US mini-mill costs drop below integrated mill costs…but for how long?

US mini-mills are typically higher cost

On an operating cost basis, US integrated mills are typically lower cost than their mini-mill peers. Scrap prices are tied to the marginal cost of hot metal production—meaning that the input for scrap-based steelmaking is typically higher than the average ironmaking bulks mix (n.b. iron ore, coal and coke). Supply and demand dynamics in both steel and scrap markets influence scrap prices and high steelmaking margins will increase the spread between scrap prices and ironmaking costs and vice versa. In the USA, domestic scrap prices are influenced by export scrap prices―with US export scrap prices being linked to European and Turkish scrap prices. Scrap prices in Europe and Turkey are in turn driven by the marginal cost of hot metal production in these regions, which is typically higher than in the USA.

Mini-mill costs are more volatile

Lower-cost US integrated producers, such as US Steel and ArcelorMittal USA, have access to captive iron ore pellet that is charged to the mill on a cost plus logistics basis, these same integrated producers also have varying access to captive coal and coke that is also charged to the mill on a cost plus logistics basis. Higher-cost integrated producers, such as AK Steel, typically buy all or most of their iron ore and coal from merchant producers such as Cleveland-Cliffs and SunCoke. In this case the raw material purchases are typically conducted on a multi-year contract basis, with quarterly price adjustments that take into account changes to seaborne raw material prices, shape premia, steel prices and CPI movements.

These pricing arrangements for the integrated producers have an important impact on costs—the costs for integrated producers tend to move slowly, changing with contract adjustments and/or mining cost changes. As such, the costs for integrated steelmakers are less volatile than for mini-mills.

Metallics prices have moved downwards in 2019 and costs for mini-mill producers have declined quickly. The costs for mini-mill producers are much more responsive to changes in market prices due to the shorter timeframes on which mini-mills purchase their raw material inputs—typically on a monthly basis. As can be seen in the chart below, the costs of a mini-mill are more volatile when compared to that of an integrated producer.

What’s happening in 2019?

In 2019, steel markets have weakened and scrap prices have dropped to closer to marginal hot metal production costs. In the USA this has meant that flat-rolled production costs for mini-mill producers have dropped, with mini-mills on average now lower cost than the higher-cost integrated operations. In addition, raw material prices for iron ore and coal have been high for most of 2019 due to supply side issues, although these issues have been unwinding in recent weeks. The result of these swings in raw material prices has led to partitioning on CRU’s HRC cost curve, which can be seen in the chart below.

Will mini-mills stay lower cost?

CRU does not expect that the current cost level for mini-mills will be maintained―low scrap prices reduce US domestic scrap supply and there is a growing appetite for scrap from the growing mini-mill sector. In addition, CRU forecasts that steel prices and margins will increase from 2019 Q4 and these factors signal that scrap, and metallics prices more generally, will rise. In turn, this will lift mini-mill costs back above average integrated mill costs in 2020 and they will stay higher than integrated mill costs out to 2023.

This relative improvement in cost position will come as welcome relief for the integrated sector in the USA, which struggles to realise the EBITDA margins and profitability of the mini-mill sector. From 2020 onwards, the integrated sector will again see cost inflation, which is explained in more detail below.

What does CRU’s Steel Cost Model tell us about the drivers of the cost changes for the integrated sector?

CRU’s Steel Cost Model provides superior granularity and transparency that allows the user to understand exactly what is driving changes in costs and competitiveness in the USA and the rest of the world.

Overall, costs will rise for the integrated sector from 2020 onwards for a variety of reasons, including:

• Iron ore supplied on a contract basis will feel upwards price pressure due to rising HRC prices and US inflation
• Iron ore supplied on a cost-plus logistics basis will see delivered prices rise due to mining cost inflation
• Rising metallics prices will also impact US integrated producers, but to a lesser extent than mini-mills
• Higher wage rates, negotiated by workers unions in 2018 when steel prices were high, will increase labour costs

A forecast decline in coal prices globally somewhat offset these cost rises, however, overall, costs are forecast to rise.

Conclusion

The operating costs of integrated mills are generally lower than mini-mills. However, in 2019, weaker steel markets have pulled down metallics prices and, with them, the costs of mini-mill producers. Given our expectations for the raw materials and metallics markets, CRU does not believe the current low cost base of mini-mill producers will be maintained―mini-mill costs will rise as the steel market improves and additional mini-mill capacity begins to come online. The integrated sector will see some relief as their costs drop below those of the mini-mills in 2020 but, from 2020 onwards, costs for the integrated sector will also begin rising.

About CRU Steel Cost Service

CRU's Steel Cost Service provides a comprehensive examination of steelmaking costs for semi-finished, flat and long products across the global industry for the years 2006-2025. Access to the Cost Analysis Tool allows users to generate individual asset reports with all key operation data via the web-based software. For further information about the Steel Cost Service and to request a demo, please get in touch.