Why Sheet Buyers Should Ignore Published Capacity Utilization Rates

We received the following email from a manufacturing company asking us to explain how capacity is calculated and to provide a better understanding of the sheet or flat rolled portion of the market, which definitely is not running at 70 percent with extended lead times and skyrocketing prices.

If what was recently indicated by Morgan Stanley Equity Research Analyst Evan Kurtz about capacity being taken off stream is to be believed, then between 7.1mm and 10mm/tons of melt capacity has been idled and another 6.5mm/tons are at risk of being idled…

That said, a reasonable person might consider that the idled capacity would actually be reflected in the utilization numbers, but it is not….at least not exactly. A call to the AISI offices in Washington confirmed that the AISI is only considering removing capacity that has been permanently idled, but is still counting capacity as being available if it is on hot/cold or market idle…..interesting….

The significance of this is that the current utilization % rate is being shown as roughly 71% – 72% by the AISI.

Doing the math on the weekly melt and capacity suggests a total current capacity of just under 122mm tons.

This is down by about 2.6mm tons since mid-year 2015, which incidentally was about roughly the amount of melt taken off stream when US Fairfield was permanently idled.

If you take the 2.6mm tons into consideration against the total amount referenced as being idled, there is still a gap of between 4.5mm and 7.4mm tons of melt unaccounted for, meaning real capacity is currently between 114mm tons and 117mm tons. The real net effect of this is that actual utilization rates are more like 74% – 75% than the 71% – 72% being reported. That spread may not seem like much, but all of this leads to market perception and sentiment relating to mill strength and health.

We know that the wheels come off the bus when utilization rates get to be around 85%……..and if you’ve been around long enough, then you’ve seen that movie before and there is also no spoiler alert to a surprise ending.

If Utilization is really around 75% now and at a time when the industry is desperately trying to remove all but self-serving (semi-finished) imports from the marketplace, then how long will it take for utilization rates to go up 10 points? 10 percentage points is approx. 11.5mm tons…….we’re importing at a pace of approximately 30mm tons on a YTD basis….and again, the industry is desperately trying to remove any ton that doesn’t serve the mills best interest.

It seems to me that the US manufacturing sector is in for a very rough ride as the domestic steel makers force their protectionist will through Washington.

If you’ve reviewed this take before, then perhaps it’s time to bring out this information again.

This end user is not alone in the criticism of the AISI numbers and the fact that the utilization rate is confusing rather than helping buyers. We got this from one of the domestic steel mills:

Taking raw steel production, half of which is estimated every week (and therefore in my mind not reliable), and somehow inferring what the utilization rates are in a market that rerolls a lot of slabs that are not melted here in this country is problematic.  Raw steel calculations are for the entire industry, both flat and longs, so that another issue with the number published every week.

Lastly, you have the issue of measuring capacity that is running versus total capacity available to run. If mills here are not running because they are idled at present, how should that capacity be counted?    In my opinion, that should be considered in the overall capacity utilization analysis given that the facilities that are not running could end up running again in the very near future.  So, the numbers we see each week should be by no means construed as actual.

From SMU perspective, flat rolled steel (sheet) buyers (and the financial community) should be wary of the weekly AISI raw steel production and capacity utilization reports. The data is somewhat suspect due to the limited percentage of participation by the domestic steel industry, they do not segregate out long and flat products and they do not eliminate mills where the blast furnaces have been idled for a period of time (such as Granite City and Ashland right now). The AISI does not take into consideration semi-finished slabs/billets purchased by the mills which can be significant on any given month. The true capacity utilization rates on flat rolled sheet are well above the 70-72 percent rate and are more likely closer to 90 percent than 70 percent.