Steel Industry’s New
Comfort Zone
Presented to
ISRI
September 19, 2007
Presented by:
Michael Locker, President
Locker Associates
Copyright 2007 Locker Associates, Inc.
225 Broadway Suite 2625, NYC 10007 212-962-2980 lockerassociates@yahoo.com
Locker Associates/0
Locker Associates: Client Service
Business consultants with deep steel expertise
Over 25 years of experience
 185 U.S. and Canadian engagements -- focus on steel & other
metals, as well as manufacturing and distribution
 Emphasis on reorganizations requiring operating improvements
• Identify & negotiate with buyers for distressed companies
• Evaluate company business & market plans, as well as cap ex
• Economic and industry analysis and forecasting
• Joint labor-management efforts to enhance performance
 Publisher of Steel Industry Update since 1985
• Highly respected steel industry expertise
• Often quoted in general and trade press
• Numerous presentations at industry conferences & events
• Well-connected to Wall Street analysts, business consultants and
investors
Locker Associates/1
China Exceeds All Expectations
Production up from 129 to 418 mil. tonnes since 2000
 China has experienced extraordinary growth in last 6 years
• Production & demand now account for more than a third of
world steel output
• Raw material prices have soared due to explosive demand
• China has absorbed excess imports, but balance is changing
 Perfect storm of rapidly expanding market, cheap labor,
solid infrastructure, focused investment & abundant capital
 But many small, inefficient mills with high emissions remain
• Top 10 mills comprise just 33% of total output, down from ‘05
• Over 800 steelmakers
• Brutal price competition
 Far more growth to come: ‘07 production at 484 mil. tonnes
• By 2010, forecast production is 580 million tonnes
Locker Associates/2
China Steel Industry Statistics
Freight train keeps coming
(thousand tonnes)
Total Raw Steel Production…..
2005
2006
2007*
348,000 418,000
281,300
Total Exports…………………….….
25,625
49,200
44,970
Total Imports………………………..
24,600
18,600
10,240
Net Exports…………………………..
1,025
30,600
34,730
* Seven months ending July 30, 2007
In 2007 at the current rate of production, China will produce
482 million tonnes of steel, while exporting 77 million tonnes
Locker Associates/3
Source: AMM
US-China Input Cost Comparison
Excluding iron ore, China has input cost advantage
Integrated
Costs/tonne*
Mini-sheet
USA(1)
China(2)
USA
China
$47
$76
NA
NA
88
75
NA
NA
173
96
NA
NA
$250
$209
$241
$214
Labor cost/hour
$49
$2.76
$49
$2.76
Man hours/tonne +
1.74
5.44
0.51
7.00
Unit Labor Cost
$85
$15
$25
$19
Iron ore
Coking coal
Coke
Scrap
Notes: (1) No purch coke, 100% SS iron ore (2) Inland mill, 20% domestic raw materials * Cost per tonne of input
+ For tonne of hot-rolled band Data as of February 2006
Locker Associates/4
Source: World Steel Dynamics, data as of February 2006
US-China Process Cost Comparison for HRB
Gap grows as steel is further processed
Integrated
Mini-sheet
Costs/tonne*
USA(1)
China(2)
USA
China
Labor Cost
$85
$15
$25
$19
Material Cost
222
192
264
237
Other Cost
120
102
133
96
Operating Cost
$427
$309
$422
$353
Blast Furnace
$161
$148
NA
NA
Liquid Steel
281
236
$331
$299
Slab
321
271
354
319
HRB
399
317
409
369
HRB (with overhead) **
427
333
422
376
Notes: (1) No purch coke, 100% SS iron ore (2) Inland mill, 20% domestic raw materials * Cost per tonne of HRB
** Includes overhead cost, but excludes VAT tax rebate of $24/tonne
Locker Associates/5
Source: World Steel Dynamics, data as of February 2006
Will China Flood the World Market?
