***NOTES FROM ROME: Material management – why it’s hard to be in stainless
The formula for stainless steel prices is simple: just look at raw materials.
Flagging? As the stainless community gathered in Rome, raw materials topped the agenda.
The formula for stainless steel prices is simple: just look at raw materials.
Stainless steel scrap and alloying materials, such as nickel, chrome, molybdenum and vanadium, account for such a large portion of stainless steelmaking expenses that the only other variable worth considering is energy.
The price of nickel and chrome now constitute 90% of the cost of producing grade 304 stainless steel slab, ThyssenKrupp Acciai Speciali Terni (AST) md Harald Espenhahn told MB’s 9th Stainless and Special Steel Summit in Rome last week.
“Raw materials are the biggest part of our costs,” SMR md Markus Moll agreed.
Even before the economic crisis, stainless steelmakers were not well. With overcapacity still prevalent and demand at relatively low levels, raw materials like these will continue to be the most important determining factor for the stainless steel sector. For the foreseeable future, at least.
This puts stainless steel mills in a difficult position. Producers say they have very little influence over how these prices are determined, so are unable to manage their balance sheets effectively.
Analysing the sector structurally, the evidence supports their case.
Thanks to demand fluctuations over the past few years and the fragmented nature of the stainless steelmaking sector, mills are suffering margin erosion from both their suppliers and their main customers.
Stainless steelmakers around the world have a combined market capitalisation of around $5 billion. And the industry has a consolidation rate of 60%, according to Unicredit risk manager Andreas Schober.
Stainless steel end users, in the meantime, have an approximate combined market capitalisation of around $20 billion and enjoy a consolidation rate in the region of 90%.
Stainless steelmaking raw materials suppliers, which enjoy a consolidation rate of 90% as a sector, have achieved even higher values. Altogether they are worth a whopping $50 billion, Schober believes.
With both end users and suppliers so well consolidated, mills are bring fewer chips to the bargaining table.
And with each sector valued at such high levels, producers have little prospect of integrating in either direction.
Some are luckier than others.
Outokumpu, for example, is already partially vertically-integrated. And the stainless steelmaker has restarted investments that will see it not just become self-sufficient in ferro-chrome by 2012, but also a merchant seller.
Mechel, Russia’s only stainless steel producer, is in a similar position.
But even these companies have broad requirements which they are forced to satisfy externally – Mechel is looking to establish strategic partnerships for molybdenum and vanadium, while Outokumpu is taking a similar approach to nickel.
Thanks to the industry’s valuation, upstream integration isn’t a realistic proposition for stainless steel producers that don’t already own or control assets.
Raw materials companies are prohibitively expensive when it comes to acquisition. And the industry’s corporate structure encourages them to maximise profits.
Greenfield opportunities are limited as well – stainless steelmakers aren’t set up to make direct investments of this nature.
“We are just too small to go into the raw materials business,” Acerinox ceo Bernardo Velazquez told the conference. “The idea of trying to benefit from non-commercial refined products requires a certain kind of set-up.”
“It is extremely difficult to find a nickel project that is financially feasible,” he said.
So mills around the world try to deal with materials volatility in different ways. In Europe and the USA, where demand contractions have been particularly pronounced, they have introduced an alloy surcharge system.
These producers track prices during a defined period, usually one month, before the month of stainless steel delivery. They use these prices to determine a charge to be levied on top of base prices in an attempt to pass the changes directly on to their customers.
Talking shop: delegates gather at the MB conference.
The system is far from perfect. Look at Outokumpu.
In the second quarter of this year the Finnish stainless steelmaker reported €55 million ($70.4 million) worth of raw material inventory-related gains due to the difference between the alloy surcharge its formula calculated and the prices it actually paid.
The company uses a one-month reference period in advance of stainless steel deliveries to calculate the charge. But it buys raw materials on a different basis.
For the same reason, Outokumpu is likely to report a loss from these activities in the third quarter, MB understands.
This isn’t the only problem with the system. Passing on price volatility to stainless steel consumers undermines its use as a component in many applications.
The volatility of prices for raw materials, such as nickel, is too much for many end users.
According to Macquarie Bank Commodities Research director Jim Lennon, world use of nickel in stainless steel has already begun to fall. The share of world stainless output accounted for by 400 series steels is on the rise, he said at the conference.
The share accounted for by 200 series production is also increasing.
“200 series in China has arguably expanded the range of stainless applications to areas not previously available to 300 series due to cost,” he said.
“The high price of nickel and the likely permanent higher cost of extraction has led to the questioning of some applications,” Lennon continued. “Is 300 series really needed in kitchenware, for example?”
Buyers from ITW Food Equipment Group, Franke Foodservice Systems and Faurecia Exhaust Systems have all been pushed to explore substitution over the past few years. In some cases, they’ve been successful.
ITW director of sourcing Pete Dow told the conference his company has already substituted a third of the nickel content in its products, used in the food preparation industry. ITW has no intention of reversing this shift, even if nickel prices fall and austenitic prices stabilise.
The replacements the company has made are permanent.
Franke hopes to achieve similar levels of nickel substitution. The company has conducted extensive research into the use of ferritic grades rather than austenitics in its manufactured goods, which usually find themselves in kitchens.
Franke buys 100,000 tonnes of steel each year and 70% is stainless, predominantly commodity grades like 300 series, used for deep-drawing applications. The manufacturer is more exposed to nickel price volatility than most.
Unfortunately Franke hasn’t enjoyed the same success as ITW. Without retooling and reengineering many of its products, the company won’t be able to shift far away from nickel-bearing grades, aside from replacing a few fasteners and other incidentals.
So Franke is piling pressure on its suppliers to come up with new solutions.
“We need stainless producers to continue to innovate and develop new, lower-cost, no-nickel alloys that will be able to substitute 4301 and 304 material,” Franke’s vp for technology and standards Chris Zweifel told the conference.
On the face of it, they seem to be responding.
“Producers have to strengthen innovation in terms of product and processing [by finding] alternative raw materials [and] new low-cost products,” Espenhahn said.
But here European producers might be missing an obvious point. Over the past one or two years, nickel prices have strengthened for one reason and one reason alone – it is in short supply.
The growth of China’s economy has demanded greater tonnages of the alloying material. And the response from producers has been slow. Increases in nickel output have been minimal.
But end users are particularly concerned not by the rise in prices. It’s volatility that has them concerned.
“Whatever the reason for it, price volatility of this magnitude means that we can’t keep using stainless steel products,” said a source at another end user. “Our only real interest is in stable prices.”
“We’ve tried to use the LME to hedge the nickel content in stainless, but haven’t been very successful,” he continued. “We are too far removed from the production process to hedge effectively.”
Developing and producing grades of stainless steel that contain less or no nickel might only be a short-term fix. Molybdenum prices have demonstrated equal volatility in recent years.
For producers that rely on the surcharge system there is an even greater threat as well. It comes from overseas.
“European stainless steel mills talk about anti-dumping duties when it comes to Asian imports, but they are really to blame,” said a source at one stockholder and distributor.
“Producers in China and India don’t use alloy [sur]charges; European prices are much more volatile and therefore uncompetitive.”