NEW YORK (TheStreet) -- The chiefs of Nucor (NUE - Get Report) and ArcelorMittal (MT - Get Report) anticipate a demand slowdown for steel during the second half of 2010.

This expected slowdown will coincide with rising raw material costs, and steel producers are likely to have a hard time passing on these higher costs to their customers. The combination likely will hurt steel industry profitability during the second half of this year.

Daniel DiMicco, chairman and CEO of steel producer Nucor, remarked that customers will pause before ordering for the third quarter in order to observe general economic conditions. And Lakshmi Mittal, chairman and CEO of ArcelorMittal, foresees steel demand slowing during the second half of the year.

Both executives made their remarks at the American Metal Market's Steel Success Strategies conference.

Steel producers are apprehensive about demand from the construction sector in light of a more than 10% decline in U.S. housing starts and a record 32.7% plunge in new-home sales during May.

Capacity utilization rates are anticipated to remain unchanged from the second quarter. Utilization rates for American steel plants reported by the American Iron and Steel Institute (AISI) during the second quarter were in the range of 70.8% to 74.8%, in comparison with the first quarter's range of 61.5% to 71.7%.

During the conference, U.S. Steel ( X - Get Report) CEO John Surma said, "The overwhelming dynamic affecting the pace and level of our industry's return to profitability today is the state of the raw materials markets."

Quarterly iron ore pricing implemented by mining giants Vale ( VALE - Get Report), BHP Billiton ( BHP) and Rio Tinto ( RTP) may help them realize higher iron ore prices during the remainder of the year.

Seaborne iron ore prices soared 90% during the second quarter and are poised to increase by 25% during the third quarter.

In the current environment of slowing steel demand, it will be difficult for steel producers to pass the hike in raw material costs to their customers.

Iron ore prices will increase an average of 12.4% during 2011, according to Morgan Stanley. Given the escalation in iron ore prices, steel producers will increase hedging against volatile iron ore prices using iron ore swaps.

Steel producers have been emphasizing vertical integration more than ever before. For instance, ArcelorMittal plans to expand iron ore capacity to 100 million tons from 60 million tons within the next five years to protect itself against price volatility.

Currently, the company has 45% self-sufficiency in iron ore at a 100% utilization rate.

In the current scenario of increasing raw materials costs, integrated steel producers such as U.S. Steel and ArcelorMittal likely will outperform industry peers.

Going long ArcelorMittal and shortingAK Steel ( AKS) may provide superior risk-adjusted returns during 2010.

Iron ore heavyweights such as the three big mining giants and Cliff Natural Resources ( CLF), a metal stock-pick for 2010 may generate higher returns for investors.

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