2006: China becomes a net exporter of steel
 Capacity currently exceeds demand
 Government seeks to curb production and balance supply
and demand
• Government goal: Raise market share of Top 10 to 50% by
2010, and 70% by 2020
• Eliminate smaller, inefficient mills
• But resistance from regional authorities
 New export taxes on semi-finished, long and hot-roll
• Cut or eliminated VAT rebates on many other steel products
 Factors arguing against large scale exporting
• Steady growth in internal demand
• Lacking cheap raw materials, China is unlikely to export
products made with expensive imported inputs
• Pollution concerns could limit future expansion
Locker Associates/6
U.S. Carbon Steel Market
Prices sag in 2007 so far, but recovery by yearend likely
 Demand will grow by late third/early fourth quarter, prices to rise
• Non-residential construction growth – still healthy
• Heavy equipment and infrastructure remain strong
• Automotive should improve later in the year
 Consolidation has reduced price volatility, but how much?
• Mills successfully adjusted production to tough market in 2006
• Despite high import levels and growing inventory, no price collapse
• However, in 2007 mills have been slower to pull back and prices fell to
$500 again despite lower import levels
• With HR costs of $475 - $500/ton, carbon mills break even
• BUT not a good sign for mills ability to maintain pricing discipline
 Imports down in 2007
• Higher prices and demand in Europe, elsewhere in world
• Chinese moves to reduce exports have an impact also
Locker Associates/7
Global Pricing Trends and U.S. Price Outlook
World prices stay robust, U.S. prices bounce back
 Credit crisis has roiled markets, but should not derail steel
Strong world economy has driven demand and prices
• Construction is booming worldwide -- Asia, Middle East, Russia
• Infrastructure, non-residential and residential
• Lifts demand for plate, beam, bar, SBQ and sheet
 Global supply-demand crunch
• World export prices, before freight, are higher than U.S. prices
 Healthy U.S. demand also supports high spot prices
 U.S. Prices rebound by early fourth quarter of 2007
• Hot-rolled band: $600/ton
• Cold-rolled: $725/ton
• SBQ: $850/ton
Locker Associates/8
Massive Price Fluctuations
Carbon prices stagnant in 2007 so far
US$/net ton
900
6000
CF SBQ
800
700
Galvanized
CR Sheet
600
4000
HR Sheet
500
3000
Stainless Steel #304
400
HR Sheet
2000
300
1000
12
/'9
3
12
/'9
4
12
/'9
5
12
/'9
6
12
/'9
7
12
/'9
8
12
/'9
9
12
/'0
0
12
/'0
1
12
/'0
2
12
/'0
3
12
/'0
4
12
/'0
5
6/
'06
9/
'06
12
/'0
6
3/
'07
4/
'07
5/
'07
6/
'07
7/
'07
200
Locker Associates/9
Source: Purchasing Magazine
Stainless #304
Carbon sheet/CF SBQ
5000
Raw Material Costs Have Soared
Retreated in 2005/2006, but holding steady in 2007
($/metric tonne)
2000 2001 2002 2003 2004 2005 Q106 Q206 Q107
Met coke (FOB China)….
$77
$71
#1 Heavy Melt (US)……
96
75
92
120
210
192
221
240
250
Auto bundles (US)…….
128
115
130
163
332
264
279
332
340
DRI (FOB, S. America)…..
100
78
101
142
253
235
202
282
310
Pig iron (FOB, S.A.)…….
113
107
119
170
290
244
227
308
325
Slab (FOB, Tier 1)……….
206
164
200
247
463
388
357
487
450
Locker Associates/10
$82 $153 $298 $195 $123 $150
NA
Source: World Steel Dynamics
U.S. Carbon Steel Market Data
Imports drop in 2007, shipments down also
2004
2005
2006
6 mos.
2007
Raw Steel Production…….…
109,879
102,830
108,640
53,438
Capacity Utilization….……
94.6%
85.8%
87.9%
85.7%
Mill Shipments………….…….
111,384
103,474
108,609
53,151
Exports…………………….…..
7,933
9,393
9,728
5,424
Total Imports………………….
35,808
32,108
45,272
17,822
Finished Imports………………
28,389
25,192
35,953
14,519
Apparent Steel Supply*……..
131,840
119,273
134,834
62,246
Imports as % of Supply*…….
21.5
21.1
26.7
23.3
Total Employment (000’s)….…
123
122
122
NA
Hourly Emp Cost/Hour……..
