Predicting the price of steel

Steel and oil. What do the two have in common? When it comes to cost, the connection between them is too tight for coincidence, but despite this, price predictions remain anybody’s guess.

He who could predict the price of steel, would no doubt be a very rich man. And the reason why the steel industry is not full of very rich men – at least, not all of them – is because few can predict the price of steel.

The factors that affect steel prices in the Middle East weave a complex, interconnected and intricate web. Sliding variables within one factor can affect change in another. One variable may be offset, or magnified, by another, leading to one big headache when trying to predict the price of steel for financial planning or futures-trading purposes.

The various factors that affect price can be split into four main umbrella terms. The first, the cost of raw materials, is the obvious favourite in the battle for influence, but is by no means the clear winner.

Global, regional and local demand is a second strong contender. As in any industry, the twin-issues of supply and demand must carry out a battle known as the “burden of adjustment,” in a never ending bid to discover an often elusive harmonious balance.

Freight is a third factor. With the dominant suppliers of raw materials being spread across the globe, hawking their wares across international boundaries, much depends upon the geographical location of proprietor and consumer.

Fourth is the single most important and influential factor in the global economy – the price of oil. In fact, a quick glance at corresponding graphs of oil and steel prices over the past seven years is all it takes to reveal that one does indeed drive the other, the similarity between the peaks and troughs being far too striking for coincidence. A closer look at each of these factors reveals the depth of the headache posed when trying to predict the price of steel.

Raw Materials
The two dominant raw materials used in steel production for the construction industry are scrap and iron ore. Put simply, cheaper raw materials equals cheaper steel. For some years, the Middle East industry could depend upon a wealth of scrap, both heavy industrial grade and light, from the industrial wastelands of the Eastern Bloc.

The fall of communism and subsequent end of the Cold War in 1989 led to a period of economic uncertainty in the former Eastern Bloc as nations dragged themselves back to their feet, while the machines of communist heavy industry lay dormant. This led to an influx of cheap scrap metal.

“Scrap used to come in big quantities from Eastern Europe, Russia, Ukraine and all those places where you had a lot of industrial remnants producing a lot of scrap for the rest of the world,” explains Madar Steel CEO Samar Hassan.

However, as the wheels of economic recovery began to turn, fueled by abundant supplies of natural gas, construction began to boom within the former Eastern Block countries, and a need arose for those nations to feed their own appetite.

“Today the countries of Eastern Europe have a lot of production of steel in their own countries so they are using a lot of scrap,” Hassan says.

So, though the Middle East has seen a healthy flow of scrap for some years, that flow would appear to have come to an end.
 

And though the global slowdown has restricted the rate of construction in Eastern Europe, it has done exactly the same in the Middle East, meaning the slowdown in effect becomes obsolete. 

The seasonal factor also plays its part in terms of scrap. Price rises during the winter months from the Eastern European region are not uncommon as trade routes fall victim to adverse conditions.

In terms of iron ore, prices are determined globally through major contracts and regional contracts between key iron ore miners and major global steel producers. In this respect, the global recession does impact.

“Prices will see a fall of perhaps 25% to 30% this year, flat next year and up possibly in 2011,” Raw Materials Group president Magnus Ericsson told a mining conference last month. So though scrap may be thin on the ground, price relief will come through affordable raw materials.

Global, regional and local demand
Turkey is the key supplier of steel to the Middle East. It also exports to the US and Western Europe. Construction markets in the US and Western Europe are weak, which spells good news for the Middle East.

However, with various public construction packages at the centre of global economic stimulus plans, most notably in the US, we should see a gradual increase in demand over the coming months.

To add to this, demand in India, China and elsewhere in the Middle East, though not what it was six months ago, is an ongoing factor that should keep inflating prices in the mean time.

A further factor that works towards the stabilisation of prices is the number of exporting nations. “At a certain point in time Turkish exporters may find a better price away from the Middle East so they may divert a little of their steel from the region here,” Hassan says. “But in that case the Chinese come in and the Ukrainians are available so it is not really affecting the local industry.”

Freight
The distance between the trade locations, not to mention political tensions between countries along trade routes, and climactic seasonal conditions, all play their part. Storm clouds in either case can spell trouble for the steel trade.

The geographical location of Turkey defines it as the key supplier to the Middle East. The Suez Canal trade route has taken a buffering with fears of piracy off the coat of Somalia affecting commodity prices, although Nato pledged earlier this year to increase its efforts to fight the plague, with six warships due to arrive in the at-risk area in the coming months, according to reports.

Seasonally, trade routes from key suppliers such as Turkey are less affected, with climactic conditions notably more settled in the Mediterranean and Middle East regions than in Northern and Eastern Europe.

As Hassan explains, the open market of the UAE complements a trustworthy and relatively short freight time.
“Because it’s a 100% open market you can fix any shortage within the freight period between Turkey and the UAE, which is about three weeks,” he says. “If you place an order today, in just two and a half to three weeks, you will have your steel.”

It goes without saying that freight is itself affected by energy costs. If oil is trading at $140 a barrel, it’s going to cost substantially more to send a ship from the Eastern Mediterranean to the Gulf. Therefore, to make any prediction at the future cost of freight, it is necessary to first look at energy.

Energy
The effect of the price of oil on steel prices is dramatic. It is the single most important driver. When oil peaked at a blistering high of $147 a barrel last July, steel was trading at a sweat-inducing high of its own, peaking at $1550 per tonne of rebar in the Middle East market. And as the oil price began its sudden nose-dive the following month, steel took to its own slippery slope, falling 73% in just four months.

So as the cost of a barrel of crude can spike and plummet with a single oil “event,” such as a rise in political tensions between the West and Opec, so the price of steel can be equally exposed to the vagaries of global geopolitics due to the conspicuous link between the two.

Big picture
All of this leaves the industry at the mercy of a highly unpredictable market. The price of steel can be indirectly influenced by a number of events; an Iranian missile test; a harsh winter in the Carpathian Mountains; a peak in pirate activity off the coast of Somalia; the passing of a bill through the US senate; or the tearing down of a dormant factory in Azerbaijan.

However, an attempt can be made to view the big picture. According to author Paul Roberts in his book The End of Oil,
“Research showed that after each of the six major oil price spikes since the Second World War, global economic activity
began to fall within six months.”

We witnessed the biggest oil price spike in history a little over six months ago, and sure enough, the global economy now finds itself deep in recession. This has been mirrored by a drop in demand for steel. This situation will likely remain for some time until the effects of the global stimulus packages begin to ripple through, and demand shows signs of recovery.

The experts are predicting that 2010 is likely to remain flat, with a recovery in steel prices from 2011, which spells good news for contractors operating on a tight budget.
 

Suppliers, on the other hand, will be hoping for a swifter recovery. Something which could be triggered anytime, any place, anywhere.