Capacity utilization ratio
The capacity utilization rate is a key indicator of the steel industry’s health. In simple terms, the capacity utilization rate refers to the actual production compared to the maximum production possible through existing plants. Historically, steel prices moved in tandem with the capacity utilization rate. Now, we’ll look at the global capacity utilization ratio in January.
Utilization rate came down
The above chart shows the movement in the capacity utilization ratio. As you can see, the ratio fell to 72.5% in January. In comparison, the capacity utilization ratio stood at 76.6% in January 2014. Currently, the ratio is at a three-year low.
Steel prices are negatively impacted by lower capacity utilization rates. Steel prices are a key factor that impact steel companies’ performance. Steel Dynamics (STLD) has one of the highest capacity utilization rates in the steel industry. In its US operations, U.S. Steel Corp. (X) achieved a utilization rate of 75% in the fourth quarter.
With a low capacity utilization rate, competition between existing industry players increases. This puts pressure on prices as producers try to increase their sales to reach optimal capacity utilization rates. Running the plants at less-than-optimal capacities also increases the cost of production.
The reasoning is quite intuitive. The fixed costs are distributed among a lesser number of units. So, the per unit production cost goes up. According to analysts, steel companies’ profitability is negatively impacted if plants operate at less than an 80% utilization rate.
One of the reasons for a low capacity utilization ratio has been the slowdown in China. We’ll discuss this in more detail in the next part of this series.