$44.16
$45.05
$43.54
NA
Average Spot Price**($/ton)
$612
$626
$658
$649
Average Scrap Price # ($/ton)
$323
$252
$281
$295
(thousand tons)
*Excludes semi-finished imports
Locker Associates/11
**Composite price of 8 carbon steel products
# Auto bundles
Source: AISI and Purchasing Magazine
U.S. Imports Fluctuated at High Levels ‘92 -‘06
Imports down in 2007 so far
(million tons)
Finished
Semi-Finished
9.3
40
6.8
8.6
30
7.9
6.6
7.4
8.6
6.4
7.5
6.9
8.8
4.8
20
35.9
34.7
2.4
27.2
22.1
10
29.4
23.6
21.6
29
28.4
25.2
23.8
18.3
14.7
0
%ASC*
1992
1994
1996
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007F #
15.9
19.5
18.4
26.4
21.2
22.3
20.3
20.4
15.8
21.4
22.0
26.7
na
*Imports in ASC calculation exclude semi-finished # 2007 forecast based on first six months actual imports annualized
Locker Associates/12
Source: AISI, LA
Most Analysts See Healthy 2007
With high production levels continuing through 2010
Locker Associates/13
U.S. Steel Shipment Forecasts
Firm/Forecaster (mil tons)
'07
108
AIIS/von Bulow .................
CIBC/Novak ......................
107
CRT Capital ......................
108
E&E Corp/Rhody ..............
108
TN Consulting/Mueller ......
107
Locker Associates ............
107
'08
108
110
109
109
108
110
'09
-109
111
110
108
106
'10
-109
110
110
-110
Consensus Forecast……
109
109
110
108
Source: LA, forecast as of 7-07
Industry Consolidation Moves Forward
Recent lower stock prices could spur more mergers
 Market concentration has increased, but room for more
• Top 5 U.S. players had 39% share in 1995, up to 65% by 2005
• Market far less concentrated internationally – Top 5 players have less than 20%
 Arcelor-Mittal merger creates new world scale, foreign mills seek partners
and entry into North America
 World carbon industry moving to 5-10 mega players, each with 50-100
million tons of capacity
 Remaining integrated orphans in North America like AK, WCI and
Stelco will find partners
• USW favors present players to buy orphans
• In our opinion, foreign newcomers are more likely, like Essar at Algoma
 Further consolidation to come for minimills, especially long producers
• Still less concentrated
• Looking for higher value, downstream capacity
• Nucor continues to purchase small-medium players -- Harris, Magnatrax, LMP
Locker Associates/14
Significant Minimill Consolidation in 2006-07
Both domestic and international players are buying
Major Deals
Date
Acquirer
Target
Capacity*
Price*
August 2007
Nucor
LMP Steel & Wire
0.1
$28
August 2007
Nucor
Magnatrax
na
$280
July 2007
SSAB
Ipsco
4.3
$7,700
June 2007
US Steel
Lone Star
1.0
$2,100
March 2007
Nucor
Harris
na
$1,020
January 2007
Evraz
Oregon
2.9
$2,300
Dec 2006
Ipsco
NS Group
1.0
$1,460
October 2006
Tenaris
Maverick Tube
2.0
$3,200
June 2006
Gerdau
Sheffield
0.6
$187
May 2006
Nucor
Connecticut
0.3
$43
April 2006
Steel Dyn
Roanoke
1.0
$240
Note: Does not include acquisitions by financial buyers *Capacity in million tons; price in $ millions
Locker Associates/15
Source: AMM and LA
Steel Far Less Consolidated Than Other Metals
Major customers and suppliers also have more leverage
Worldwide Industrial Concentration by Sector
19%
Carbon Steel
28%
Paper
39.1%
Copper
46.8%
Aluminum
54.2%
Auto
67%
Glass
70%
Coking Coal
81%
Iron Ore
0%
20%
40%
60%
80%
100%
% of production by top five producers
Locker Associates/16
Source: Forward Magazine Jan-Feb/2007
Major Changes in Capacity
New mills coming onstream, older capacity shut
 Existing U.S. mills are rounding out capacity
• Nucor re-opening Birmingham steel Memphis mill – 850k tons of SBQ
 Some international players will build instead of buy
• ThyssenKrupp – new carbon/stainless plant with 4.5 million tonnes of
capacity, including up to 1.0 million tonnes of stainless
• SeverCorr – 1.5 million tons of finished steel starting later this year
• MMK announces 1.5 million ton per year cold rolled mill in Ohio
 SeverCorr and re-start of Birmingham Memphis mill put more
pressure on high quality scrap supply
 Older BF hot ends are threatened
• Esmark purchase of W-P will result in eventual shutdown of W-P BF
• Weirton hot end unlikely to come back up
• WCI hot end has uncertain future
• Other integrated BFs could be threatened by consolidation, but little
impact on minimills
Locker Associates/17
Continued Rise of EAF/Minimills
Demand for EAF products strong, input prices are key
