If the slump continues, steelmakers may cut production in this quarter, or the next, says Jt MD & Group CFO Seshagiri Rao.
JSW Steel, the leading steelmaker in India, says the industry be forced to cut production in the coming months as economic slowdown has dampened demand from clients in infrastructure and auto sectors.
While the auto sector has seen one of the sharpest drops in sales, government spending in infrastructure projects hasn't reached desired levels.
If this was bad enough, steelmakers are also facing an unusual situation: even as steel prices have gone south, rates of raw materials like iron ore and coking coal remain high. This has kept cost of production elevated, even as margins have come under pressure.
Due to these factors - and unless there is a stimulus from the government - it is unlikely that demand will pick up in the near future, said a senior official from JSW Steel.
"If you look the four sectors that reflect economic activity - capital goods, infrastructure, oil & gas and metals and mining - none of them is talking about investments...it is looking difficult for steel companies to make money in such circumstances," JSW Steel's Jt Managing Director & Group CFO Seshagiri Rao, told Moneycontrol.
"A production cut could be the answer. If not in this quarter, in the next quarter we could see a big cut in supply, all the variables remaining the same," said Rao.
JSW Steel last cut production in 2011, when a mining ban in Karnataka led to a severe shortage of iron ore, a key raw material in steel making.
In 2008 too, the steel company had closed its blast furnace for about a month as demand from auto and infrastructure sectors slumped.
An unusual cycle
This is the fifth down cycle that Rao is seeing in his 32-year career in the steel sector.
There was one in 1989, followed by the Asian financial crisis in 1997, and the third in 2008. JSW Steel faced a slowdown in 2011 because of the raw material crunch. And now, in 2019, another down cycle is impacting the industry.
But it is an unusual one, says the veteran.
"In almost all the cycles, raw material and steel prices moved in the same direction, even if not in the same proportion. If steel prices fell, iron ore and coking coal rates would also come down. But not this time," says Rao.
So even as steel price corrected to $480 a tonne, iron ore prices headed north. Similar was the trend in coking coal prices. But there was no supply adjustment, except in Europe. ArcelorMittal had cut production in many of its units in Europe.
But in rest of the steel market, including in India, producers have refrained from cutting production.
While prices of iron ore and coking coal have in the last month corrected, the general belief is that there is room for much more. And that is because the slide in price of steel products has been steeper.
A Business Standard report pointed out that since the beginning of the year, price of TMT bars and billets have fallen by up to 21 percent. Industry players have called for a cut in iron ore prices.
"A correction in iron ore is possible," says Rao.
Financialisation in steel sector
Explaining how the sector has evolved since 2008, Rao underlined that the circumstances have become more volatile.
"And that is because raw material contracts were earlier set, yearly. With the raw material price known, the steel rates would also move in similar range," recounts Rao.
But raw material contracts later became half-yearly, quarterly, monthly and are now indexed. "Funds entered, invested and any small disruption - actual or potential - led to changes in prices. With this financialisation, the movement in steel prices has become too volatile," says Rao.
On the other hand, the financialisation didn't happen in the steel side. Things remained the same when it came to fixing steel contracts. Even today, clients of JSW Steel prefer fixed price when awarding contracts. Some, like in auto, take into account price trend of the previous six months while deciding on the contract. But others, especially in infrastructure, don't.
"So adjusting to this kind of a situation itself is a challenge", says Rao.
The change has affected the length of a peak or a trough in the sector. "Prior to 2008, the downturn or a peak used to be longer," added the senior executive.This story has been updated after JSW Steel clarified that its comments were in relation to the industry and not itselfThe Great Diwali Discount!
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