World components: Steel shocks

The Economist

One of the few boons of the recent global recession for carmakers was that it drove the soaring steel prices of 2008 down sharply. Now, however, prices are starting to climb again on the back of renewed demand. Profit margins in the auto industry are already razor-thin and other costs have been pared to the bone. So carmakers’ only remaining option may be to pass the increased costs of the crucial metal on to consumers.

The price of steel has been rising for over six months, albeit in a volatile way. They are still some way off their highs in 2008, when prices boomed by 60%, but they have recovered much of the ground they lost during the 45% slump in 2009. According to the Economist Intelligence Unit’s latest forecast, the price of steel will average US$568 per tonne in 2010, compared to US$489 in 2009 and US$889 in 2008.

A number of factors lie behind this recovery, notably including renewed demand and increasing interest from speculators. But the main driver remains the vast Chinese market, whose thirst for the metal is rising in line with booming consumption of consumer goods. In 2009, Chinese demand for steel accounted for more than 45% of global consumption, and rose by 18% compared to 2008. That was a sharp contrast to the 22% slump in demand in the rest of world, led by North America, Europe and Japan.

Contributing to the volatility of prices, however, is a radical change to the way that iron ore is priced. For the last few decades, iron-ore contracts have operated on an annual basis, which gave buyers a degree of pricing certainty. In the last month, however, mining companies – led by the UK's BHP Billiton and Brazil's Vale – have forced steelmakers to switch to quarterly contracts so that they can respond to market conditions better. That makes steel prices harder to predict.

Car makers and suppliers hit again

As a key end user of steel, the automotive industry is particularly exposed to this price volatility. Despite the increasing focus on lighter-weight metals such as aluminium and composites, steel accounts for around 50% of the weight of the average family-sized car and around 10-15% of its production cost. Mass carmakers are particularly badly affected, because the metal accounts for a higher proportion of their end-prices.

ACEA, the Brussels-based trade body for the European automotive industry, has already spoken out against what it describes as distortive developments from the three major exporters of iron ore which it says ‘hold the significant pricing power of an oligopoly.’ “The automobile industry needs broad access to raw materials at competitive conditions, especially in times of fragile economic circumstance,” ACEA said. The World Steel Association and Eurofer have also protested, urging competition authorities to look into the new agreement.

Where still possible, carmakers such as Germany's Volkswagen are trying to mix the length of their steel supply contracts, in the hope that this will reduce their exposure to price volatility. BMW (also Germany) has fixed its steel contracts for 2010 in advance, while truckmaker Daimler (Germany) has opted for price-hedging. Other truckmakers, such as Sweden's Volvo, say that they are mainly reliant on scrap steel, the prices for which lag behind those for freshly produced steel.

Component makers, many of whom are much smaller businesses, have even fewer choices. Japan's Toyota, the world’s largest car company, actually purchases the steel itself and then sells it back to its own suppliers. That way its suppliers – and hence Toyota - get the benefits of buying in bulk. If none of these tactics work, however, then the only remaining option for carmakers may be to raise their end prices, despite the threat to new car sales.

Very cool idea at Toyota...