 Scrap price will determine profitability; scrap will be high
• Auto bundles at $280/ton and on the rise
• Q4 demand rebound will support higher prices
• At $300/ton for scrap, EAF costs are higher than integrated
• Long term trend: higher prices across the cycle due to tight
supplies
• When scrap prices are up, DRI and pig iron rise as well
 Mini mills investing in older facilities
• Some Nucor mills hitting 25-year mark
• Nucor upgrading EAF, casters and hot strip mills
• Continued commitment to EAF technology
Locker Associates/18
Mills Require Higher Quality Inputs
Suppliers will need to respond
 Steel production increasingly shifts to a continuous flow process
• More capital intensive
• Highly automated, less labor
• Quality of scrap will be vital to efficient production flow – must have
precise and consistent scrap composition
 EAF sheet width and quality continue to improve
• SeverCorr mill will be first to produce 74” exposed auto sheet
• Quality nearly equals integrated output
 But high quality product requires expensive iron units
• Causing companies to backward integrate
• DRI, Pig iron and scrap segmentation
 Need for higher scrap quality will require premium service
Locker Associates/19
Buoyant Long Term Demand for Scrap
Strong world appetite for metallics in next ten years
 Growth in steel production drives need for more inputs
• Healthy growth in global economy and steel demand is forecast
• Metallics needs will soar
• Expansion in iron ore supply, but need for scrap substitutes will put
pressure on supply
 Insufficient reasonably-priced scrap to meet demand
• Scrap is elastic to a point, but obsolete scrap reservoir is limited
• Scrap demand by 2017 will meet or exceed obsolete supply
• Will take time to develop scrap substitutes and build more pig iron
capacity
 Scrap prices will stay relatively high, with intense price spikes
Locker Associates/20
Global Metallics Balances to 2017
Both scenarios result in scrap crunch
Global Metallics Balances
to 2017
2007e
High BF
Growth
2017e
CAGR
07-17
Moderate
BF Growth
2017e
CAGR
07-17
Apparent Steel Consumption
1,207.0
1,800.0
4.08%
1,800.0
3.77%
Crude Steel Production
1,342.0
1,973.0
3.93%
1,973.0
3.93%
BOF Production
942.0
1,379.0
3.88%
1,379.0
3.88%
EAF Production
400.0
592.0
4.00%
592.0
4.00%
71.0
90.0
2.54%
90.0
2.54%
1,718.4
2,453.0
3.60%
2,453.0
3.60%
953.0
1,390.0
3.55%
1,300.0
3.15%
67.4
180.0
10.32%
155.0
8.68%
698.0
883.0
2.38%
998.0
3.64%
Home scrap
175.0
243.0
3.34%
243.0
3.34%
New Scrap
173.0
250.0
3.75%
250.0
3.75%
Obsolete Scrap
350.0
390.0
1.09%
505.0
3.19%
Obsolete Scrap Reservoir
340.9
410.0
1.86%
410.0
1.86%
Obs. Scrap as % of Reservoir
103%
95%
(million tonnes)
Foundry Production
Metallics Requirement
Ore-based metallics
Scrap/hot metal substitutes
Scrap requirement
Locker Associates/21
123%
Source: World Steel Dynamics, June 2007
U.S. Tax System Undermines Manufacturing
Competitors with VAT have advantage over US players
 Tax imports and provide rebate on exports
• Compensates exporters for the tax they pay to foreign countries
• Raises cost of imported goods, making them less competitive
 Canada, Mexico, Japan, Korea, China, India, Australia and
most of Europe have VAT system; average tax is 18%
 Impact: US exporters pay extra 18% on products sold abroad
• While importers get 18% discount on U.S. sales
 Solution: Restructure U.S. tax system
• Shift from income to consumption tax (VAT)
• Must be revenue neutral to government authorities
• Some manufacturers are now pushing for change
Locker Associates/22
Asian Currency Manipulation Also a Threat
Japan and China Keep Currencies Artificially Low
 China’s currency undervalued by 40%
• Mainland manufacturing costs have a 40% subsidy
• Yen is also artificially weak with similar benefits for Japan
 Japan & China buy Treasury bonds to keep dollar from
declining against their currencies
• WTO prohibits government subsidies for manufacturing
• But US government does not view currency manipulation
as a subsidy
• Federal government has pushed China to let market
determine value of yuan -- with very limited success
 US companies and labor should pressure our
government to push harder
Locker Associates/23
But US Plants Can Compete Against China
Tenneco Shanghai vs. UAW Tenneco shop in Michigan
Tenneco Automotive - China vs. U.S. Plants, 2005
Shanghai
Employees (hourly/salaried)……..
