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Iron Ore And Scrap Surcharges For US Customers On the Way?
May. 10th, 2010
Perhaps some of you caught the headlines this past week that Severstal Sparrows Point announced a $125/ton iron ore surcharge, “The Severstal NA spokesperson, Elizabeth Kovach, told SMU in an email statement: “…we are confirming an increase of $125 per ton for shipments to non-indexed contracts for Severstal Sparrows Point products effective June 1, 2010. This increase partially offsets the significant escalation in raw materials costs, which have increased in the range of 120 percent this year alone.” The more interesting point that John Packard raises in his post involves the speculation of one steel executive, “who believes it is only a matter of time before some form of iron ore and/or scrap surcharge for both contract and spot customers will become commonplace.”
And though in our price forecasts on steel we felt the US market would see some impact from rising iron ore prices incurred by the Asian steel mills, we felt that the US market still faced much less volatility with regard to iron ore due to a couple of key factors.
First, more than half of US steel production comes from Electric Arc Furnaces (EAFs) which, “now account for well over half of American steel production,” according to a December 2009 Bureau of Labor Statistics report. Last year, the US produced 58.1 m metric tons of steel as compared to 91.4m metric tons in 2007. (The US typically produces in the 90+m metric ton range). China produced 567.8m metric tons in 2009 and 500.3 m metric tons in 2008. (And are currently on pace to produce 612m metric tons this year, according to data from the World Steel Association). We have seen estimates that EAF production in China represents 9.1% of total steel production, according to the World Steel Association. We should add that electric arc furnace making methods in China are not quite the same as electric arc furnace making methods in the US (e.g. the Chinese use much less scrap and instead add hot metal or cold pig iron). If the US produces more than half of its steel via EAF, iron ore surcharges do not at all relate to that same percentage of the market.
(We’ll talk about scrap surcharges in another post as well as a potential growing trend of US EAF producers adding virgin iron ore to produce higher quality steel products)
The second factor that in theory ought to put the brakes on the notion of iron ore surcharges involves the level of vertical integration of each of the primary integrated steel producers. With 2009 production of 14.9m tons, US Steel’s share of the US industry was approximately 26%. We know from reading their annual reports that US Steel has 80% self-sufficiency in coking coal and has 22.4m tons of annual iron ore pellet production capacity due to stakes in several iron ore mines. So US Steel in theory ought to be “well protected” from rising iron ore costs.
Let’s get out our napkin shall we? Over 50% of the US market is served by Electric Arc Furnace production of which none of it or nearly none of it should be impacted by iron ore price fluctuations. (Some mills use iron carbide which comes from iron ore but we’ll leave that out for the time being as it is a small number). The biggest integrated producer, US steel who last year had +/-26% market share is vertically integrated and though impacted by world market pricing to some extent, faces much less raw material price volatility. So that leaves the remaining 24% of the US industry served by integrated producers who do rely on iron ore. Let’s look at the next 800-pound gorilla in the room, ArcelorMittal at 50-60% self-sufficiency in iron ore as we previously reported, produced 73m metric tons globally last year. We estimate their North American production at 16.55 m metric tons, though some of that was produced in Canada. Some report ArcelorMittal as North America’s largest producer by volume. Its plants in the US consist of both EAF and BOF facilities. I haven’t had a chance to research what percentage of their US production sees no impact from rising iron ore costs but let’s assume there is some. We could make an argument that 50% of US produced material is not at all subject to rising iron ore costs. 25-26% (US Steel) also has strong control over its raw material costs. That leaves at most 25% of the US market subject to rising iron ore prices (assuming we put all of ArcelorMittal’s US production capacity in that bucket).
Buying organizations should watch the behaviors of US Steel and ArcelorMittal closely. As any move by either of those two mills could be substantial though technically, US Steel ought not to need to consider adding a surcharge (and instead use their iron ore self-sufficiency as a means of creating a bigger competitive advantage). I suppose not surprisingly, we have seen press accounts that US Steel has applied some iron ore surcharges to a portion of contract orders. That leaves the AK Steels’ and Evraz’ (among others) of this world as possible “followers” of the Severstal announcement. (AK Steel apparently has also started to deploy some sort of surcharge to contract orders). Time will tell.
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