Big Steel, Price Swings of Yesteryear… and Dominance Role Reversals

Reproduced from a 19 April 2010 article by courtesy of "Transport Trackers"

Given the recent stories on steel and price hikes we took a quick look sample historical reactions to price hikes. In April 1962, John F. Kennedy panicked after US steel companies proposed to raise steel prices $6/ton, as the proposed rises threatened his economic program. He went on TV, after earlier planning a multi-pronged campaign against Big Steel, to denounce the steel companies price change decision (“in ruthless disregard…” Please refer to http://www.youtube.com/watch?v=x‐sIYl5C4mY). ...

If one thinks about it, a ton of steel was $20 ‐ $40 in the 1920s while an ounce of gold was fixed at $20.67/oz before the Fed appeared to get a present from Roosevelt in 1933 through the re‐fixing of gold at $35/oz. Steel per ton could loosely be put at $600 ‐ 800/ton today against about $1,100/oz for gold. Just an observation: Steel is up by a factor of about 20x in a century; gold is up by a factor of about 40x... We are not experts in steel and commodities, simply interested bystanders wanting to know more about many of the products going on ships, and their drivers.

Margins for the US steel industry were estimated, in an article of the day citing AP Business News, 10 April 1963, at about 4% net profit margin in 1962, down 15% from 1963. In comparison, US steel in 2009 had a negative EBIT margin over 15%, though this had come after a five‐year streak of EBIT margins averaging just under 10% prior to 2009.

Kennedy’s 1962 frontal assault on Big Steel led US steel companies to drop prices even below levels they had tried to raise them from (the attack coming when margins were 4%). By 1963, a number of papers came out on economic effects in the steel industry, with none other than Townsend’s Greenspan (remember Greenspan’s consultancy firm?) preparing a paper for the Society National Bank of Cleveland, among other papers, showing that US GDP between 1955‐62 increased 20% in real terms but that the steel industry, one of the centerpieces of the US economy at the time, was slowing in real terms, given only a 5% expansion during the period.

The article citing Greenspan (an analyst at Wellington submitted to the Financial Analysts Journal for November 1963) went on to speak of the US loss of market share to foreign producers. … In other articles we saw talk of 2.5 – 3.5% wage increase complaints from steel bosses. But overall, we got the feeling from most discussions that a lot of people walked around assuming flat costs, especially raw materials sourcing. Another thing people/ organizations did, as seen in many articles of the time available for viewing today via Google, is repeat verbatim press blurbs, so quite often price rise announcements simply stated the quantum of rise with no reference to base price (ie, it’s difficult to get one’s bearing on price points).   … From reading articles from the 1920s on steel, on comparatively more turbulent times for steel prices than the late 50’s and early 60s, the price of steel had about doubled between pre‐ and post‐ WWI from about $20/ton to about $40/ton.

We had noted in recent weeks, some research reacting to iron ore price increases without appropriately adjusting for cost increases 1 . We still think more work needs to be done on this front, but some, among others, have flagged the impact of higher spot iron ore and quarterly contracting for some of the mills that historically relied more on annual contracting. Margin squeezes and demand patterns after price rises appear important questions/topics...

1 We could not believe one note we read from a large broker in late March ‘10, which raised steel price estimates for 2010 by LSD percentage points and put the average forecast for steel/ton for 2010 far below current price, with barely a mention of margin squeeze or indication of forward iron ore pricing views given the numbers laid out…. But we have seen other notes more recently doing a better job of forecasting margin squeezes. Still we would like to have seen a theme piece on steel looking at elasticities of demand in China and globally based on higher ore, coal, steel, etc..No doubt, someone is doing it. … Our long term view is that China needs to bring down production and demand which feeds into the construction of empty or low vacancy buildings, and stop stimulating for the sake of stimulating…China has taken baby steps in this regard, though in some sense even these steps have at times appeared more than that of the US Fed…But that’s just our view.

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So what’s changed in 50‐100 years of looking at price data and relationship?

Short answer: Not much, and everything. Today, repeating of press blurbs and sensationalism in headlines is perhaps still based on similar practices as in past. There are a lot more moving parts, to be sure. In the past, we could go years without a price change in an input. Later (in 60s, 70s??), some of that price stickiness was even down to command economy features, even in the US economy…Back then you’d get a US president dedicating speeches against price rises. Today we have infinite price changes of inputs and outputs, issues of over‐demand out of China, cheap capital from central banks, and…2The politics of steel perhaps haven’t changed as much as one would think, though. The politics were bad in the 1960s… and they are bad now.

What’s changed the most, in our view, is the order of things not just turning upside down (which Hegel or Marx would have understood/liked), but steel (and oil, etc) geopolitics are going in multiple directions at the same time.

In the heyday of the rise of the US as a superpower, it was about US dominance taking over from the British, etc. Everyone “knew their place...” 3The new good guys (US) were producing and dominating the market for key outputs. Sourcing contracts were in place and it was done more efficiently than the new bad guys (USSR) were doing it. Today, China (which was briefly aligned with the then bad guys) is producing more, if not most, efficiently, yet. And now it is sourcing at spot rather than on contract from developed and developing countries alike.

