By Yury Adno

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b>The expiring year 2004 will undoubtedly become a history of the world metallurgy. A rapid growth in demand for steel has stimulated an unseen jump in steel production. Over the recent 30 years world iron and steel industry has reached a peak of its sustainable development. While in 1970-2000 actual consumption of steel products increased by only 1.2% a year, in 2001-2004 this increase, according to some estimation, may exceed 20%. Just within 8 months of this year world steel production has increased by as much as 8.5% and is expected to reach a record level of 1 billion tons.


A higher demand gives rise to another spiral in price escalation. A significant growth in consumption of steel products has been marked worldwide, with some countries experiencing shortage in key types of metallurgical raw materials including iron ore, scrap metal, coking coal and energy resources. All this push up prices for different steel products even more. During the first quarter of this year the prices increased by 1.3 –1.7 fold, the most significant increase seen lately.

Over the recent 8 months prices for iron and steel products on the Russian market have increased by 35-40% to raise a wave of protests among key steel consumers. Producers of steel pipe products and steelworks, oil and construction companies, representatives of automobile and some other industries accused steel makers of an unjustified price escalation and an attempt to provoke inflation. They pointed out that higher prices for steel would result in lower profitability in allied sectors and insisted on introduction of government control and seizure of a so-called excess profit from selling steel on the domestic market and imposing higher customs duties for export. Ultimately the key steel makers were directly accused of a cartel conspiracy.

We have to hand it to the RF Government, they resisted the nervousness and confirmed their commitment to market principles. Prime Minster Michael Fradkov firmly stated that his cabinet would not introduce regulated prices.
Now that the dust has settled one can ask a question what is the real reason for such unprecedented jump in prices and for how long price environment will remain favorable for the steel industry?
A number of external factors can be outlined.
Firstly, metallurgy is one of few Russian industries which is 100% integrated into world economy. Therefore, domestic prices are inevitably dependent on the condition of the world market of steel products and some external factors to determine the market e.g. dollar weakening which has been evidenced over the recent years. It also should be pointed out that on the whole world economy keeps on its steady development, though at different rates in different countries, in the positive direction to facilitate a higher consumption of steel as the key investment commodity. Another explanation to a higher demand for steel is customers` concern about a shortage for the material, which may potentially arise on the market under the conditions of global economic growth. Moreover, higher prices can be explained by a higher rate of concentration of production capacities and assets in world steel industry led by such transnational corporations as Arcelor, LNM Group, ThyssenKrupp, Corus and JFE, which to a significant extent determine world prices for steel.

Secondly, there is another pretty serious factor, which is an intensive economic growth in China (annual rate of its DGP increment amounts to 8-9%). A quarter of world steel production and 27% of world steel consumption are attributed to this country. According to estimation of China Iron and Steel Assotiation (CISA) compared to the previous year this year China will increase its steel production by 270-280 mln. tons, while importing about 35 mln. tons of steel. China invests about a $10 billion USD in development of its own steel industry and is able to become a net-exporter of steel products at least to the countries of South-Eastern Asia. It is very likely that during the coming years China will achieve this goal despite the Chinese government` s efforts to curb the rate of domestic steel production growth by imposing limits on investments and shutting down steel making facilities with production capacity of less than 1 mln. tones.

Thirdly, some analysts believe that in the future we will see a stronger tendency for higher global prices for key raw materials, which process is now reflected by higher world prices for oil. The main reasons for that are depletion of available reserves, irraplaceability of some types of natural resources, high capital intensity of exploration, ore field development and construction of new mining facilities. This list of reasons should be added with a relative gap between development of resource saving technologies and the rate of natural resources consumption including lack of materials able to replace in commercial volumes such versatile material as steel. To restore the order in prices to its previous state, where the rate of growth in prices for raw materials lagged behind that for knowledge intensive and innovative products, the key world consumers should exert significant efforts first of all aimed at development of knowledge intensive innovations.

As to functioning of the Russian economy and key factors associated with this, it is worth tracking down dynamics of the main operating expenditures in the steel production cost break down. First of all we can highlight a rapid growth in prices for iron ore, coke, products and services offered by natural monopolies like RAO Unified Energy System of Russia, Gazprom and Russian Rail Roads in Russia (see table below). Data represented in the table shows that key components (including power supply and rail road tariffs) of the production cost ran significantly ahead of the growth in prices for iron and steel products. It was the key reason for a higher share of raw and consumable materials costs in the iron and steel industry (according to official statistics this share increased from 51 up to 56%).

At the same time this statistics reveals that even with the steel price going up the major steel- consuming sectors have not reduced their production rate. It is the sectors which demonstrate the highest in Russian economy rate of production growth at a pretty high profitability. Thus, for example, in the first quarter of 2004 production growth accounted for 14% in the machine building industry and 16% in the construction sector. Over the recent year demand for steel on the Russian market has increased by 10%, which fact evidences a stable cooperation between different sectors of the Russian economy able to resist any variations in prices.

Sure, Russia has a lot of possibilities to make the price formation process more predictable and prices less sensitive to acute fluctuations. One of the facilitating factors is integration of the Russian iron and steel industry. This process results in strengthening the position of Russian companies on international markets allowing them to influence the price formation conditions. As to specific measures taken, some steel consumers have head a call of major steel makers for entering into long-term contracts with them for supplying steel at fixed prices. Fixed price supply contracts may reduce price fluctuation risks, exclude mediators` markups and provide for a wide scope of opportunities for applying different benefits and discounts for regular purchasers and large volume bulk deliveries.

In experts` opinion the year 2005 may become the beginning of a gradual cyclic recession in the world steel industry to result in lower prices which process according to forecasts of some analysts may start as soon as in the middle of this year.
With the economic growth rate predicted relatively high, one can suppose that Russia will see further growth in steel consumption and, consequently, further increase in steel production.
At the same time Dmitry Gorshkov, a top manager from Severtal, believes that higher scarcity of raw materials and higher prices for them in combination with higher tariffs for services of the natural monopolies will facilitate push up prices for key types of rolled iron on the domestic market.
In the long-term perspective the world steel market conditions will be to a significant extent determined by American and Chinese economies. In particular, should during the next five years China achieve the announced growth in metallurgical capacities and become a net-exporter while reducing its import of iron and steel products, it may significantly deform world market to make the problem of excessive production capacities in the iron and steel industry more acute.
Table 1
Changes in prices for products (services) of the main industrial sectors considered the key partners of the Russian iron and steel industry in 2000-2003.
_____________________________________________________________________________ Industry Average Growth per Year, % 2003 vs. 2000 %
____________________________________________________________________________
Electrical energy industry 28 164
Gas production industry 28 132
Rail Road Transportation,
Including Payment for
Using Carriages 23 124
Iron Ore Mining 24 122
Coal Mining 21 112
Iron&Steel Industry 21 112
Hot Rolled Mill Products
for Pipes Used in Oil Production 21 110
Oil Production 21 96
Machine Building Industry 17 85
Cold –rolled Mill Products
For Automotive Industry 17 78
Oil Refinery 17 72
Based on data provided by the RF State Statistics Agency