The Steel Price Dilemma
Update Oct 2004
By Bill Ray
"Nobody saw it coming” is the statement heard time and again. Producers are now painfully aware of January, February and March price increases. In some cases, April steel deliveries were priced upon shipment. You can't run a business that way. Where is steel price going over the remainder of this year? How do you bid work? What steps can be taken on fixed price contracts that are underwater? Is there a silver lining to this bad news? This article provides some answers.
A brief review: Reinforcing steel prices feel like they are very nearly double the year ago levels. The immediate cause for the increase is supply bottlenecks: Energy prices are up sharply. There was a coal mine fire that had the effect of reducing supplies of coke, A key steel mill in South Carolina shutdown. The price for steel scrap is way up, due to buying by China.
Steel expansion in China relies on scrap
Where is steel price going from here? Start with the fundamentals. There is continuing excess production capacity in North American steel mills. American mills rely heavily on scrap, and those that don't are often obsolescent. Offshore steel mills are the low cost producers in a worldwide commodity business. Precasters can quickly grasp the implications of this because many precast markets are commodity in nature. Commodity prices are volatile, and subject to intense competition. Price is set by the low cost producer.
Imported steel sets the price, and we have become dependent upon it. Indeed, the American economy generally has become dependent on imports of all kinds and this has resulted in an ever-weakening dollar exchange rate. Here is the key, the weakening dollar is not likely to improve and steel prices are not likely to go back to where they once were.
Price forecasting is more art than
science. Here is the conventional wisdom: We are probably at
the peak right now. Various supply and demand factors are kicking
in. For example, ships to move scrap are proving to be a bottleneck.
Coke production is being restored. There is some stockpiling going
on, aggravating the current shortage. Today's
prices are encouraging new capacity and restart steel production.
Some work has been canceled or delayed. The normal reinforcing steel
shipping season runs through summer. In the future, export restrictions
may be placed on scrap, but don't count on that.
Steel prices are expected to ease later this year, but will not return to old levels
The price of scrap is volatile, and a leading indicator of future steel price trends
After year end, we will probably see some pullback in prices. Scrap prices continue to be volitile. At the time of this update, (October) some steel producers have been quoted saying the prices are at their cyclical "peak." Analysts who study such things say that some of the price increase in bar, mesh, and strand is likely to go away next year. But that still leaves a big increase in place and prices sharply higher than they were at the beginning of 2004.
Quoting work requires that you hedge steel price. Most steel suppliers will quote only up to 30 days. Press for longer commitments. I say an escalator clause is a must in contracts that extend 6 months or more, even if it makes your bid “nonconforming.” Private owners have flexibility on price escalators. Every major industry association has endorsed price escalators. The Federal Highway Administration (FHWA) has endorsed escalators on new work [only.]
Escalator clauses come in two varieties. In long lived contracts, you can, and must, convince the owner or GC that an escalator is preferable to a risk premium in the bid. Remind your customer that, if prices go down, the escalator will work in their favor.
Stockpile Another way to hedge is to stockpile the steel required for the job. I recommend that this be done only if the owner will pay for the reinforcing steel as a stored material on your yard. The producer should not have to carry more than 30 days steel inventory. There is not a futures market in steel so standard hedging, like candy makers use to lock in the cost of sugar, is not available to precast producers.
.American steel mills compete in a world wide commodity market
Don't speculate in steel. I talked to a manager who purchased 50 tons of nails as a way to hedge the price of reinforcing steel. He doesn't use nails in his business. Maybe the nails were a bargain, maybe not. Speculation is high risk. For sure it is a distraction from the main event, running the business.
Legal considerations come to the fore in any losing contract. Here is a checklist.
An Action Plan Upside-down fixed price contracts are a huge problem for some producers. Bridge producers are particularly hard hit but there are other producers that have big fixed-price contracts they can't live with. Here is a list of options that may be helpful as a checklist to make sure you are considering everything. Producers have successfully used the items in this checklist to their advantage. If you are underwater in a contract, look this over carefully. These are ideas here that are proven to be effective.
Problem or Opportunity
Every problem is an opportunity. Some producers in the short run have very serious problems with certain fixed price contracts. All producers have the opportunity to bid work intelligently during this unstable period, gaining good contracts and avoiding expensive mistakes. Most producers have a big opportunity to benefit from the increased competitiveness of precast compared to steel systems.
The silver lining If that's
the bad news, is there a silver lining? Yes indeed, and an important
one for management!
The precast advantage. Finally, remember that among our greatest strengths are:
This is the time to sell the whole package.
So in summary, the last few months have been difficult for some producers and a big challenge for all of us. Some experiences of those producers are summarized here. They provide some good points to consider. In the future, we should focus on our new and improved competitive position. There will be a big payoff for the alert producer.
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click here for Cement Shortage Managment Bulletin
click here for Steel Price I for background perspective