***NOTES FROM NEW YORK: New normal – introducing the Stockholm Selection

New York City was the place to be last week. The world’s largest steel conference kicked off at the Sheraton Hotel just a few blocks south of Central Park and, as usual, there were movers and shakers aplenty.

John Surma makes his presentation at this year’s SSS

New York City was the place to be last week.

The world’s largest steel conference kicked off at the Sheraton Hotel just a few blocks south of Central Park and, as usual, there were movers and shakers aplenty.

Some use the Steel Success Strategies (SSS) conference as an excuse to visit clients or colleagues.

Others take time to gauge the state of the markets, network with other delegates and discuss important issues for the industry.

And several go there for the shopping. The dollar might be more expensive than it was a couple of years ago, but the Big Apple is still a good place to pick up the latest trends. Apparently.

Almost every single delegate made it to the main ballroom for the event’s first keynote presentation. The room was full to bursting.

As ceo of the world’s largest steelmaker, Lakshmi Mittal is an influential man. And his annual address at SSS is a highlight for the sector.

It’s his only regular speaking slot each year and industry insiders travel from all round the world to hear it. Which in some ways is strange, since it’s not normally that groundbreaking.

Apart from the odd inflammatory comment directed at the steel traders in the room, or a sideways swipe at steel futures, which Mittal believes offer no benefits to the steel industry, he tends to steer away from controversy.

The main themes of the Mittal philosophy are pretty well known by now.

Consolidation: the industry needs more mergers and acquisitions so that steelmakers can command more control over prices and maintain production discipline.

Tick.

Raw materials: prices are too high and negotiations are tilted out of steelmakers’ favour because of the dominance of the three largest iron ore producers.

“The reality is that raw material costs will increase over this year, at least,” he said.

Tick.

China: if Asia’s largest economy over-invests in steelmaking to feed its stupendous growth then the whole industry will be sabotaged by over expansion.

Tick.

All good points. But points that were made last year. And the year before.

After all the turmoil of ’08 and ’09, attendees to the Steel Success Strategies conference needed as much insight as they could get. The challenges they now face are, in some ways, greater than ever before.

Judging from the discussions had by many of the panels, one of the largest challenges lies in the way that raw materials are now priced – iron ore in particular.

You’d have to be pretty uninterested in the steel sector not to already know that annual benchmark prices have pretty much disappeared.

The new era has heralded shorter contract terms, index-linked pricing and variations in the way deals are sealed from company to company.

The steelmaking sector isn’t happy about that.

“Chinese iron ore production hasn’t kept pace with steel production [which] has resulted in 2009 being a record year for iron ore imports,” Mittal told delegates. “As a result, spot prices have rocketed and miners have taken the opportunity to move to quarterly prices.”

“This brings greater volatility and more speculation [and] it will therefore be more difficult for steelmakers to offer long-term prices to their customers,” he said.

US Steel ceo and chairman John Surma agreed.

“The overwhelming dynamic affecting the pace and level of our industry’s return to profitability today is the raw materials industry,” he said.

Without steady and predictable raw materials prices, agreed on an annual basis, steelmakers will be forced to do whatever they can to keep volatility off their balance sheets. And this isn’t sustainable – look at stainless steel.

Mills can’t just keep passing on pricing. Doing so will undermine their own profit margins and erode the use of steel in important areas like automobile assembly.

Sooner or later, manufacturers, builders and other end users will start to look for other, more consistently priced materials. If prices rise high enough, or become volatile enough, substitution is a massive threat.

That’s obviously not good news for the steel industry. But it’s not good news for the health of the wider economy either.

“Manufacturing is where wealth is created [and] it drives research,” Surma said, telling delegates that “steel is essential to sustaining our global infrastructure”.

How can steelmakers not only safeguard its use in the sector, but also help manufacturers and other businesses in tangible sectors to flourish?

“This change [in iron ore pricing] has reinforced our plans to pursue vertical integration,” Mittal said, referring to ArcelorMittal’s plan to become self sufficient in raw materials. “Due to our vertical integration [so far], we’re a low-cost player in all our major markets.”

Investors are already favouring companies with these kind of assets and well-structured businesses. Private equity in particular is targeting companies that are looking to bring new raw materials production capacity on stream over the next few years.

“Our industry is claiming progressively less of the value created by steel,” Surma told delegates at SSS. “Steel is becoming a medium for mines to reap the value of our resources.”

“If we expect to provide raw materials suppliers with a reasonable market and steel consuming sectors with a decent profit from using our product we need to recapture our position in this value chain,” he added.