US Hot Rolled Midwest Avg $/ton, 1980 – Current (Monthly Series)

Source: Bloomberg

Notes

1 We could not believe one note we read from a large broker in late March ‘10, which raised steel price estimates for 2010 by LSD percentage points and put the average forecast for steel/ton for 2010 far below current price, with barely a mention of margin squeeze or indication of forward iron ore pricing views given the numbers laid out…. But we have seen other notes more recently doing a better job of forecasting margin squeezes. Still we would like to have seen a theme piece on steel looking at elasticities of demand in China and globally based on higher ore, coal, steel, etc..No doubt, someone is doing it. … Our long term view is that China needs to bring down production and demand which feeds into the construction of empty or low vacancy buildings, and stop stimulating for the sake of stimulating…China has taken baby steps in this regard, though in some sense even these steps have at times appeared more than that of the US Fed…But that’s just our view.

2Thisremindsus   of   a   versionof   “Stay”  mostnicelyupdatedby   JacksonBrownebackin   the‘70s…  (today…  “wegottruckerson   CB…”) from http://www.youtube.com/watch?v=jtuvXrTz8DY (1978 performance linked here)

3 …Until we got thinks like the Leontief Paradox… This takes us back to the Leontief Paradox on Heckscher Olin theorem problems, which was based on Leontief in 1954 (quite early on …) finding that the US, the most capital‐abundant country in the world, exported labor‐intensive commodities and imported capital‐intensive commodities in contradiction to the Heckscher‐Ohlin, which held that “a capital‐abundant country will export the capital‐intensive good, while the labor‐abundant country will export the labor‐intensive good.”

Author: Charles de Trenck / Publisher: SCMO

So you want to be an Intra-Asia Trade player?

Reproduced from a 12 March 2010 article by courtesy of "Transport Trackers"

Container veteran Niels K Balling contributed this think piece on Intra-Asia containers. We leave his title in place as it reminds us of the song by the Byrds, and later sung by Patti Smith (So You Wanna Be a Rock and Roll Star). Mr Balling notes, in passing, that the intra-Asia market is so big and complex that trying to boil it down in this fashion perhaps does not do it justice, so he apologizes in advance...

The Southeast Asia/North Asia countries comprising the core Intra-Asia market have become the largest container trade in the world, by far (despite some over-counting a few years back in a now infamous looking at the market by a well-known report we refer to sometimes). We exclude the Asia/Australia and Asia/India and Middle East trades as they are independent trades served by independent assets.

Key issues:

Total REAL profit pool of the core Intra-Asia trade is destined to remain miniscule

Only niche operators will be able to cover the cost of dedicated capital deployed to this theatre

Roughly 1/3rd of the trade volume is handled by main line operators on trunk routes

Rest evenly split between dedicated major services, feeder services, niche operations and domestic protected trades

The Main Line Operators (MLOs) provide negative marginal pricing to offset equipment positioning needs they have anyhow, and to build container terminal volumes that generates lower total terminal handling cost. In other words sunk cost discounted to zero (or less), combined with marginal pricing for growth purposes to achieve lower variable cost. That's not entirely crazy as the volume gain often will generate more value through terminal handling discounts than the real Yield of Intra-Asia cargo. And the discount may apply to the TOTAL volume thus leveraging the discounted Intra-Asia business to great effect.

Any dedicated operator (as some of the traditional Intra-Asia shipping companies will tell you) can never recover the cost of normal operations against such network economics.

Next come feeder (about 15% of Intra-Asia volumes) and the quasi feeder operations. The latter comprises about 55% of dedicated Intra-Asia services. These are services deployed for combined Intra-Asia trade and MLO network purposes. The feeder and quasi feeder operations work on the same discounted cost basis.

The only reason for existence of 3rd party feeder operators is that they can do it cheaper than the main line operators despite the latter counting on their own sunk cost. How can the 3rd party operators survive? In most cases it comes down to lower asset and capital costs - for as long as it lasts.

In other words on a net, net basis a relatively large part of the major Intra-Asia trades are served based on dedicated shipping services to their operational scope without any hope of rate or cost differentiation against the main line operators' network economics. They cannot bring specific financial value to the table that can support a dedicated operation. And they die – and get reborn – regularly.

Overall Intra-Asia has a negative profit pool due to the sunk cost approach by main line operators. That's a great trade facilitator and may continue to support rapid volume expansion of Intra-Asia container volumes.

But where's the money for the shipping investors?

There's a lot of money available in this profit pool. If one knows where to look. There are several niche opportunities as well as classic arbitration windows available.

The niches are fairly obvious, especially within the Refrigerated foodstuff area. This is becoming an interesting niche because of slow steaming by main line operators. Certain products, like bananas, are highly transit-time sensitive and need fast, reliable transport. The arbitrage opportunities are however an even more interesting and growth opportunity generating.

The Intra-Asia trade to a large extent is an outgrowth of the coastal economic development within Asia. Part of the success of Asia is that logistics costs were always low. This is no more a given. Redistribution within Asia is becoming more costly, though sea represents the cheaper option and contributes to reducing costs. Just think of haulage cost in Japan to outlier areas. Or Taiwan, Korea cost for trucking to other consumer areas. And/ but... China is now joining the game.

The Intra-Asia trade regionally is essentially similar to domestic haulage in the US and Europe.

There are no major green issues yet except Japan, where basic economics already make it very compelling to distribute to say Southern Japan via China by ship rather than paying huge costs over road and ferry via Tokyo or Kobe. In other words, use shipping to avoid domestic land based transport.

Intra-Asia will continue to provide growing opportunities for transport arbitrage opportunities, for new entrants. And Intra-Asia transport costs will continue to remain low based on intelligent MLOs going beyond normal yield management to leverage their network for ever better marginal cost throughout their global operations.

For both types of operators Intra-Asia will continue to expand in value.

For new entrants the advice is that deep understanding of their market of choice will make the difference between survival and quick demise.

Author: Niels K Balling / Publisher: SCMO