BMO Metals Outlook
- Keywords:
- steel
The metals industry has been on a wild ride over the past few years, from the effects of COVID-19 and supply chain disruptions to supply-demand issues and the effects of the Russia-Ukraine war. Producers, service centers and distributors have greatly benefited from global uncertainty, with some telling us that they feel as if they’ve “won the lottery” or had their best year compared with the past five to 10 years combined. Global uncertainty on the supply side has played into their hands, providing metals companies with an equity infusion that typically happens once a decade. For end users, it's been a different story over the last 12 to 18 months. Metal has been difficult to source and secure at a reasonable price, forcing metal buyers to pay a hefty premium.
The situation has improved in the past few months for metal purchasers, but uncertainty fueled by the war in Ukraine, COVID-related lockdowns in China, ongoing supply chain issues, and the availability of energy in Europe and elsewhere due to the Ukraine war have made it challenging to procure inventory at a reasonable price. Tariffs and quotas, regardless of which political party is in power in the U.S., has remained in place, which can also complicate sourcing from foreign imports.
To get a sense of where the industry is headed, we recently held a virtual event with two of our metals industry experts. David Gagliano, Senior Analyst at BMO Capital Markets Equity Research, provided an overview of the current forces shaping the U.S. steel industry—particularly the sheet steel market—and expectations for 2023. Colin Hamilton, Commodities Analyst at BMO Capital Markets, discussed the global market dynamics for base metals and generally all metal-related commodities.
Following is a summary of the event.
Domestic steel cools off
Gagliano pointed out that after spiking by a factor of nearly 3x in 2021 compared with recent historical averages, sheet steel prices have since corrected back toward historical norms. Supply shortages and supply chain bottlenecks have eased, giving way to a slower demand environment. He also noted that domestic prices have normalized compared with global prices, particularly in Asia.
“After trading at record high spreads for well over a year, those spreads remained intact for much longer than normal, due in large part to logistical challenges and, more recently, the massive trade flow disruption earlier this year created by the Russia-Ukraine war. Those trade flow disruptions are now subsiding as we've seen the world readjusting, rerouting and resourcing their supply needs.”
The long products market has held up better than the sheet products market. Gagliano noted that rebar-to-scrap spreads are about two times the typical historical average. "The combination of import restrictions, solid U.S. construction demand and consolidation on the long product side have so far provided support and resulted in this resilient long products market,” he said. “Although we are starting to see some early signs of wobbling in some of those long products.”
Raw material prices and intermediate steel prices are leading indicators for the next move in finished prices. After two years of strong prices, raw materials have eased significantly. Gagliano noted that merchant pig iron prices have fallen more than 50% since March, according to BMO Capital Markets, while scrap prices have declined more than 30% for most grades. Additionally, met coal and iron ore prices have moved back toward their historical averages after spiking in February and March.
“We have seen the most recent data points from a macro and industry perspective suggest the risk-reward ratio is slanted a little more to the risk side of another downtick in prices, rather than a sustained recovery in the near term,” Gagliano said.
Supply-demand drivers in 2023
On the supply front, Gagliano said that after rising sharply in 2021, lead times have stabilized—albeit at low levels—which has led to price stabilization. “Given that we’re heading into what is generally a seasonally slow period, our view is that the restocking cycle among the service centers may be approaching an end,” Gagliano said. "That combination of lead times still sitting fairly low as service centers have restocked and maybe about to slow, and then the specter of continued rate hikes—which in our view typically prompts additional end-market uncertainty—collectively those are the reasons we think prices are more likely to remain range-bound or perhaps pull back a bit in the coming months, rather than continuing what's been a rally recently.”
Gagliano said BMO Capital Markets expects the U.S. steel industry to add between 2 million to 3 million tons of steel capacity in 2023 compared to 2022, representing a 4% to 5% increase. But he noted that BMO Capital Markets expects demand in 2023 to be on the lighter side.
“We've got slowing residential and nonresidential construction, offsetting potentially resilient automotive and energy demand,” Gagliano said. “As of now, our projection is about a 1% year-over-year increase in steel consumption, with our bear case scenario at 3% and our bull case scenario a gain of 5%.”
Overall, Gagliano said the sheet steel market looks to be well-supplied heading into 2023, which typically means lower prices. On the other hand, manufacturers are dealing with significant cost pressures. “Given our view that costs are likely to remain elevated, we think the incremental downside in most of the finished steel prices is limited and will be supported by supply-side cuts if prices trend much lower.”
Global market dynamics
Much of the trends in domestic steel pricing is taking shape globally as well. As Colin Hamilton put it, “This is inflation doing its job.”
