Steel: Over capacity draining profit

As economic growth slows across the world, the global steel industry is in a fix. Managing excess capacity in the face of a persistent gap between demand and supply is fast becoming an existential threat for many of the biggest players in the steel industry. According to the Global Steel Report released by Ernst and Young, the global production overcapacity of steelmakers at the end of 2011 stood at 493 million tons per annum. The report adds that since 2001, the global production of steel has grown at an average rate of 6 percent and over the same period the consumption grew by an average of 5.5 percent. The global steel industry is also threatened by the rise in raw material prices, retardation of economic activity in the West and lack of operational agility. Over the past few decades steel makers enjoyed purchasing power over raw material suppliers. They also had been setting prices for distributors. But more recently, the tides have turned on steel manufacturers and purchasing power has shifted to raw material suppliers. As a result, prices of key inputs such as iron ore and coking coal have spiked; corroding the erstwhile high margins pocketed by steel manufacturers. Being capital intensive, the industry cannot quickly adjust to the changes in demand patterns. Steel makers inability to make timely operational changes in certain segments means they are stuck with substantial costs that are likely to persist for some time. Steel makers should broaden product offerings and focus on profitable segments by going for niche markets and focusing on higher margin products. The focus of POSCO and U.S steel on Advanced High Strength Steel (AHSS) is an example of specific niche targeting. In emerging economies the focus should be on steel used in building infrastructure. Steel makers should also try to become more cost competitive by using derivatives and increasing involvement in upstream activities (mining). The report also focuses on optimisation of capital, especially since almost 94 percent of the financing faced by the steel industry is from debt.