Consolidation alone will not reduce volatility

Implications: Pricing volatility has not been reduced. US HR coil prices have just dropped $150/ton (25%) in the last six months and could easily go up by the same amount in the next six. The difference is that the bottom of the current cycle is above most producers' cost level.

The theory is that consolidation will reduce price volatility as producers can reduce supply to meet demand, without the fear that others will simply supply in their place (i.e. no free-riding). That assumes a closed system. An open trading system is not closed by definition and even if the industry is consolidated on a continental level, it is not consolidated globally.

Consolidation has yet to be tested in a significant industry downturn. I would argue that consolidation in its current form will be useless in preventing prices going below operating costs in the event of a serious reduction in global demand, without an increase in protection.

Analysis:

While the major mature economies' steel industries (EU, North America and Japan) are consolidated into 3-5 major suppliers, there remain second-tier players that will continue to free-ride on the "responsible" producer cutbacks. We note AK Steel and Algoma and some Mexican suppliers were prepared to cut prices first and to lower levels than the larger players.

Moreover, 60% of world supply is in Asia, and here there has been little meaningful consolidation outside of Japan. There are around 100 steelmakers that produce more than 2m tpy of steel that are not in the global Top 10. State or family ownership here makes consolidation far less likely in these current good times.

Consolidation works best where there are barriers to entry either technical e.g. in automotive or packaging where there are quality restraints, or geographically where anti-dumping duties are in place.

Steel can travel globally and it can move to the markets where prices are highest. So even if responsible producers cut supply in one market in an effort to keep prices high, over-supply from other markets can come in and compete them away.

Steel demand growth has averaged over 8% in the last five years, and there is currently little spare supply capacity in the system. This is keeping prices high. However, that growth and profitability has spurred enormous capital expenditure on expansion.

Now imagine an Asian Crisis where global demand dropped by 10%. That would leave in excess of 120m tonnes of steel looking for a home. At that stage, prices would be forced down to below average costs, and the effects of consolidation would be really tested.