by elevated imported coking coal prices in the past few years
Following the enactment of the Mines and Minerals (Development and Regulation) Amendment Act, 2015, in March 2015, that allowed the reopening of many mines that had been closed during 2014-15, domestic iron ore production grew at a healthy compound annual growth rate of 13 per cent between 2014-15 and 2018-19. This healthy growth rate coupled with the weakness in the steel industry during 2015-16 and 2016-17 pulled down iron ore prices from the high of 2014-15. The basic price (excluding taxes) of 65.5 per cent lump ore from NMDC Limited’s mines in Chhattisgarh declined from an average of Rs 4,300 per metric tonne in 2014-15 to Rs 2,544 per metric tonne in 2017-18, only to recover somewhat to Rs 3,208 per metric tonne in 2018-19, led by the recovery in steel prices during the previous fiscal year.
On taking a closer look at the production cost trends for a sample of four large domestic blast furnace operators without captive mines, that cumulatively have an installed capacity of around 31 million tonnes per annum (mtpa), the interesting fact that emerges is that the average cost of steel production remained relatively flat at Rs 32,000-Rs 32,500 per metric tonne in 2014-15 and 2017-18. However, iron ore’s share in the steelmaking cost mix declined from 27 per cent in 2014-15 to 17 per cent in 2017-18 which has been largely compensated for by coking coal’s share proportionately increasing from 30 per cent in 2014-15 to 41 per cent in 2017-18 (Exhibit 3 and Exhibit 4). Consequently, the benefits emanating from lower iron ore costs have been largely eroded by elevated coking coal costs for domestic steel mills in the past few years. Several factors such as coal mining restrictions by the Chinese government in CY 2016, supply disruptions caused by cyclone Debbie in Australia in CY 2017, and buoyant international steel prices in CY 2018 resulted in seaborne-premium hard coking coal prices (FOB Australia) increasing steadily from $113 per metric tonne in 2014-15 to $191 per metric tonne in 2017-18 and further to $203 per metric tonne in 2018-19, leading to input cost pressures for domestic blast furnace players.
Steelmakers eye higher production to balance the impact of lower spreads in 2019-20
In the past few months, amidst increasing trade tensions and concerns on the global economic growth, we have seen steel prices marching southwards. However, interestingly, coking coal prices have not followed suit, and have remained at elevated levels, nibbling at the margins of steelmakers. After two back-to-back years of elevated profitability (CY 2017 and CY 2018), steel spreads have reverted to the long period median in year-to-date CY 2019. Supported by buoyant steel prices, most domestic steelmakers have reported multi-year high operating and net profits in 2018-19. However, in 2019-20, as steel prices moderate from the June 2018 highs, and steel spreads gravitate to the long period median (Exhibit 5), steelmakers would be looking at achieving higher production levels to partly compensate for the impact of lower spreads. The buoyancy in seaborne iron ore prices has failed to percolate to domestic ore prices in CY 2019 thus far, given the supply glut. However, as the industry moves into 2020-21, a key unknown which can lead to further cost pressures for domestic mills not having captive mines is the potential ore supply squeeze following the scheduled closure of many merchant mines after March 31, 2020. These merchant mines are likely to contribute an estimated 50 mtpa of production in 2019-20. Given the slow progress in iron ore mine auctions by the various state governments so far, there remains considerable uncertainty on the ore availability situation in 2020-21.
(Priyesh Ruperalia, Vice-President and Ritabrata Ghosh, Assistant Vice-President also contributed to the article.)