“Inflation is a natural curb, and we're in an environment where we are energy constrained across the world,” he said. “With that, you're in for growth constraint. We had a very strong industrial economy last year that was driving a lot of growth, outperforming the global economy as a whole. Industrial production always gets hit at times of constraint. And being a particularly heavy energy user, we're starting to see a lot more pressure on both the supply and demand sides.”
Hamilton forecast global industrial production growth of 2% in 2022 compared to 7% in 2021. He explained that Europe has been trending downward, expecting industrial production there to decline between 5% and 10% year-over-year, and he expects that trend to continue into 2023.
“We are starting to edge down on the demand side,” Hamilton said. “Some of that is China, but a lot of that is just a global industrial cycle, which is naturally getting a bit slower.”
There are some positive demand elements heading into 2023. Hamilton noted that global automobile output is starting to recover as some of the supply constraints, particularly for semiconductors, are beginning to ease. In general, however, the demand cycle is slowing. "That's as real wages go a bit negative as global consumers—whether they be manufacturers or end users—become a bit more nervous,” Hamilton said.
On the supply side, Russia's invasion of Ukraine in February created a shock that Hamilton said will have lasting impacts. While Russia’s impact on natural gas supplies has been well noted, the country also accounts for about 40% of the global refined palladium supply, which is a crucial component in automotive catalytic converters and in certain stages of semiconductor manufacturing.
“We're seeing more Russian supply naturally flow into the Chinese market,” Hamilton said. “We've seen many companies develop markets, either sanctioned or self-sanctioned, away from Russian material. This sort of segmentation causes a couple of things. Purchasing managers get nervous, probably over-order to make sure there's enough material on the books. Then they have to deal with having excess inventory as things calm down a bit. But it also draws up lines for the longer term. We've seen consumers in developed markets have to pay a bit more for metals than might been the case in the past. We are seeing metal premiums in many cases at close to record levels.”
All told, Hamilton said BMO Capital Markets has lowered its growth expectations on both the supply and the demand sides. As purchasing managers remain nervous about supply chain issues and low inventory visibility, they’ll continue to pay a risk premium above the cost curve for the next 18 to 24 months. Meanwhile, higher energy prices and less efficient value chains create an inflationary environment in the medium term.
“Despite a decent medium-term demand side, we're still not seeing a supply reaction,” Hamilton said. "If anything, balances in a three-to-five-year outlook are looking tighter than before.”
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Andrew Pappas
Managing Director, Team Leader and Head of ABL Metals Group
Andrew is a Managing Director / Team Leader and Head of Asset Based Lending (ABL) Metals within the ABL Group of BMO Commercial Bank since 2011. Currently, Andrew o…(..)
View Full Profile >The metals industry has been on a wild ride over the past few years, from the effects of COVID-19 and supply chain disruptions to supply-demand issues and the effects of the Russia-Ukraine war. Producers, service centers and distributors have greatly benefited from global uncertainty, with some telling us that they feel as if they’ve “won the lottery” or had their best year compared with the past five to 10 years combined. Global uncertainty on the supply side has played into their hands, providing metals companies with an equity infusion that typically happens once a decade. For end users, it's been a different story over the last 12 to 18 months. Metal has been difficult to source and secure at a reasonable price, forcing metal buyers to pay a hefty premium.
The situation has improved in the past few months for metal purchasers, but uncertainty fueled by the war in Ukraine, COVID-related lockdowns in China, ongoing supply chain issues, and the availability of energy in Europe and elsewhere due to the Ukraine war have made it challenging to procure inventory at a reasonable price. Tariffs and quotas, regardless of which political party is in power in the U.S., has remained in place, which can also complicate sourcing from foreign imports.
To get a sense of where the industry is headed, we recently held a virtual event with two of our metals industry experts. David Gagliano, Senior Analyst at BMO Capital Markets Equity Research, provided an overview of the current forces shaping the U.S. steel industry—particularly the sheet steel market—and expectations for 2023. Colin Hamilton, Commodities Analyst at BMO Capital Markets, discussed the global market dynamics for base metals and generally all metal-related commodities.
Following is a summary of the event.
Domestic steel cools off
Gagliano pointed out that after spiking by a factor of nearly 3x in 2021 compared with recent historical averages, sheet steel prices have since corrected back toward historical norms. Supply shortages and supply chain bottlenecks have eased, giving way to a slower demand environment. He also noted that domestic prices have normalized compared with global prices, particularly in Asia.
“After trading at record high spreads for well over a year, those spreads remained intact for much longer than normal, due in large part to logistical challenges and, more recently, the massive trade flow disruption earlier this year created by the Russia-Ukraine war. Those trade flow disruptions are now subsiding as we've seen the world readjusting, rerouting and resourcing their supply needs.”
