The amount of steel consumed by a country has a strong correlation with its GDP growth and is a sound indicator of its stage of economic development. Numerous studies that reveal far greater per capita consumption of steel in developed countries compared with developing countries corroborate this.
India is no exception to this phenomenon. In the past decade, the rapid growth in GDP has been reflected in an equally vigorous increase in steel consumption.
There were some exceptions, however, to this generally buoyant trend: demand slumps were seen in 2008-09, due to the global financial crisis, and more recently in 2011-12, again due to the global economic slowdown, which, in turn, had an adverse bearing on domestic GDP growth.
Consequently, in 2011-12, domestic steel demand is estimated to have grown at 5-7 per cent, a far cry from the strong double-digit growth experienced in the five years prior to that. Due to lingering uncertainty over the pace of economic recovery in the short-to-medium term, Crisil Research reckons that domestic steel demand will grow by 6-8 per cent in 2012-13 compared with 2011-12. This means that demand for flat and long steel products is likely to rise marginally during the year. Long steel is a critical input in construction, both industrial and residential, whereas flat steel is used, for example, in cars and other consumer durables.
So, what does this projection of demand portend for steel prices? Something interesting — hitherto unseen, at least over the past few years — is on the anvil in domestic steel prices in 2012-13, due to a combination of disparate patterns in raw material prices and pick-up in demand.
Long and flat steel products
In the past few years, up to 2011-12, prices of long steel and flat steel products have always moved in tandem. But, we expect a departure from this trend in 2012-13.
Domestic prices of flat steel products are likely to slip by up to 5-7 per cent during the year, in line with the fall in the cost of production of flat steel and in the landed price of imported flat steel products. By contrast, prices of long products are poised to rise by 4-6 per cent. The key contributing factor to this is the dichotomy in prices of coking coal and non-coking coal.
The price of coking coal, which is used as an input in the manufacture of steel by large producers, shot up to historical high of $330/tonne in the early part of 2011-12 due to the floods in Queensland, Australia (which is the world's dominant exporter of coking coal) in January 2011. But with the gradual recovery in production, Crisil Research expects average coking coal prices in 2012-13 to be $220-240/tonne, over 20 per cent lower year-on-year.
Hence, for large producers, the cost of production of steel will decline in 2012-13 compared with the previous year. On the other hand, the cost of production will go up for small and mid-size steel producers, who use non-coking coal as an input.
In India, non-coking coal has, historically, been cheaper than coking coal because Coal India Ltd (CIL), the only domestic supplier of coal, kept domestic prices of non-coking coal lower than international prices. Because of this, small and mid-size steel producers were able to produce steel at lower cost compared with large producers.
In 2011-12, however, prices of non-coking coal spurted by 30 per cent as CIL hiked prices to narrow the difference between domestic and global prices. This increased the cost of production in 2011-12 for small and mid-size producers by about 22 per cent, although they still enjoyed a cost advantage because of high coking coal prices due to the floods in Australia.
In 2012-13, non-coking coal prices are expected to remain firm due to healthy demand and domestic coal shortage, which will necessitate continued imports. Hence, for small and mid-size producers, the cost of production will continue to either remain firm or even rise further in 2012-13.
The higher cost of production will force small and mid-size producers to increase the prices of long products, to provide a cushion to their operating margins.
Their dominant presence in the long products market and negligible imports will enable them to pass-through the entire increase in the cost. Small and mid-size producers account for about 60 per cent of the domestic production of long products, catering largely to a fragmented base of small, regional construction and infrastructure companies. Large producers, too, will follow suit with price increases in long products.
By contrast, prices of flat steel, made in India by large producers, will fall in 2012-13 due to lower production cost arising from the year-on-year fall in coking coal prices.
The price of the other critical input, iron ore, too, is expected to be firm in the domestic market in 2012-13 as supply constraints continue to plague the market.
Also, the ban on mining in Karnataka, coupled with the government's drive to close illegal mines, will continue to support high domestic iron ore prices.
The net effect of all this is that constructing homes, dams and power plants will become costlier, while car and consumer durables manufacturers will benefit from a decline in the price of flat steel.
The author is Director, Crisil Research, a division of CRISIL. Feedback to msamar@crisil.com
