Steel’s at the Tipping Point

The U.S. economy and its steel industry are recovering, but at an uneven pace, with significant gains in automotive and capital goods offset by the struggling construction and labor markets, say two leading industry economists.

By Tim Triplett, Editor-in-Chief

America’s gross domestic product was around 2.7 percent in 2010, barely above the 2.4 percent level at which steel consumption begins to grow. “Until GDP reaches 3 percent or more, steel will flounder at earlier levels,” said Glenn Kidd, industry analyst and former economist for U.S. Steel, who addressed the crowd at FMA’s Toll Processing 2011 conference last month in Orlando, Fla.

Leading the economic recovery are capital goods and automotive manufacturing. The capital goods market (nondefense, excluding aircraft) has recovered to pre-recession levels, said Kidd, even without help from construction-
related sales. “This part of the economy is back.”

U.S. automakers are projected to produce nearly 13 million cars and light trucks this year, up from about 8.5 million in 2009. While that represents healthy progress, it will be a long time, if ever, before the industry produces over 16 million vehicles per year again, Kidd said.

Pointing to one reason, he noted that automakers are done making cars they can’t sell. In the past, labor contracts gave them an incentive to overproduce. “It was cheaper for them to run the plants and sell at little or no profit than to shut down the plant and pay the autoworkers to stay home. Now, following the bankruptcies of the Big 3, those contracts have all changed. That environment is gone,” Kidd said. With so many assembly plants closed during the downturn, automakers no longer have the ability to make that many vehicles in a single year without adding back new capacity, he added.

Another headwind on new-car production is the growing number of used vehicles on the nation’s roads. Cars and trucks are built to last much longer today. “Now we all have cars that we drive long past the point we still want them. We replace them because we get tired of them,” said Chris Kuehl, FMA economic analyst and managing partner of Armada Corporate Intelligence, who shared the dais with Kidd.

Vehicles purchased in the United States contain an average of about 1,800 pounds of steel, shifting upward when big SUVs are most popular and creeping downward when high gas prices spur purchases of smaller, more fuel-efficient cars. Consumers in this country will always favor big cars, at least compared to other parts of the world, Kidd said. “We will never buy cars like Europe and Asia, so our steel content will always stay relatively high.”

On the negative side, Kidd and Kuehl said, construction-related steel demand continues to disappoint. Only a fraction of federal funding for infrastructure improvements has actually been spent, as financially beleaguered state governments are reluctant to fund their share of road and bridge projects.

While new-home construction grew from a low point of roughly 520,000 units to 890,000 units on an annualized basis in 2010, that level of activity still pales compared to the two million homes built in 2006.

New construction won’t really take off until the excess supply of existing homes, forced on the market when the real estate bubble burst, can be sold down. Unfortunately, many of today’s buyers are older people looking for smaller ranch houses and young couples seeking starter homes—not the five-bedroom “McMansions” that fill the real estate pages. “On an absolute basis, it is going to be a long time before we get housing back to those earlier numbers,” Kidd said.

Putting the market in perspective, Kuehl noted that the housing situation is not terrible everywhere. “The housing crisis is highly concentrated. Seventy-five percent of the foreclosures in the United States have taken place in just 39 counties.”

No doubt the biggest drag on economic recovery is the nation’s 9 percent unemployment level, which continues to weigh heavily on consumer confidence. With an economy that is 70 percent dependent on consumer spending, this promises to prolong the recovery, the two economists agreed.

U.S. business and industry continue to make great gains in productivity—but at a significant cost to the labor market. “The better we get at what we do, the more we can do with fewer people,” Kidd noted.

Also making the economy less dynamic is its declining labor flexibility. In the past, if a person lost his job, he would pick up his family and move to a new opportunity. Today, some are stuck with huge houses they can’t sell and huge mortgages they can’t afford. Many are dual-income households in which the other wage earner is unwilling to relocate. And divorced individuals are often averse to moving out of state due to child visitation arrangements.

But the nation’s labor situation may not be quite as bad as it appears, he added. More than nine million entrepreneurs have started their own businesses in the past few years, yet government statistics classify these newly self-employed individuals among the ranks of the unemployed. He also noted that the government has changed how it calculates the unemployment rate over the years. “If you use the system that is in place today and retroactively look at the recession in 1980, the unemployment rate would have been 22 percent. So when people say the current recession is the worst ever—no it’s not.”

Scrap’s new paradigm
Despite the relatively weak demand from many end-use markets, steel prices are surprisingly high at around $870 per ton for hot-rolled coil. One reason is the high cost of steel scrap, which is trading at over $400 per ton. Steel scrap prices will probably never return to previous low levels, Kidd said, as scrap has shifted from a buyer’s to a seller’s market. “As the minimill industry has grown to a capacity of 50 to 55 million tons a year, they have basically outpaced their raw material source. You don’t make scrap, you harvest it. And there is only so much out there.”

Indeed, minimills may have lost the raw material cost advantage of the recycling-style business model they brought to the market four decades ago, when steel scrap was abundant and in low demand. “Today, they have outgrown their supply and find themselves in a totally new dynamic,” Kidd said. “That is why the big ones are trying to find alternative carbon sources like DRI. But there is no cheap solution, and it won’t lower their costs back to what they were when scrap was $60 a ton. You’ll be lucky to see scrap drop back to $100, and then only briefly.”

Adding to the costs facing both producers and distributors is the looming shortage of trucking capacity. Transportation costs will go through the roof this year, predicted Kuehl.

During the last recession, about 900 small and medium-sized trucking companies went out of business, while the large companies cut capacity, in terms of equipment and drivers, by 60 percent. Large customers, such as Walmart, have secured future commitments from the major carriers. “Sixty percent of the trucking capacity in the country is already spoken for. When the economy starts to heat up, only 40 percent will be left, and it will be more expensive. Also, there will be a driver shortage. Fuel surcharges are already having an effect. Freight rates will be your nightmare toward the end of this year and certainly next,” Kuehl added.

U.S. steel mill shipments rebounded to nearly 69 million tons last year from 60 million tons the year before—a positive growth rate, but still well below the 100-million-ton peaks of the past. “Two of our bigger markets [construction and automotive] were hit hardest by this bank-driven recession. We cannot expect the steel market to return to prior recent high levels for quite some time,” Kidd concluded. n­­

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Thursday, February 22, 2018