FOCUS: Brexit, high raw materials costs damp British Steel’s flame

Troubled UK long steel producer British Steel entered compulsory liquidation on May 22. Fastmarkets examines the reasons behind the company’s recent struggles, from uncertainty about Brexit and a slump in orders, to rising costs for raw materials.

Brexit uncertainty
The future of British Steel remains uncertain, with the UK’s Insolvency Service approaching “more than 80 potential trade purchasers” to bid for the business.

The company, which produces around 2.8 million tonnes per year of long steel, including sections, wire rod and rail, exports the majority of its production, with the European mainland a strong target market.

Interested parties will still be concerned about the lack of certainty surrounding the UK’s future trading relationship with the European Union (EU), after the UK was granted a six-month extension to delay its departure from the EU (‘Brexit’) until October 31, 2019.

UK and European steel market participants have repeatedly called for the EU and UK to reach a Brexit agreement to avoid extending the uncertainty.

“The growing uncertainty around Brexit is a major contributory factor in the compulsory liquidation of British Steel, which saw a slump in orders from EU customers,” Vassilis Akritidis, partner at UK financial law firm DWF, said.

“Similar risks may have come from non-EU customers because Brexit would have removed the UK from trade agreements currently in place with third countries [through EU membership]. While this was not the only factor, Brexit has added weight in snapping British Steel,” he said.

Prior to entering compulsory liquidation, British Steel was in discussions with the British government about “a package of additional support to assist the company to address broader Brexit-related issues, while continuing with its investment plans.”

The company also had to borrow £120 million ($151.44 million) at the end of April from the UK government to cover its 2018 bill from the EU’s Emissions Trading Scheme (ETS) for the company’s carbon emissions.

The situation arose after free carbon allowances issued by the UK were suspended from the ETS on January 1, 2019, because of the delay in a Brexit agreement between the UK and the EU. This meant that UK steelmakers did not receive their free allowances for 2019, a development for which British Steel had not budgeted.

Order slump
“Buying activity of EU market participants at British Steel has been slowing since the end of last year, based on the uncertainty over whether there would be any tariffs on UK-origin steel arriving at mainland EU ports,” one UK-based trader told Fastmarkets.

“People were placing orders at the start of the year on the understanding that material would arrive before March 29 [which was the UK’s original departure date from the EU] but, closer to that date, there has been more reluctance,” the trader said.

Market participants expect a similar buying pattern to emerge ahead of the new October 31 Brexit deadline.

“Exports were lucrative for British Steel because they can benefit from letters of credit [LCs] and therefore they can load several thousand tonnes onto a ship and get payment more quickly, while payment for domestic sales can take longer,” he added.

The effect of removing British Steel’s supply from the market will be limited in the commodity-grade long steel trade, but will affect longer-term customers and project-driven demand for products such as rail, market participants said.

“Rail is the big one – [British Steel] sells around 500,000 tonnes [per year],” one European producer source said. “Even if the company continues trading, it isn’t likely to be in the same shape. Customers that are heavily dependent on British Steel are likely to spread their bets and hedge the risk through a couple of other suppliers.”

British Steel is a major supplier to UK public rail infrastructure company Network Rail, providing around 100,000 tpy of rail.

“We have improved our order book with the company – increasing rail production volumes, bringing orders forward and committing to a long term schedule – as well as offering immediate payment to ease the pressure on cash flow,” Network Rail said.

“In the longer term, we have plans in place so that we can continue to deliver the reliable railway millions of people depend on every day,” Network Rail added.

For wire rod products, the steelmaking company is not considered a “massive player on the European mainland” but supply would reduce if it stopped trading, according to a buyer in mainland Europe.

“All EU wire rod mills had big plans for price and production increases of high-quality wire rod, so it is not surprising that some, including British Steel, temporarily switched to making lower carbon grades [such as mesh-quality] to make sales, amid the demand slowdown from the automotive sector,” he added.

Fastmarkets’ weekly domestic price assessment for mesh-quality wire rod in Northern Europe was unchanged week on week at €500-520 per tonne delivered on May 29, with mills hoping for a gradual price recovery in the coming weeks.

Some of British Steel’s domestic customers are likely to be partially protected in the short term, through stockpiling, should the company stop trading, sources said.

