Lower raw material costs
In the last part of this series, we saw how steel prices in the US corrected by ~10% in 2014. However, the fall in raw material costs was even more severe. Please be aware that iron ore and coal are the primary raw materials for steelmakers using blast furnaces. U.S. Steel Corp. (X) mainly uses blast furnaces. ArcelorMittal (MT) uses blast furnaces for almost two-thirds of its production.
For companies that use electric arc furnaces, or EAF, for steel production, steel scrap and electricity act as raw materials. Nucor (NUE) and Steel Dynamics (STLD) mainly produce steel through EAFs. Currently, both companies are part of the SPDR S&P Metals and Mining ETF (XME).
Raw material costs could come down
Iron ore prices dropped by ~50% in 2014. This can be seen in the above chart. However, steel plays enter into long-term supply agreements with their suppliers. Basically, this means that they weren’t able to take full advantage of lower iron ore prices in 2014.
A lot of these supply agreements will be renegotiated this year. Since coal and iron ore prices are currently low, these agreements will likely be executed at lower prices. This will help reduce steel plays’ unit production costs.
However, the fall in raw material prices won’t have the same impact on all steel plays. It will likely vary depending on the company’s degree of vertical integration. Steel companies are vertically integrated when they own mining assets.
In this next part of this series, we’ll discuss the steel companies that are positioned to take advantage of lower iron ore and coal prices.