But this isn’t a complete answer. Mittal himself admits that it will take an industry-wide move to maintain annual or longer-term pricing, even if the world’s largest steelmaker achieves self-sufficiency in ore.

Martin Abbott, ceo of the London Metal Exchange, believes there is an alternative. The LME’s two steel billet contracts, which are soon set to merge into one global reference, are nothing new.

It’s not the first time that Abbott has spoken at this conference but this year, he had something more substantial to talk about.

“What we’ve seen from March of this year has been a rapid increase in the amount of contracts being traded,” he said. “The LME volumes are rising and we are beginning to take a truly global position with our contracts.”

“Year-to-date we have traded in total over 6.5 million tonnes,” he continued.

So how does that help steelmakers?

“If you have LME pricing you can also get hedging, which means you can free up lines,” he told the conference. “You can do more business [...] this is a management tool.”

But for now, even though they are rising, volumes are still limited. Most steelmakers won’t be able to take advantage of industrial hedging until they’ve grown larger, and exchange pricing will have to become more widely accepted before physical contracts shift en-masse to a new model.

In the meantime, the stakes of the game are getting higher. Integrated steelmakers in developed economies like western Europe and North America are already under pressure. Unless something drastically changes, they will find it harder and harder to compete with lower cost plants overseas.

“The most challenging competitors are those from China,” Mittal said. “The continued growth in China is setting new standards for us all.”

Plus, the footprint of world steel demand is shifting.

“I do not see a recovery in demand [in developed economies] before 2012, the road ahead will continue to be rocky,” he continued. “Even if demand reaches pre-crisis levels in 2010, it will have a very difficult geographic profile.”

Companies outside these regions will have to work harder to keep their cash flow fluid as customer demand reduces. And they will have to do a lot more than fight to keep their cost per tonne low.

“There will also be pressure for the industry to produce better products with better processes [and] with greater environmental efficiency,” Mittal said, drawing his keynote speech to a close.

“Innovation will be important, and I don’t just mean new products – product development and new facilities are, of course, important. But it must extend beyond this,” he said. “Those companies that can be innovative will emerge as the fittest.”

Listen to the maestro – he’s spot on.

Whether or not the recent upturn in some key economic indicators means we’ve really embarked on recovery remains to be seen. But it’s obvious that steel mills in western Europe, North America and other more developed regions won’t be able to just shift back to operating at pre-crisis levels on pre-crisis terms.

That’s the real “new normal” – competing on a cost per tonne basis is a competition that has no winners. At least not any more.

“Steel price volatility has been exactly in line with volatility in steel equities,” Renaissance Capital’s Rob Edwards said. “Uncertainty in steel pricing flows through to relatively low valuations for the steel industry itself.”

Spiro Youakim of Lazard & Co sang from the same hymn sheet.

“Equity values have declined considerably from their highs at the beginning of the spring – most no longer reflect the fundamental values of the corresponding companies,” he said.

“Companies with sustainable operating margins have been awarded higher multiples than their peers.”

“We do feel that this characteristic will remain a defining feature of our industry for some time to come,” he added.

Incentive enough, surely, for companies to start thinking about how they can construct business models that think more about end use markets, product development and new services.

It’s a horrible term, but the business environment does seem to be getting better, more so in some areas than other. But we are no way near to a full recovery.

Until this resurgence from disaster arrives, the only way for many companies to survive will be through innovation. That’s why we’re introducing something new at MB.

There are plenty of companies that already have the right idea. They’re doing impressive things. Not just because they make business sense now that demand is low, but because they’ve had the foresight to invest ahead of the crisis.

“Good to great companies [have] a culture that says you prepare for the bad times during the good times, and prepare for the good times during the bad times,” Nucor ceo Dan DiMicco said at the conference.

Right on. Starting later this year, MB is going to case study some companies that are excelling. Not because they’ve managed to pin down their costs and beat the competition on prices, but because they’ve had the courage to invest in the sustainability of their businesses.

We also want to hear the views of MB readers. It’s your views that count, and the models that have inspired you are extremely important.

It’s not a competition, just an interesting exercise that will hopefully help to inspire other companies to make their own innovations and move the sector forward.

Once we’ve case-studied these companies, MB plans to form a panel. These industry experts will be invited to meet and discuss why the chosen ten are interesting, and why they’re important to the industry. We hope you’ll find it useful.

It’ll be called the Stockholm Selection, and there’ll be more details soon. Why Stockholm? Keep reading.

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