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Monday | 18 August, 2008 | 5:02 am

Strength in the softness

By John Loos

August 2008 - If you read the daily headlines splattered across newspapers, cable news channels and financial blogs these days, it seems the U.S. economy has been engulfed by an enormous tempest of uncertainty. The economy's doom seems imminent with copious use of the dreaded R-word, recession, striking fear into the hearts of any who will listen.

While it's obvious the economic waters of the United States are choppy these days, the course the economy is sailing isn't set in stone.

The sheet market experienced frustration and stagnation across many regions in 2007 thanks to muted demand and less constrained supply. And, 2008 has already proven memorable by being ushered in with substantial price hikes and general economic craziness. Currently, the mood ranges from cautious to confused thanks to a housing market in nosedive, continued weakness in demand, lofty price levels and a general fear of what’s to come.

It’s certainly an odd time to be in the business, but not necessarily a bad time.

High-flying prices,br> For some, such as Timna Tanners, analyst for UBS, New York, things need not be so gloomy. The fundamentals of the steel market seem strong, with inventories near 10-year lows and imports at two-year lows.

"We expect 2008 is another good year for North American steels and that strong profits are likely," Tanners wrote in a Jan. 22 report published by UBS. "We see overseas margin pressure from raw materials costs and bloated Asian inventories, with high inventories starting to come back in line in Europe. In the United States, end-market demand is weak and recession is a risk, but restocking should support domestic sales and imports should remain low through the first half of 2008, with North American prices helped by a severe discount to global."

According to Purchasing.com, the average price of hot-rolled coil in 2007 was $527 per ton, with early forecasts for 2008 in the $550 per ton-to-$580 per ton range. These projections quickly changed at the beginning of the year, when tightened supply and increased raw material costs took full effect. Scrap prices, for example, have had near-record jumps, including a $100-per-ton increase in January. In turn, sheet prices surged, with an incremental $50-per-ton increase announced for February/March.

Tanners and UBS predict that prices will have crested in the second quarter, with hot-rolled sheet hitting roughly $675 per ton and cold-rolled sheet spiking around $770 per ton. They predict both to cool only moderately by year's end, dipping to $640 per ton for hot-rolled and $735 per ton for cold-rolled.

"While we had forecast steel prices rising in 2008 amid tight domestic supply and elevated overseas prices, the 30 percent sheet price hike over the past four months has exceeded our outlook," Tanners said. "We believe price hikes will stick amid tight supply and see little threat to pricing through year end." One potential foil to high prices is a scenario in which the already-soft demand bottoms out. However, after weak demand in 2007, the industry seems prepared for similar conditions.

"Service centers have figured that demand is not going to get a whole lot better so I think the weakened demand isn't a terrible surprise," says Peter Dennen, senior vice president of Dennen Steel Corp., Grand Rapids, Mich., a nontraditional service center that does contract manufacturing with stamping for OEMs. "I don't think it's going to have as big of an impact on 2008 as it did in 2007 because I don’t think people expect it to be as tough as it was. I think service centers have gotten their inventory in line based on lower demand."

Once more, same as before?
In any precarious economic situation, the first reaction is to look for precedents for evidence of what will happen next. When addressing the compelling volatility that ushered in 2008, some have looked back to 2004, another wild year characterized by the sudden surging of prices.

"I don't see this as a whole lot different than 2004 pertaining to pricing," says Rich Merlo, president and CEO of JDM Steel Service Inc., Chicago Heights, Ill., a service center specializing in hot-rolled cut-to-length. "I don't like to compare those two years because we're not there yet, but I remember in early 2004 there was a lot of negativity about how the prices wouldn't stick, or you couldn't drive the price up at the end-user level. I think we're seeing the same kinds of things this year."

However, there are key differences. 2004's wild ride was largely attributable to China's explosion, and today the giant’s momentum appears to be cooling. There also wasn’t such fervent talk of a recession four years ago. In 2008, with the industry coming off a middling-to-weak 2007 and having been dueling with a peculiar economy for months, companies seem less flabbergasted by the skyrocketing prices.

"The economy today is a different economy than it was [in 2004]," says Dennen. "I think people are being much more cautious in 2008, trying to manage their inventories so that if there's a huge change, they don’t get surprised like they did in 2004, which I think is good because the big swings we have in the market aren’t good for the mills, for us or for our customers."

Housing worries
Foreclosures are increasing. Home values are plummeting. The housing market crisis has tested the patience of most everyone in the steel industry. According to CNNMoney.com, home sales are near a 13-year low and, as of January, the median home price was $216,000, down 15.1 percent from one year earlier.

"Everything that we read leads us to conclude that the current housing scenario is the villain out there," says Lonnie Terry, president and CEO of the North American Steel Alliance. "The glut of houses in inventory has such far-reaching consequences, and with no viable solution on the horizon, everyone is concerned."

Merlo agrees the housing market is a burr in the side of the steel industry, but questions the extent of damage it can actually do.

"I don't think there's any question that [the housing market] has an impact," he says. "Anything related to construction as far as home building goes is going to be hit. I think appliances obviously won't be as robust. But I don’t know if the housing market alone is enough to take the steel business to its knees. I don’t think it is."

Ultimately, it appears as if 2008, while not exactly shaping up to be a banner year for the sheet market, will prove manageable, if not opportunity-laden, for companies prepared for softer demand and not easily flummoxed by higher prices. Whatever the economy does, the overall health of the global steel market, low imports and more closely managed inventories suggest North American companies should endure 2008 relatively unscarred. According to Tanners, "U.S. prices are still $60 per ton to $80 per ton below offered foreign tons, suggesting freight cost drops are still insufficient to attract import."

"Demand, obviously, isn't going to be growing, so I think people are going to probably try to manage their business as tightly as possible," says Dennen. "I think it's a time to be careful, and I think that’s what most service centers are doing. They’re trying to be cautious and take care of their customers and not overexpose themselves if something changes."

"Like 2004, the supply guys are in control," says Merlo. "I think we just need to realize it's a cyclical market. It’s going to go up, and it may stay up for awhile. Wall Street guys are saying that this could last through the first half of 2009. I don’t want to make any predictions. We just take it one day at a time."

The wild introduction to 2008, both in terms of steel prices and the economy in general, is not reason enough to reach for the life preservers. The seas may be bumpy, some may get a bit seasick, but the North American steel industry, and the sheet market in particular, should sail on to calmer and hopefully more prosperous waters. MM

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