“The rise in stockpiling ahead of Brexit has not really changed prices. A few people have stockpiled steel but it is not easy nowadays to stockpile steel [in the UK] if you don’t have cash,” the UK-based trader said.

If British Steel stops production in the UK, “the biggest kick in the teeth will be to project-based fabricators,” he added.

Structural steel fabricators for major UK infrastructure projects such as airport expansions will have priced a large proportion of their supply against British Steel’s prices, sources said.

“This is a problem because steel sections will become more expensive in the UK if British Steel stops production, because there will be a shortage of local material and that will raise prices for existing material at stockholders,” the trader said.

“Imports from mills on the EU mainland could be possible in the short term [after Brexit] if no tariffs are imposed – and EU mills are desperate for orders right now,” he added.

Raw materials costs
Blast furnace-based UK steelmakers, such as British Steel and Tata Steel, have also been negatively affected by an increase in prices for higher-grade iron ore from countries such as Brazil, Sweden and Canada – key iron ore suppliers to the UK market.

“We can see that UK demand for iron ore pellets for blast furnaces has increased and replaced a lot of lump ore usage,” Fastmarkets’ senior raw materials analyst, Miriam Falk, said. “Sinter fines have also seen their share decrease as mills have opted [to consume] more pellets, which is a higher priced product that mills often select when they try to optimise productivity at the blast furnace.”

The premium for iron ore pellets rocketed upward in 2018. Fastmarkets’ 65% Fe iron ore pellet index averaged $129 per tonne cfr Qingdao in 2018, and was $128 per tonne cfr so far in 2019. This compared with Fastmarkets’ 65% Fe Brazilian Fines Index, which has averaged $101 per dry metric tonne cfr Qingdao so far in 2019 and was $90 per tonne over 2018.

“This will have had a significant effect on steelmakers’ margins,” Falk said.

Similarly, the prices of coking coal imported into the UK, predominantly from the United States, Russia and Australia, have also increased sharply in recent years.

Fastmarkets’ Premium Hard Coking Coal Index has more than doubled since 2015, averaging $206 per tonne fob Australia so far in 2019, up from $90 per tonne fob in 2015.

The spike in raw materials prices has been exacerbated by the weakness of sterling, which was at £1 to $1.46804 on June 23, 2016, when the initial Brexit referendum was held. Sterling has since fallen, and was trading at £1 to $1.26197 on May 31, 2019.

Fastmarkets research team notes that, on a sterling basis, the Fastmarkets 65% iron ore pellet price delivered to China has risen by 120% since May 2016, compared with 90% on a US dollar basis. Fastmarkets’ premium coking coal prices were up by around 160% in the same comparison on a sterling basis, compared with a US dollar rise of 125%.

Furthermore, with Northern EU domestic steel beams prices only up by 21% on a sterling basis compared with May 2016, Fastmarkets’ research team estimates that British Steel will not have been able to offset its higher raw materials costs by exporting long steel when sterling was weaker.

Fragile future
While British Steel has been buffeted by the recent effects of Brexit, weakness in the value of sterling and high raw materials costs, the company also remains affected by historical logistical inefficiencies across its sites in the UK.

The rolling mills for construction steel and for special profiles, both located in north-east of England, are supplied by the blast furnaces in Scunthorpe, which is more than 150km south of the mills, adding extra transportation and re-heating costs to the production process.

The overall future of the UK as a steelmaking nation is also under question.

Several challenges remain for UK steelmakers – great uncertainty around the UK’s future trading relationship with the EU, high energy costs for producers, and continuing “global [steel] overcapacity and an uncompetitive UK policy landscape,” according to industry body UK Steel.

UK crude steel production has declined sharply in recent years, and totaled 7.27 million tonnes in 2018, down from 10.91 million tonnes in 2015, according to the International Steel Statistics Bureau (ISSB).

This was due to the 2015 collapse of Sahaviriya Steel Industries (SSI) UK’s 3.6 million tpy slab plant on Teesside, in north-east England. The UK steel market will be desperately hoping that a repeat performance can be avoided just three years later.

The coming six months will be decisive for both British Steel and the UK steel industry as a whole.

Lee Allen and Carrie Bone, both in London, contributed to this report.

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