Excess supply looms in the US

While not all the intended new capacity is a direct result of S232, nor may all of it come to fruition, all forecast scenarios point to weaker mill margins and lower steel prices in the period to 2023.

Highlights
CRU held its annual Steel Briefing in New York City on 17 June 2019. This Insight summarises the key takeaways from papers presented by CRU North America market specialists Josh Spoores and Ryan McKinley.

• Up to 20 Mt of new hot-rolling and over 8 Mt of steelmaking capacity could come on stream in the USA in the next four years, in part spurred by the Section 232-fuelled price and margins gains in 2018;
• This will leave a hangover of excess domestic supply which will depress domestic steel prices and margins;
• Further margin squeeze risks for mills take the form of further or complete repeal of S232, and higher scrap prices arising from greater domestic scrap demand.

Near term weak demand; longer term excess supply
Last year Section 232 (S232) drove US domestic steel prices above and beyond levels implied by international prices plus the tariff and logistic costs, and as high as a peak of $918 /s.t in mid-July 2018. What this did achieve? Substantial margins for domestic mills through much of 2018 for sure. But S232 was at least in part also responsible for an acceleration or new interest and in some cases commitment to investment in new steelmaking capacity. In addition to hot-rolling and downstream, new heavy-end steelmaking capacity identified includes:

• Big River Steel, Osceola, Arkansas, 1.5 Mt new EAF
• Nucor, Ghent, Kentucky, 1.5 Mt new EAF
• Steel Dynamics, Location TBA, 2.7 Mt new EAF
• US Steel, Granite City, Illinois, 2.5 Mt restarted BOF

In total, some 18-20 Mt of new or restarted hot strip mill capacity, for instance (see chart), has been identified to be in place by 2023, and this is a major contributor to our forecast of lower prices over that timeframe. Moreover, sheet prices are falling back towards their historic premium over global prices, without regard to S232 which we assume remains in place over the period. Clearly its removal provides further downside risk to prices.

In the short term, price falls have been and will continue to be a function of weaker demand for both seasonal reasons but also amidst economic headwinds. Real demand is weaker, particularly in automotive. On top of that, while inventories are balanced, they are set to fall in the near term given falling prices and concerns over underlying consumption. This will further undermine apparent consumption. In addition, exemptions to S232 for Mexico and Canada are relaxing import supply, though this is less of a price mover currently and for the most part import volumes remain in check.

In the longer term, overall industrial output growth, and that which is specific to steel-intensive sectors is set to slow to around 2% y/y or below. That follows growth of 4% in 2018. Therefore steel sheet consumption in the USA will see a CAGR of just around 1% in the 2019-2023 period. That does not square with 18-20 Mt of new capacity additions, and while ultimately not all these may come to fruition, a home-grown deterioration in the supply/demand balance is implied.

That will surely depress margins over integrated mill costs (see chart), and we expect to below average levels seen over recent history, making 2018 seem like an aberration.

Further risk to margins from scrap price hikes
There are other consequences of growth in domestic steelmaking capacity beyond deterioration in the finished steel supply/demand balance. Our analysis shows that US scrap prices are reasonably well correlated to US steel production levels (see chart). This is because higher steel output means higher scrap demand and an increase in both intra- and inter-regional competition for scrap.

Therefore, increases in domestic steel production, particularly new EAF output which is predominant in planned investments, implies higher scrap prices. We have evaluated three scenarios for capacity additions, the most extreme of which assumes 100% of all intended capacity additions come online by 2023, the most conservative assuming 25% of new additions are realised.

In the most extreme case, shredded scrap prices, delivered Great Lakes, could rise to around $430 /t. If none of this is passed on by steelmakers in the form of higher prices, this implies a severe margin squeeze – a reduction in margins of over $100 /t compared with the 10-year historic average. In the low case, this reduction in margin is limited to around $30 /t.

In reality, the margin squeeze in any scenario would be lower as some of the scrap cost increases implied by higher demand would be passed. Moreover, prices could be kept in check by additional domestic DRI and possibly pig iron capacity. However, full pass through would not be guaranteed given the anticipated deterioration in the domestic finished steel supply/demand balance as described above.

Conclusions
What at first sight appeared as a leg-up to domestic steel producers – S232 – may well have had the unintended consequence of weakening the US market in the longer term through encouraging home-grown oversupply. While not all the intended new capacity is a direct result of S232, nor may all of it come to fruition, all forecast scenarios point to weaker mill margins and lower steel prices in the period to 2023.