A Deeper Dive into May 2016 Steel Industry Indicators

(Continued from Prior Part)

Global steel industry

Global steel production has fallen on a year-over-year (or YoY) basis for 16 consecutive months. In April, production fell 0.43% YoY. However, the decline rates have come down in the last couple of months. As steel prices have risen globally, producers have an incentive to produce more steel.

Apparently, one thing that is driving the current rally in steel prices is production cuts that take took effect last year. If steel companies continue to ramp up production without any commensurate increase in demand, we could see its impact on global steel prices. Let’s now look at the steel industry’s April capacity utilization rate.

Capacity utilization rate

The capacity utilization rate is a key indicator of the steel industry’s health. In simple terms, the capacity utilization rate refers to actual production compared to the maximum production possible using existing plants.

Running production plants at less-than-optimal capacity increases the cost of production. The reasoning for this is intuitive. Fixed costs are distributed among fewer units, so the costs per unit go up. According to analysts, steel companies’ profitability is negatively impacted if plants operate at less than 80% utilization rates.

Capacity needs to be curtailed

The global steel industry operated at a utilization rate of 71.5% in April. That’s 1.3 percentage points lower than the corresponding month last year. However, the utilization rate has improved over the last few months as steel companies have ramped up production. For the steel industry’s capacity utilization to improve from these levels, some of the excess capacity will have to be curtailed.

There are hopes that China will adhere to its commitment to cut excess steel capacity. But in the last few weeks, China seems to be taking a more confrontational stance in contrast to the conciliatory tone in the beginning of the year. If China (FXI) falters on its commitment to cut excess steel capacity, we could see its impact on global steel markets.

Meanwhile, US steel producers such as United States Steel (X), AK Steel (AKS), and ArcelorMittal (MT) have maintained supply discipline. We’ll analyze that in the next part of the series.

You can also consider the SPDR S&P Global Natural Resources ETF (GNR) to get a diversified exposure to international natural resource companies. Almost a quarter of GNR’s holdings are invested in steel and other metal companies.

In the final part of our series, we’ll take a look at the stagnation in US steel production.