UNITED KINGDOM October 06 2016 4:42 PM

LONDON (Scrap Register): For the past five years European flat steel prices have ebbed and flowed but always ended lower, the inevitable result of a region struggling with structural overcapacity while undergoing a sharp decline in steel demand over a sustained period. Throw a macro-economic debt crisis (2012) into the mix, along with the more recent issue of rising steel imports from Asia, and it is easy to see why the industry has continued to stutter since the global financial crisis, reported the Steel Index in a research note.

This all came to a head at the end of 2015 when flat rolled steel prices across Europe reached a nadir, falling to their lowest level in over a decade. Since then spot prices for HRC have recovered strongly. But how resilient is the market, and what are the challenges it is still facing? 

Imports pressure abating

A jump in both Chinese domestic and export prices early in the year started a domino effect around the world. As the price of imported steel into Europe suddenly spiked, European mills regained the upper-hand in commercial negotiations for their spot sales. That in itself was not exactly newsworthy, but it was coupled with fervent calls for trade protection measures against the perceived dumping of steel on European shores.

The European Commission (EC) duly responded, imposing anti-dumping (AD) duties on Chinese and Russian-origin cold rolled (CR) coil and Chinese-origin rebar. The EC also opened an investigation into hot rolled coil (HRC), plate and seamless tubes imports from a number of countries.

This spike in new investigations (many of which are yet to be concluded) has so far had mixed results. Whilst it has stemmed the tide of imports from China (HRC exports into Europe, for example, are below their 227kt peak, reached in February this year) the total volume of imports remains stubbornly high. Indeed, it demonstrated the difficulty of reducing import flows using targeted trade protection measures. There are always more countries willing to take the place of another whose market access has been cut off by such restrictions.

While European steel producers maintain that they are fending off unfair competition, many market participants disagree. Reliance on trade protection measures irked traditional steel importing segments of the market. A number of re-rollers, coil processors and traders formed a consortium to oppose the EC’s decision to impose AD duties on some finished steel products, arguing that it would affect the competitiveness of downstream manufacturing industries.

Price volatility

Diminishing volumes from Russia and China saw European mills introduce, and successfully implement, a number of price increases throughout the year. Measured from trough to peak, TSI’s North European HRC index gained €138/tonne year-to-date – the series’ biggest continuous upward movement since 2011. And with recently announced mills’ list price increases gaining acceptance, we may see even greater movement in prices later this year.

Only subtle improvements in domestic demand

While North European HRC prices increased from the start of the year by more than 40%, demand growth was less spectacular. Some countries, such as Germany and the Netherlands, continue to demonstrate strong economic growth, whilst France has been experiencing a downturn for the last six months, according to PMI readings from the manufacturing sector. And some recent figures might be a cause for concern. According to Eurostat, Eurozone industrial output in July fell by 0.5% year-on-year, the largest y-o-y drop since November 2014; German industrial production fell by 1.2% y-o-y.

Performance by steel-using sectors also differs. While the automotive sector in Europe remains a star performer with 2016 projections of 5.5% y-o-y growth, expansion in other sectors is more modest. The European Steel Association (Eurofer) forecast that EU apparent steel consumption will remain practically flat this year at 153 million tonnes.

The absence of significant improvements in demand may put the recent price recovery at risk. If European mills are to be successful in managing the current price uptrend they will require more help from the EC and crucially fewer demand shocks.

Changes in the market structure

The European steel industry is seeing an increase in mergers and acquisitions activity, which could lead to structural changes in the market.

The Italian government is arranging a sale of Ilva, with two groups being named as frontrunners to acquire it – a joint bid by ArcelorMittal and Marcegaglia, and by Arvedi together with Italy’s state lender CDP. At the same time, there were reports that Germany’s Thyssenkrupp and India’s Tata Steel are looking into signing a memorandum of understanding on merging their European steel businesses. At present few details are available, but speculations are that the companies may be heading towards a 50-50 merger. If and when both of these tie-ups are finalised, the landscape of the European steel industry would be different.

Indeed, shuttering production capacity will be an unavoidable outcome of such M&A activity, but we may also see changes to prices – specifically greater uniformity in prices across Europe. ArcelorMittal is already attempting to introduce parity for its list prices across Europe. For example, spot prices in Iberia, where it is the major supplier, have recently been much closer to those in Northern Europe, than in other South European countries, and Italy in particular, where the market is more fragmented.

In Italy, prices were supressed by both increased import volumes and lower priced material from Ilva, which was undercutting other domestic producers on prices. But with AD measures in place, Ilva’s new owner can be expected to change its pricing policy of being the lowest-priced supplier. Could this also lead to Italian prices moving up, in line with those in the North of Europe? 

Managing price volatility

One of the ways to manage exposure to price volatility for European producers during the prolonged price downfall that the market was experiencing for the last few years was to increase a proportion of contract business in their portfolio.

A freefall in spot prices in the second half of 2015 would have been partially offset if prices for a larger part of producer’s output were agreed before the downturn began. For buyers, it meant paying for HRC according to an agreement negotiated when spot prices were some €70/t higher. The situation was reversed in 2016 – H1 contracts were negotiated when prices were at the bottom, and producers just had to watch how spot HRC prices rose by more than €100/t during the period.

When a similar situation recently occurred in the Asian market, there were two waves of order cancellations defaults on pre-agreed transactions. First, when prices jumped, producers were refusing to supply cargoes at prices confirmed earlier. Then the situation reversed when a sharp downturn in prices began a few months later. Although Europe avoided such a scenario, it shows how unmanaged price volatility can affect market dynamics in extreme cases and test even the most well-established business relationships.

European buyers often respond to sudden or anticipated large price swings by withdrawing from the market. But a fall in demand in a weak market can create a vicious downward spiral, deepening price declines even more. Even in periods when prices strengthen, buyers have in recent years on occasion stepped away from the market despite minimal price fluctuations.

One way to avoid these distortions of market activity would be the adoption of index-linking in commercial contracts for portion of buyers’ and sellers’ procurement or sales portfolios, respectively. As prices naturally fluctuate through business cycles, neither side of the agreement would feel ‘cheated’, afraid that they are committing themselves at a peak or a trough of the market. And if the commercial terms are tied to the current month’s price average, deviations from spot prices would be minimised, while extreme movements are smoothed.

It is also possible to go a step further and to lock in future prices by tying indexed deals to positions in the derivatives market, thus securing margins and eliminating forward price uncertainty from the equation.

Acceptance of using a third party, independent index in contract negotiations can free both steel buyers and sellers from chasing the best price in the market, and instead allow companies to focus on managing services and customer relationships. The shift in focus can help to improve a company’s competitive position and, crucially enable it to return to what it does best – adding value.

Using current month iron ore and coking coal term purchasing would align European buyers with the faster moving Chinese procurement cycle. Doing the same with steel prices (linking to the current month) might do more than any legislation to keep European sales prices competitive enough to stave off imports. A lag in European prices is, after all, what encourages imports when differentials become too wide.