A sharp drop in oil pricing has a ripple effect but how far it spreads depends on timing and fortitude

February 2015 - Three major pipe producers are idling capacity, signaling the impact the recent dramatic decline in crude oil pricing has on steel. But government and market experts say the price of crude reflects a supply glut and does not necessarily signal weak economic prospects in North America, where manufacturing remained robust through the end of 2014.

Production in the U.S. manufacturing sector rose modestly in December versus November and was up 4.9 percent from December 2013, the Federal Reserve reported in mid-January. Manufacturing capacity utilization was flat month over month but rose 2.1 percent year on year.

One side effect of relatively low crude oil pricing, however, may be increased U.S. steel imports. As production and transportation costs fall globally, exporting nations fail to curb output and ship their surplus steel to regions with the most attractive demand and pricing.

Crude oil forecast

The U.S. Energy Information Administration (EIA) stated Jan. 13 that December’s Brent price fell to the lowest level since May 2009, which “reflects continued growth in U.S. tight-oil production, strong global supply and weakening outlooks for the global economy and for oil demand growth.”

EIA forecast Brent crude oil prices will average $58 a barrel during 2015 and $75 a barrel in 2016. The agency couched its predictions with this: “The current values of futures and options contracts suggest very high uncertainty in the price outlook.”

Total U.S. crude oil production averaged 9.2 million barrels per day in December and EIA forecast production would average 9.3 million bbl/d in 2015 and 9.5 million bbl/d in 2016, not far from 1970 peak oil production.

Analyzing oil pricing, World Bank Group’s analysts said Jan. 13 that the decline reflects several years of “upward surprises in oil supply and downward surprises in demand, receding geopolitical risks in some areas of the world, a significant change in policy objectives of the Organization of the Petroleum Exporting Countries (OPEC), and appreciation of the U.S. dollar.

“Soft oil prices are expected to persist in 2015 and could undermine investment in new exploration or development,” the analysts predicted.

Idling pipe mills

Three major domestic producers of oil country tubular goods and line pipe announced they would somehow adjust capacity. Others were expected to follow suit but had not notified employees or the public as of the tail end of January.

Citing a decline in tubular market conditions, which is impacting demand for its products, U.S. Steel Corp. announced it would slow or idle production at several plants. On Jan. 5, it said layoffs would commence March 8 at Lorain Tubular Operations, affecting 636 people, and in Houston, affecting 142 employees. On Jan. 26, the Pittsburgh-based integrated producer said it will temporarily reduce operating levels at Lone Star Tubular Operations in Lone Star, Texas, and Fairfield Tubular Operations in Fairfield, Alabama. Fairfield Works, the primary flat-roll supplier to Fairfield Tubular Operations, will also adjust operations. Although it is not a full idling of steel production, more than 1,900 workers across all three plants were notified of layoffs. 

Tenaris announced Jan. 9 it would reduce production at mills in Blytheville, Arkansas, and Conroe, Texas, and at a couplings facility, laying off about 500 workers.

“The energy industry’s present circumstances have driven Tenaris to make these reductions. Despite the positive OCTG trade case ruling, the U.S. continues to see record levels of imports of OCTG from South Korea,” the company stated. “This has been aggravated further as oil prices have fallen.”

Evraz temporarily idled its seamless pipe facility in  Pueblo, Colorado, on Jan. 31, and laid off 200 workers.

Oilfield decisions

“We are reading almost daily about budgets among the exploration and production (E&P) companies. Word on the street is there will be more cuts to drilling activity,” Paul Vivian, an economist and co-owner of the Ballwin, Missouri-based Preston Pipe Report, says. 

“People servicing in the field expect rig counts to fall. I think what generated layoff warnings is [pipe] orders are getting canceled or delayed or cut by some percentage.”

The reduction in active rigs won’t occur all at once, however, according to Vivian, because planning requires a 90- to 120-day window. Pipe mills and distributors working closely with E&P companies “know what rig activity will be three to four months out,” and if supplying a rig that will dig a new well Jan. 1, they will have needed to order sheet at least as far back as Nov. 1.

After assessing the cost-benefit ratio of operating each well, drillers may idle only one or two rigs at a time. “That’s why drill rig count doesn’t fall 500 in one week,” Vivian says.