The long products market has held up better than the sheet products market. Gagliano noted that rebar-to-scrap spreads are about two times the typical historical average. "The combination of import restrictions, solid U.S. construction demand and consolidation on the long product side have so far provided support and resulted in this resilient long products market,” he said. “Although we are starting to see some early signs of wobbling in some of those long products.”
Raw material prices and intermediate steel prices are leading indicators for the next move in finished prices. After two years of strong prices, raw materials have eased significantly. Gagliano noted that merchant pig iron prices have fallen more than 50% since March, according to BMO Capital Markets, while scrap prices have declined more than 30% for most grades. Additionally, met coal and iron ore prices have moved back toward their historical averages after spiking in February and March.
“We have seen the most recent data points from a macro and industry perspective suggest the risk-reward ratio is slanted a little more to the risk side of another downtick in prices, rather than a sustained recovery in the near term,” Gagliano said.
Supply-demand drivers in 2023
On the supply front, Gagliano said that after rising sharply in 2021, lead times have stabilized—albeit at low levels—which has led to price stabilization. “Given that we’re heading into what is generally a seasonally slow period, our view is that the restocking cycle among the service centers may be approaching an end,” Gagliano said. "That combination of lead times still sitting fairly low as service centers have restocked and maybe about to slow, and then the specter of continued rate hikes—which in our view typically prompts additional end-market uncertainty—collectively those are the reasons we think prices are more likely to remain range-bound or perhaps pull back a bit in the coming months, rather than continuing what's been a rally recently.”
Gagliano said BMO Capital Markets expects the U.S. steel industry to add between 2 million to 3 million tons of steel capacity in 2023 compared to 2022, representing a 4% to 5% increase. But he noted that BMO Capital Markets expects demand in 2023 to be on the lighter side.
“We've got slowing residential and nonresidential construction, offsetting potentially resilient automotive and energy demand,” Gagliano said. “As of now, our projection is about a 1% year-over-year increase in steel consumption, with our bear case scenario at 3% and our bull case scenario a gain of 5%.”
Overall, Gagliano said the sheet steel market looks to be well-supplied heading into 2023, which typically means lower prices. On the other hand, manufacturers are dealing with significant cost pressures. “Given our view that costs are likely to remain elevated, we think the incremental downside in most of the finished steel prices is limited and will be supported by supply-side cuts if prices trend much lower.”
Global market dynamics
Much of the trends in domestic steel pricing is taking shape globally as well. As Colin Hamilton put it, “This is inflation doing its job.”
“Inflation is a natural curb, and we're in an environment where we are energy constrained across the world,” he said. “With that, you're in for growth constraint. We had a very strong industrial economy last year that was driving a lot of growth, outperforming the global economy as a whole. Industrial production always gets hit at times of constraint. And being a particularly heavy energy user, we're starting to see a lot more pressure on both the supply and demand sides.”
Hamilton forecast global industrial production growth of 2% in 2022 compared to 7% in 2021. He explained that Europe has been trending downward, expecting industrial production there to decline between 5% and 10% year-over-year, and he expects that trend to continue into 2023.
“We are starting to edge down on the demand side,” Hamilton said. “Some of that is China, but a lot of that is just a global industrial cycle, which is naturally getting a bit slower.”
There are some positive demand elements heading into 2023. Hamilton noted that global automobile output is starting to recover as some of the supply constraints, particularly for semiconductors, are beginning to ease. In general, however, the demand cycle is slowing. "That's as real wages go a bit negative as global consumers—whether they be manufacturers or end users—become a bit more nervous,” Hamilton said.
On the supply side, Russia's invasion of Ukraine in February created a shock that Hamilton said will have lasting impacts. While Russia’s impact on natural gas supplies has been well noted, the country also accounts for about 40% of the global refined palladium supply, which is a crucial component in automotive catalytic converters and in certain stages of semiconductor manufacturing.
“We're seeing more Russian supply naturally flow into the Chinese market,” Hamilton said. “We've seen many companies develop markets, either sanctioned or self-sanctioned, away from Russian material. This sort of segmentation causes a couple of things. Purchasing managers get nervous, probably over-order to make sure there's enough material on the books. Then they have to deal with having excess inventory as things calm down a bit. But it also draws up lines for the longer term. We've seen consumers in developed markets have to pay a bit more for metals than might been the case in the past. We are seeing metal premiums in many cases at close to record levels.”
All told, Hamilton said BMO Capital Markets has lowered its growth expectations on both the supply and the demand sides. As purchasing managers remain nervous about supply chain issues and low inventory visibility, they’ll continue to pay a risk premium above the cost curve for the next 18 to 24 months. Meanwhile, higher energy prices and less efficient value chains create an inflationary environment in the medium term.
“Despite a decent medium-term demand side, we're still not seeing a supply reaction,” Hamilton said. "If anything, balances in a three-to-five-year outlook are looking tighter than before.”
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