A Steel Industry Primer

Clayton Steel Holdings (PLTE), which filed to go public on August 7th, published a handy introduction to the steel industry in their S1 filing, excerpted below. Everything you wanted to know about steel and were afraid to ask.

In 2005, domestic steel mill shipments reached over 103 million net tons, a decrease of 7.0% from 2004, according to the American Iron and Steel Institute. Estimated steel use in North America reached 126 million tons in 2005, approximately 25% of this supplied by imports. Steel is sold principally to the automotive, construction, steel product fabrication, container and packaging, oil and gas, electrical, machinery and appliance industries. In some of these industries, such as the automotive and construction industries, steel competes with other substitute materials such as plastic, glass, composite and ceramic materials.

Manufacturers of steel are classified as either “integrated mills” or “mini-mills.” Mini-mills differ from integrated steel producers in that their primary input is scrap metal, whereas the integrated mills make steel by processing iron ore and other raw materials in blast furnaces. Mini-mills and integrated mills generally have significantly different management styles, labor relations, cost structures and scale efficiencies. Mini-mills are generally considered more efficient and technologically advanced than integrated mills, with lower ratios of fixed costs to variable costs and more effective human resource allocation than integrated mills. Consequently, mini-mills are typically able to operate more cost effectively than integrated mills. Of the total steel shipments in the United States, it is estimated that mini-mills accounted for approximately 50% in 2005.

The domestic steel industry has experienced strong profitability following a trough period from 1999 to 2003. Increased shipments, consumption, and production were driven by strength in several key end-markets and a stronger overall economy. In addition to strong domestic demand for steel, structural changes to the U.S. steel industry, including consolidation and the widespread acceptance of steel scrap surcharges, significantly contributed to the rebound in the domestic industry. We believe that these structural changes will reduce industry cyclicality and result in greater pricing discipline.

There are a variety of major product segments produced by steel mills, including long products (rod, bar, rebar, etc.), sheet and plate. The steel plate market is a relatively small segment of the overall steel industry, representing only 10% of U.S. steel shipments by weight in 2005. Consistent with overall industry consolidation and rationalization trends, since the beginning of 2003, approximately 1.2 million tons of capacity has been eliminated from the steel plate market and the number of principal plate competitors has been reduced from ten to six. Furthermore, there is currently no new domestic plate capacity expected to come online. Steel plate is used in a wide range of end-markets, including construction and heavy equipment, general construction, railcars, shipbuilding, bridge, fabrication, numerous industrial applications and wide diameter pipe, and demand is expected to grow in many of these end markets through 2008. The strength and diversity of these markets creates a more stable supply/demand balance than that for sheet steel, which is highly dependent on the auto industry. Relative to sheet products, steel plate is more costly and difficult to ship, reducing import pressures, which are further mitigated by the demand for plate from developing economies such as China and India.

The stable supply/demand balance for steel plate is reflected in its price, which has remained virtually flat over the past year. Between April 2005 and April 2006, monthly domestic plate prices ranged from a high of $796 per ton to a low of $750 per ton, a variance of only $46 per ton, or 6% from the yearly low. This consistent pricing for plate differs significantly from other segments, such as hot rolled sheet, where prices have ranged from a high of $575 per ton to a low of $435 per ton between April 2005 and April 2006, a variance of $140 per ton, or 32% from the yearly low.

The steel plate market is comprised of three segments: coil, standard discrete and custom discrete. We focus on the niche custom discrete plate market, which we believe to be approximately 1.6 million tons annually and which commands higher prices per ton than other segments. Since 2000, three steel plate mini-mills that historically served the custom discrete market and had aggregate capacity of over two million tons have been eliminated, leaving very favorable market conditions for the remaining three participants.