SMU Deep Dive: How High Can HRC Go?

First a Look Back at Where We’ve Been

Steel Market Update’s average hot-rolled coil price was $1,340 per ton ($67/cwt) when this article was filed, up 36% from $985 per ton at the beginning of the year and more than triple a 2020 low, seen last August, of $440 per ton.

That’s the highest hot-rolled price SMU has ever recorded. And that includes the summer of 2008, before the global financial crisis, when HR prices hit $1,070 per ton. Adjusted for inflation, that’s approximately $1,280 per ton. It’s also substantially higher than a more recent post-Section 232 peak of $915 per ton recorded in summer 2018.

So, what’s unique about this bull run in steel prices?

For starters, almost no one saw it coming. Many flat-rolled steel contracts were negotiated last fall in terms of a percentage decrease to CRU. Say CRU minus 6-8%. That was seen as a more sensible mechanism to protect against downside risk than a fixed dollar discount, say CRU minus $25-50 per ton.

Whoever was negotiating those contracts last fall might have some explaining to do now. Because CRU minus 7% at current prices is equivalent to CRU minus nearly $95 per ton. Upside risk might have been underestimated.

Some sources, even mill sources, predicted last fall that prices would not hold above $700 per ton for long. And prices don’t typically stay that high for an extended time before cycling back down to approximately $600 per ton–or around breakeven for some mills.

But a pandemic market is no ordinary market. Prices rose as demand patterns shifted and as consumers who could not spend on travel and experiences instead spent money on steel-intensive goods such as vehicles and appliances. 

What Overcapacity?

Prices have continued to rise despite persistent warnings about the potential for a supply glut stemming from new domestic flat-rolled steel capacity now in the works.

Case in point: Hot-rolled coil prices rose even as Big River Steel added and ramped up a second electric-arc furnace (EAF) and caster at its mill in Osceola, Ark., earlier this year. And prices continue to rise ahead of Steel Dynamics Inc. (SDI) starting up a new mill in Sinton, Texas, this summer.

SDI’s new mill will bring three million tons of new capacity to the market. But one could make the case that those tons are needed to offset the idling of older integrated mills, such as U.S. Steel’s Great Lakes Works near Detroit and a blast furnace at the company’s Granite City Works in southern Illinois.

The idled “B” and “D” blast furnaces at Great Lakes Works have annual capacity of 1.22 million tons and 1.27 million tons, respectively. And the idled “A” furnace at Granite City has capacity of 1.2 million tons per year, according to the Association for Iron and Steel Technology’s (AIST) directory of iron and steel plants. In other words, the new capacity from SDI won’t even fill the gap left by capacity idled by U.S. Steel alone. 

Is it Sustainable?

2008 provides a cautionary tale. Prices fell from $1,070 per ton in July 2008 to $530 per ton by the end of the year, according to SMU pricing archives. In other words, they fell by more than 50% in less than six months.

And the litany of worries about the current market remains lengthy. Do current high steel prices risk destroying demand because end users will not be able to pass them along to their customers? Will service centers be able to rebuild inventory and continue to participate in the market as some bump up against credit limits? And what if there is another surge in COVID-19 infections and deaths?

Then there is the microchip shortage, which has hobbled automotive production across North America since late last year.

These are real concerns. But they have been with us since at least the beginning of the year, and so far they’ve done little to stop upward pricing momentum.

And the chip shortage, while it has the potential to hurt steel demand, also has the potential to squeeze prime scrap supplies.

Keep in mind that prime scrap, unlike obsolete grades, is not elastic to price. High prices bring more obsolete grades–think demolished buildings and old cars–into the market. Prime scrap is the byproduct of industrial processes such as stamping. Auto companies do not stamp parts they don’t need just because prime scrap prices are high. So they will be producing fewer vehicles and generating less prime scrap if the chip shortage continues.

The problem: Mills will need more prime scrap as new flat-rolled capacity, all of it EAF-based in the U.S., is added. And that dynamic has the potential to set a new, higher floor under domestic steel prices.

That example underscores the importance of not overlooking potential supports to high prices. Because too often the focus is on reasons why prices might fall, an outlook that arguably let the steel industry be blind-sided and unprepared for a recovery.

What Should We Look for the Balance of This Year?

For starters, the Biden administration has proposed a multitrillion dollar infrastructure package. The exact contours of the bill and when it might be passed remain a matter of debate. But the discussion is less about whether an infrastructure bill will be passed and more about where the money will be spent.

There is not an anti-infrastructure camp. There is one side that wants to see the money spent on traditional infrastructure–roads, bridges, ports and airports–and another that would like to see the definition of what is considered infrastructure expanded to include such items as green technologies. Neither of these definitions hurts steel demand.

And then there is China. It’s often said that China drives the bus and the rest of the world is along for the ride. China, after all, was first into the pandemic and first out of it–and first to scour the world for steel as life returned to something resembling normal following the initial COVID-19 outbreak.

Keeping an eye on demand and price trends there is crucial. Because chances are where China goes, the rest of the world will eventually follow.

Remember, no one really knows where this price escalator stops. Some of the biggest steel buyers in North America were convinced that hot-rolled coil prices would never top $1,300 per ton. Some current offers are as high as $1,400.

By Michael Cowden, Michael@SteelMarketUpdate.com