The consequences of the government shutdown are unclear. More information about the reach of the shutdown continues to emerge daily.  In addition to the 800k government workers furloughed or simply working without pay, there is upwards of four million contract workers affected by the shutdown.  This report has been most directly affected by the shutdown by the lack of economic data provide by the government.  Data regarding steel imports, residential housing, construction spending, auto sales and durable goods are some of the major reports missing and these reports (ex-imports) provide significant information about the condition of steel demand.

On the supply side, the AISI Steel Production Capacity Utilization and Raw Steel Production data showed the utilization rate fell to 79.8% with production of 1.89 m short tons for the week ending January 11th.  In fact, the utilization rate has remained above 78% since late July.

This table sums up the weekly AISI raw steel production data on an annual basis.  In 2018, the AISI mills produced 96.2m tons, a 4.5m or 4.9% YoY increase.  Service center data shows YoY shipments are up 3.9% with December inventory up 5.5%. New domestic mills (JSW and Granite City) have added supply and are competing with incumbent mills for customer orders with even more production planned to come online in the near future.

This chart compares the Platts Daily HRC Index with the AISI Capacity Utilization Rate. The production rate looks to be too high when compared to the sharp drop in flat rolled prices.  It appears the domestic mills have been melting too much steel for too many months and have yet to respond to slowing demand.  One major upside price risk for steel prices is any decrease in production, planned or unplanned.  Whether or not the mills take down production is a major unknown.

Considering the sunk costs and political ramifications, it is highly unlikely that U.S. Steel would shut down Granite City after just reopening it.  U.S. Steel is working through an asset revitalization plan, which could limit some production at different mills as this maintenance occurs.  Nucor and Steel Dynamics could easily slow their EAF production, but they run the risk of giving up market share if they do.  The addition of Granite City and introduction of JSW coincides with what looks to be a surplus of steel combined with a slowdown in demand.  Service centers saw a build in their inventory in December and we are expecting an unseasonably slow January.  Taken together the conclusion is there is too much steel.  The steel industry looks to have entered a period of an ultra-competitive supply side where incumbent mills are playing defense with their customer’s orders against these additional tons and new entrants.

This type of environment makes it very difficult for a price increase to take hold as the mill making the announcement runs the risk that the other mills take their customer’s orders while they ask for higher prices.  Another interesting supply-side dynamic is as the price in Asia has been improving and the domestic price has been falling, the import differential had been converging toward a level that drastically slows import orders. A price increase would widen the differential and push some purchase orders to international mills.

Another interesting factor in the steel supply-side is that service center data showed a sizable increase in inventory in December.  This cost of this inventory is much higher than current spot and service centers have been working to draw down these inventory levels.  A price increase could give these service centers the opportunity to unload this inventory, which would likely lead to less orders going to the domestic mills.  This would extend the time mills would have to hold out from getting orders to make the increase stick and with lead times at ultra-low levels, again it looks difficult to pull off.  However, if there is follow through with demand coming back to life, the service centers will have to restock after they sell their current tons.  Again though, the current supply-side dynamics provide for a low probability of success of a mill price increase.

In the steel market, we see downside risks outweighing upside risks warranting a prudent and risk-averse purchasing and inventory management strategy.

The following issues provide the foundation of our view:

• Declining rates of growth in manufacturing and tariff induced demand destruction
• Increased/increasing domestic steel production capacity
• Weakening global economics
• Crude oil price falling sharply
• Higher interest rates
• Strengthening U.S. dollar
• U.S. residential construction industry slowing
• Falling global flat rolled prices
• Tariff resolution potential