Four Weeks into a Decline, U.S. Production Cut Nearly 5%

North American steel mills are quietly cutting production in response to decreased order levels evident since early May in response to fears of a surge in imports on the back of a potential slowdown in Chinese steel consumption.

Weekly domestic production, as reported every Monday by the American Iron and Steel Institute, has dropped by about 4.8% from a peak of 1.808 million tons (mt) for the week of June 19 to last week's 1.722mt. In contrast to recent cyclical downturns, today's production cuts are actually being implemented more frequently than they are being announced, as mills are more inclined to "walk the walk" these days rather than just talk about them.

Worries about charges of "signaling" or other antitrust issues mean that the only mill production cuts that are visible to the naked eye are union-driven WARN notices, and even these are quietly announced.

Stark Contrast With Chinese Production

The production response in the U.S. is in stark contrast with China, where in the past 12 weeks since steel prices peaked we've seen only a 2.9% production cut despite a far deeper steel price decline, down about double the level in the UnitedStates.

Production Meaningfully Overstated

The weekly production data has an implicit bias at inflection points, so that the current production rate is actually overstated. The industry's operating rate reported on July 10 showing a decline from 74.8% in mid-June to 71.2% is actually only a nominal reflection of reality because about half of the AISI member companies do not report weekly production and operating rates. In these cases, the AISI uses the prior month average production as a proxy.

If we assume that companies not reporting "real time" operating rates are cutting at the same pace as the ones that are reporting then the implied operating rate of the North American industry is actually closer to about 68% of capacity, the lowest operating rate since early February. The assumption may indeed be heroic; the only thing we know with certainty is that the domestic operating rate is actually most probably lower than indicated.

Further Production Cuts Likely

We'd expect to see further production cuts in coming weeks, both in the U.S. and abroad, in response to what are really only moderate declines in pricing and demand so far this mini-cycle. Unlike prior cycles, production cuts these days come faster than in the past simply because the variable cost piece of the North American production equation has risen dramatically for two reasons.

First, the proportion of EAF produced steel is up to 60% of the region's production; by its nature EAF steel is more variable cost (scrap vs. mined ore and coal). But EAF production is far easier to cut as well; EAF mills have more flexibility in production cuts than their blast furnace brethren. But even the blast furnace producers today have far greater flexibility in production cuts than in the past by virtue both of the greater proportion of variable costs in their process, but also because the consolidated industry has far more degrees of freedom with its vastly increased number of blast furnaces.

Michelle Galanter Applebaum spent more than 20 years as a managing director at Salomon Brothers in New York and was the No. 1-rated steel analyst from 1988-2003, according to Institutional Investor magazine. In 2003, Ms. Applebaum formed Steel Market Intelligence, a 5-person Chicago-based equity research boutique providing advisory services to institutional investors. In addition to publishing 10-15 reports/week, Ms. Applebaum sponsors numerous CEO-level meetings for her investor clients during the year. She is regularly quoted on Bloomberg, Dow Jones, The New York Times and makes frequent appearances on CNBC and other news programs. Ms. Applebaum lives near Chicago with her husband, visiting children and 2 dogs.

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