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Rising Steel Prices a Shock to Japanese Industries

  • March 23, 2010

With China's economy humming again, prices for iron ore and scrap iron are starting to rise. For Japanese industries caught between rising costs for raw materials on the one hand and deflationary pressures hammering product prices on the other, future iron and steel prices will be crucial.

Japanese steel manufacturers were taken aback by the price for iron ore quoted by the Brazilian mining company: more than US$100 per ton, a 90% increase over the 2009 level and a figure that approaches an all-time high.

The demand by executives of Vale, formerly Companhia Vale do Rio Doce, which came in the chill of early March, seemed almost like a pronouncement on the position of Japanese industry?in the eyes of their international partners, Japanese manufacturers have suddenly become much less powerful.

The steel companies that Vale representatives visited, which included Nippon Steel Corp. and JFE Steel Corp., declined to commit themselves, but an insider admits that “there is very little room for negotiation."

Japanese manufacturers bargain from a weak position

The current round of negotiations over the price of iron ore began early this year, and with each successive discussion, the price has risen, largely because China is increasing its imports.

This increase in demand is creating a supply-side shortage, causing a sharp hike in spot prices for the iron ore and coal that are used to produce iron and steel. The Japanese steel manufacturers have already accepted a higher coal price for April through June this year?US$200 per ton, which is 55% higher than last year.

Scrap iron from Japan and elsewhere at a Chinese port (Takahiro Onishi)

Why are Japanese manufacturers in such a weak position when it comes to negotiating prices with the major suppliers of natural resources? The simple answer is that Japanese industries including steel now have far less purchasing power.

China is not only the world's largest consumer of steel, but has also become the world's largest producer. In 2009, it produced 567.84 million tons of crude steel, up 13% from the previous year. This amounted to a little over 46% of world production. Japan's production of crude steel is projected to top 100 million tons this year, less than a fifth of China's output.

During Japan's high-growth periods, its steelmakers enjoyed a commanding presence among Asian corporations, and power on the supply side was divided among a larger number of companies. Even for major players in extractive industries, Japan was a preferred customer. With the economic growth of competitors such as China and India, however, Japan has become just another buyer.

Even the major raw material suppliers appear to have been unsuccessful in their negotiations with China, the world's largest consumer. In the talks that took place immediately before those held in Japan, the suppliers' bid to raise prices seems to have stalled. An industry expert at an iron and steel trading company conjectures that “they probably want to establish a precedent of higher price levels by forcing price hikes on Japanese manufacturers who now lack negotiating clout. They will then reopen negotiations with the Chinese."

At the same time, however, the world's largest steelmaker, ArcelorMittal, is said to have reached an agreement with the major extractive corporations as early as February. Although the agreed price level is thought to involve a sizable increase, the hike in raw material costs is not as problematic for ArcelorMittal because the Europe-based company has considerable mining rights all over the world. It could even be that these rising costs will give the company an edge over its rivals.

Scrap iron prices climb to a high not seen since the financial crisis of fall 2008

Japan may be bullied by extractive industries over iron ore, but the country is not completely without natural resources. Manufacturing processes and the demolition of buildings produce scrap iron, which is less expensive than iron ore.

Historically, the major steel manufacturers have increased their procurement of scrap iron whenever iron ore prices have risen. Now, however, the price of scrap iron is also going up. As of March 10, the export price of scrap iron shipped from Kanto area ports had climbed to 34,000 yen per ton. The price of H2, the standard domestic grade in the Kanto area, had also climbed to 35,000 yen. Both had been selling at well below 30,000 since October 2008 in the aftermath of the financial crisis, but in just two months since the beginning of this year, the price has risen by almost 10,000 yen.

The price of scrap iron closely reflects global economic trends and industrial output in particular. While steelmakers all over the world use scrap iron, only industrialized countries such as Japan and the US generate it in quantity. Now, the price is rising because of growing demand in China and other emerging economies, but the supply is not, owing to economic stagnation in the industrialized countries.

A representative for Suzutoku, a major wholesaler and processor of scrap metals in Sumida Ward, Tokyo, says that “inventories are not increasing because buildings and other structures are not being demolished."

In Japan, the effects of the economic slowdown came at the same time as a change in government. The new administration headed by the Democratic Party of Japan has acted on its campaign slogan, “Not concrete, but people," reducing public works to beef up social programs. Construction and infrastructure projects have slowed, reducing the supply of scrap iron.

This supply shortage has been exacerbated by steelmakers in South Korea responding to projected demand in China. They increased the capacity of their electric and blast furnaces, but because, like China, domestic supplies of scrap iron are low, they began purchasing scrap iron from industrialized countries?Japan shipped a record 9.4 million tons of scrap iron overseas in 2009. The rising price of scrap iron this year is partly a result of this development.

Rising raw material costs may hit Japan harder now than in 2008

Japan has weathered hikes in raw material costs before, but manufacturers are more apprehensive this time. The two recent spikes?one during the 1973 oil crisis and the other during the inflationary spiral that preceded the financial crisis of 2008?occurred when the Japanese economy was healthy.

The current increase in manufacturing costs is quite different because, even as costs inflate, the domestic economy is gripped by the deflationary pressures of a recession.

Because the economy was relatively strong in 2008, manufacturers were able to pass their higher manufacturing costs on to consumers. Prices for end products such as cars and electrical appliances went up in quick succession; while there was some resistance to higher prices, it tended to be superficial. People were resigned to it, believing that what goes around would come around.

This time, however, the attitude is different. Companies everywhere are slashing their prices, and there is relentless pressure from consumers for this to continue. On the other hand, pressuring companies to absorb higher costs when their profits are already wafer thin could be the straw that breaks the camel's back.

It is small wonder that steelmakers and those in the distribution chain feel that they must pass on the increased costs if they are to survive. Some firms are already moving in that direction. In what is a highly unusual move, given that pricing negotiations for iron ore are still ongoing, major steelmakers are rumored to have approached users such as automakers and electronics firms, asking them to accept a price increase.

Steelmakers are said to be asking for an increase of 15,000 yen per ton over last year's material prices, but users appear to be resisting. One major automaker even lowered the price it charges a parts supplier for a steel product that the automaker resells to the supplier for processing. By lowering the resale price, the automaker is sending a clear signal that it is against any price increase by the steelmaker.

In these circumstances, it is easy to see that manufacturers with limited purchasing power who rely on domestic steelmakers for their materials will not be bargaining from a position of strength. In many industries?automobiles, consumer electronics, shipbuilding, and general contracting, to name just a few?the high price of steel may well become a catalyst for mergers or other industry-shaking restructuring.

Furthermore, rising material costs are unlikely to be limited to steel. Oil prices are already inching upward. Western Texas Intermediate, a benchmark crude oil traded on the New York Futures Exchange, averaged US$62 a barrel in 2009, but has been priced at more than US$80 in March this year.

Raw material prices are rising and corporations now have a fight for survival on their hands as they struggle to pass the costs down the consumption chain. They will need to hone their cost competitiveness and build on other strengths such as product development if they are to emerge as winners. The rising cost of steel is merely the beginning.

(Takahiro Onishi and Mariko Kodaki, Staff Writers, Nikkei Business)

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