Why steel investors are mindful of capacity utilization rates

Taking the industry’s pulse

The capacity utilization rate is a key indicator of the steel industry’s health. In simple terms, the capacity utilization rate refers to actual production as compared to the maximum production possible using existing plants. Typically, steel prices move in tandem with the capacity utilization rate. To learn more, read Must-know: Why capacity utilization affects steel producers.

Let’s look at the global capacity utilization ratio in August.

Capacity utilization figures fell in July

As the chart above shows, global capacity utilization rates fell in August. The capacity utilization rate was 74.2%, or 1.4% lower than in August 2013. The capacity utilization rate in August was in fact the lowest rate we’ve seen this calendar year.

Why it’s important to monitor this ratio

Steel prices tend to move in tandem with capacity utilization rates. Steel prices are a key factor affecting performance, directly impacting the revenues of companies such as ArcelorMittal SA (MT), United States Steel Corporation (X), Nucor Corporation (NUE), and Steel Dynamics, Inc. (STLD). Prices also impact the performance of exchange-traded funds (or ETFs), such as the SPDR S&P Metals and Mining ETF (XME).

With lower capacity utilization rates, competition between industry players increases. Producers try to increase sales to reach optimal capacity utilization rates. This strategy puts pressure on prices. Running production plants at less than optimal capacities also increases the cost of production. The reasoning is quite intuitive. Fixed costs are distributed among fewer units so costs per unit go up. According to analysts, the profitability of steel companies is negatively impacted if plants operate at less than 80% utilization rates.

While steel production has increased, capacity utilization rates have fallen. We’ll look at this anomaly in the next article of this series.