Yearly Wages (hourly)……….…..
Wages, as % of Total Cost…….
Production (# of units)…………....
Revenue ($ millions)……………..
Capacity, 2005 / 2006…………..
Employee Turnover (hrly/slrd)…..
Absenteeism……………………..
Average Age……………………..
Output/Employee (# of units)……
Revenues/Empl ($000).…………
Unit Labor Cost………………….
Locker Associates/24
225/50
$2.5-$3K
1%
400,000
$53
85%/100%
5%/13%
1%
29
1,456
$194K
$1.55
Litchfield
296/28
$22.5-$48.8K
12%
1,400,000
$171
65%/85%
Less than 1%
10%
40
4,321
$528K
$7.54
Source: Fortune Magazine, LA
New Reality: Tougher Emissions Laws
First movers have the advantage
 Steel is a major source of carbon and other pollutants
• Conventional iron-making releases one CO2 tonne per steel tonne
• Global steel industry responsible for 6% of man-made CO2
 Some progress is being made
• Steel energy use decreased 28% over 20 years, emissions down
• New technologies, more co-gen plants
Next administration will have stricter environmental regs
• Carbon and other climate change emissions reduced
• Possible carbon tax; widespread carbon trading in U.S.
 Steel industry will face new benchmarks, profitability hurdles
• Europe and Japan already dealing with this -- ThyssenKrupp
• Those who change now will have a head start
• Will require creative thinking and innovation
Locker Associates/25
Major Steel Trends: What’s Next?
Highlights I
 China still drives the world market; India on the ascent
 Steady U.S. demand in 2007, possible slowdown in 2008
 Spike in U.S. steel prices in late 3rd, early 4th quarters
 New capacity in the U.S.; some older hot ends threatened
 Challenges facing U.S. mills: troubled customer base,
globalization, and higher raw material costs
•
•
•
•
Hollowing out of North American manufacturing
Bankruptcy & reorganization of customers -- especially auto
U.S. healthcare system is major competitive disadvantage
Other U.S. disadvantages: no VAT system and artificially low
Chinese and Japanese currencies
Locker Associates/26
Major Steel Trends: What’s Next?
Highlights II
 N.A. mergers and acquisitions peak, foreign players jockey
for position in North America and Europe
• Very high asset values are coming down
• Could fuel another round of consolidation
 Steel pricing discipline not as strong as expected
• Companies slow to cut production in ‘07
 Minimills continue to take market share and move up the
value chain -- at the expense of integrated mills
• EAF producers have reached 60% of total U.S. steel output
• Higher value production will require additional pure iron units
• Demand for EAF products strong, input prices are key
Locker Associates/27
Major Steel Trends: What’s Next?
Highlights III
 Improved technology continues to foster higher quality,
lower cost substitutes
• Hot vs. cold-rolled, hot dip vs. electro-galvanized, etc.
• Increasingly replace higher priced items
 Further moves toward automated, continuous steel
production flow will require more predictable inputs
 Major threats from imports of steel-containing goods
• China and others have real currency and tax advantages
 Challenged by stricter environmental regs
• Europe has moved in this direction already
• Regulations will tighten under next administration
• Early movers will have the advantage
Locker Associates/28