Rising costs threaten steel makers’ profits

Rising costs threaten steel makers’ profits

The world’s steel makers could face significantly higher costs next year as raw material prices rise, threatening the industry’s string of big profits if it can’t successfully pass on the costs to industries ranging from car makers to construction.

The industry is set to begin talks next month with big producers of iron ore, a crucial ingredient for steel making, over next year’s prices.

The group is set to demand a 50% price increase, compared with the 9.5% increase last year. If they gain most or all of that increase, that could hurt profit margins for steel producers already contending with higher prices for coal and coke, also used to make steel.

The cost pressures also could prompt more consolidation in a still-fragmented industry as steel producers seek more bargaining clout and economies of scale.

While 70% of the iron ore that is shipped by sea is supplied by three players—Rio Tinto Ltd, Cia Vale do Rio Doce, and BHP Billiton Ltd—the world’s biggest steel maker produces about 11% of all steel.

Talks between Chinese steel makers and iron ore producers are expected to begin in early October, and are likely to set the pattern for the industry. China is the world’s largest iron ore importer. It also is the world’s largest steel maker. Demand from China’s steel mills is a prime reason that world iron ore output rose 12% in 2006, reaching 1.5 billion tonnes—a fifth consecutive high.

China imports most of its iron ore from Australia, Brazil and India, and prices differ, reflecting different shipping costs. Chinese steel makers pay about $50 (Rs1,990) a tonne for iron ore, and $50-70 a tonne to have it shipped. While a tonne of Brazilian iron ore is about $40, shipping costs are higher because of the greater distance.

Iron ore makers signalled their intent this summer to seek a 50% price increase beginning next year or when current contracts expire. Rio Tinto chief executive Tom Albanese made a case for higher prices in an interview last month. “We have to put more resources and more pressure on everything that we do to deliver the goods," he said. “We have a sector that has continued strong demand and there are restrictions that have lowered supply."

Rio Tinto said it planned to mine nearly 220 million tonnes (mt) of iron ore and other materials this year, a huge increase from annual outputs of 50-75mt earlier in the decade.

Raw material companies have complained about shortages of both equipment and workers to unearth iron ore and coal. They have said ports in Australia, a key supplier of raw materials, are often clogged and can’t efficiently and quickly handle increased shipments. Iron ore prices have increased every year for the past five years.

Some steel makers are better insulated than others against higher raw material prices. US Steel Corp. has its own iron ore and coke supplies for its US steel plants. The company’s European operations, which have been running at near full capacity to supply steel to Eastern Europe, will be affected by higher world prices from outside suppliers, said spokesman John Armstrong.

Some steel makers are trying to minimize their dependence on iron ore providers. ArcelorMittal supplies about 47% of the iron ore it uses.

The price of coke, which feeds the furnaces to make steel, is on the rise, too. China, a huge exporter of coke, is shipping the fuel at a price of about $230-250 a tonne, which doesn’t include freight charges. Last year, coke cost $140-180 a tonne. The cost to ship a tonne of steel has doubled since 2005 to $80-100 a tonne.

Steel makers said they aren’t surprised by the run-up in raw material prices, given the demand from China and constraints facing iron ore companies as they try to expand. As a result, many steel makers have been factoring in increased costs in contract talks with their own customers.

Depending on the negotiations, as well as expectations of how much higher raw material prices will go, these increases to steel customers could be about 10%, analysts said.

Contracts can cover a few months or several years. As a result, steel price increases may take some time to trickle down to end users.