Last month, I made the case for sourcing steel (and other direct materials) based on sagging demand and excess capacity. Since then, the data we’re seeing indicates the drops in production, employment and demand are worse than expected:

• US Steel Mill Capacity utilization was 36.3% for the week ending 1/3, versus a value of 88.7% for the same week last year. That means that 2/3 of the potential US steel production is lying dormant!
• The Precision Metalforming Association ((PMA)) December survey of 157 metals companies revealed: “The number of metalforming companies with a portion of their workforce on short time or layoff continued to increase to 54% in December-up from 42% in November and at a substantially higher rate than December 2007, when only 18% of companies reported workers on short time or layoff.”
• The primary US and Asian automakers posted December sales figures that were down 31% - 53% compared to December 2007.

In the past, those of us who follow steel production took notice when capacity dipped below 65%. So, the fact that it’s now at half that level is downright scary.

As the graph below shows, steel prices have risen a staggering 400% in the last six years - far outpacing other commodities that are receiving more media attention.

click to enlarge image

Last month, I had the opportunity to attend the American Metal Market and World Steel Dynamic’s Steel Success Strategies conference in NYC. Attendance leans very heavily towards suppliers (I’d ballpark it at about 70-80% of the attendees). But for all of us - from buyers and suppliers to consultants and media - the views expressed on the current state of the steel market and the direction the industry is heading was very revealing.

A series of live audience polls did a great job of capturing the mood among attendees. So let me go through some of the key questions, results and what I believe those results reveal:

Last week, we looked at the driving forces behind rising steel prices in the US: surging raw materials, a weak dollar and global consolidation. Those are the Big 3, but there are other long term forces at work here, including greater vertical integration and steel executives with finance (rather than operations) backgrounds.

Global mills are doing a much better job at controlling the global steel price by becoming more vertically integrated. Large integrated mills (which make steel from coke, iron ore, etc in large blast furnaces) are extensively acquiring global mines to better sure up their supply chain of steel-making raw materials. And mini-mills (those smaller, more nimble mills predominantly making steel by melting down scrap steel in electric arc furnaces) are now acquiring scrap dealers in an attempt to better control their raw materials supply and pricing volatility.

A lot of ink has been spilled in attempts to diagnose the recent run up in steel prices. Purchasing.com recently put the blame squarely on the raw materials cost push and strong global demand. Certainly raw material factors are still the primary contributor to the sharp rise in steel prices (iron ore costs up 65% year over year, coking coal costs tripling, scrap prices jumping, high energy costs, transportation vessel shortages, freight fuel charges, etc.), but I have to take issue with the idea that global demand is playing such a pivotal role. Instead, I would argue that the other primary factors influencing the run in US prices are:

1. The weak dollar’s effect on steel imports
2. Global consolidation in the industry

The weak dollar and resulting drop in imported steel outweigh the impacts of global demand. In fact while demand in many US industries is high, the contraction in automotive, housing and appliance sectors is keeping the overall US demand in check. Unlike the period of 2004-2005, when steel-making costs jumped AND demand spiked, this market is marked by high steel-making costs and moderate global demand. The big difference now is that domestic steel mills have been able to charge what they want due to a lack of cheaper-priced imports. In other words, the weak dollar has put the brakes on steel imports.