Consensus forecast for drill rig counts in 2015 “is being reduced based on the expectation that oil prices will remain below $60 a barrel for quite some time,” he continues. “Some E&Ps are forecasting [active rig] reductions for the next three to four months. Mills look at that from a cumulative standpoint and say, ‘Oh my gosh, we’re producing too much pipe and need to cut back shifts.’” 

When various pipe manufacturers announced efforts, beginning in 2011 and 2012, to add or build 4 million tons of oil country tubular goods capacity in a market that at most consumes 10 million tons of the stuff, a red flag should have been raised, comments Chuck Bradford, president of Bradford Research Inc., New York.

“Even if oil [prices] stayed high, the price of pipe was going to collapse” when all that capacity came on line, he says. “It doesn’t matter what oil prices do—there was going to be surplus pipe and so this was a catastrophe waiting to happen.”

Imports’ role

The United States “is a huge import market” for energy tubulars, Bradford says. “Some of those companies building capacity (like Tenaris, cited earlier) thought trade cases would prevent imports, but they have not.”

OCTG imports grew 18.5 percent last year to 3.6 million metric tons. Korean OCTG imports surged 56.9 percent and kept arriving even after tariffs were applied in the wake of an August determination by the U.S. International Trade Commission that Korean imports injured domestic producers.

“Falling oil prices make the world a smaller place,” Credit Suisse metals analysts said in a recent report, and warned that with oil below $60 a barrel, “regions of steel overcapacity such as China are a lot closer to the U.S. than they used to be.”

Keybanc Capital Markets analyzed January’s preliminary import license data and said that, when extrapolated for a full month, imports may reach a record monthly high of 3.9 million metric tons and, “ironically, the highest growth rates occur in energy focused products—OCTG and line pipe—supportive of domestic capacity rationalization activity via U.S. Steel and Tenaris.”

The Preston Pipe Report’s Vivian argues that pipe imports are actually more likely to fall in tandem with lower demand. When crude oil supply and demand eventually balance out again, additional domestic production by transplanted pipe producers should mean those companies won’t bring in as much material from their home countries.

“Benteler won’t be importing as much pipe from Austria because they will be producing here. One expects their imports to fall 50, 60 percent and even more. When the Russians are making pipe here, it means Russian imports should fall,” Vivian says.

Feedstock

A decline in steel pipe sales and shipments will likely result in shrinking demand for the sheet steel and semi-finished bars that make up welded and seamless pipe. “I am hearing that prices for hot-rolled coil that goes to ERW (electric resistance weld pipe) are coming down,” says Bradford.

In a Jan. 15 note to investors, Cowen & Co. Senior Analyst Tony Rizutto wrote, “Steel sentiment has deteriorated further in the past month with U.S. HRC prices hitting $575 a short ton. The precipitous fall in oil prices, lower raw material costs, a strengthening U.S. dollar and import pressures continue to weigh on prices.”

But, the economy?

Oil wasn’t the only victim in the commodity sphere. “Copper was crushed, aluminum was crushed, grains were crushed,” says Bradford. “We see almost all commodities coming down as the dollar strengthens. Lower commodity prices—especially oil and copper—usually is a harbinger of lower economic activity,” but that may not be the case in 2015.

There may be a decoupling between battered oil pricing and U.S. economic health. The Fed’s economic conditions survey results released Jan. 14 indicated continued steady growth prospects for manufacturing activity and for manufacturers’ capital spending plans.

Exchange rates also play a role. “Because the ruble is down, the cost of Russian steel production is down. The aussie (Australian dollar) crashed, the loonie (Canadian dollar) crashed. Brazil’s real collapsed.” However, oil is produced in local currencies and then sold globally in dollars so “the situation is not as bad as some believe.” 

Further, business news outlets have published numerous articles “about Chinese oil usage falling but it’s not true,” says Bradford, who visited China last year. “Their crude imports were up 9 percent in 2014 versus 2013,” but it wasn’t noticed because the Chinese government continually revises previously published economic data upward: imports and exports, oil and steel production, etc.

Cooler heads don’t believe we should anticipate another global recession or anything close to it based on the events of the past few months. “We can look at the pattern in the normal course of events, and you hear Tenaris say it has faith in the long-term prosperity of the North American energy market,” says Vivian.

“Every market has cycles. Often, those cycles are dramatic in terms of depth and severity of the downturn as well as the expansion mode. This was the case after the recession and we hope this downturn is much less severe.” MM

Photos: Anadarko Petroleum