Strategic Sourcing: Which Regional Price Discrepancies are Sustainable? Katherine Lewis Director, European Pricing and Purchasing 24 June 2009
Bottom Line Even though metals price differentials registering on exchanges, they are short-lived Causes of price premiums in the current downturn China s Stimulus Package Look for structural differences in strategic sourcing How fast do markets react? More heavily traded items and items traded on exchanges react most quickly More downstream items may take several months to respond
The Stimulus Effect China s Spending $586 billion in stimulus In the first three months of 2009, new lending by Chinese banks grew 30%, to $676 billion China s stimulus package, unlike its Western equivalents, is focused on industry and infrastructure Railways, Airports, Power Plants This draws materials in; whereas, the majority of spending in Western stimulus packages is in sectors that do not require heavy materials Western packages dominated by consumer side protection and relief
China s Spending (cont) Ore imports reached a record 57 million metric tons in April Copper purchases reached record 400K mt in April Oil stockpiles estimated around 30 days after crude imports jumped 14% in April Localities are stocking inventory in an effort to support prices and therefore production Experts fear stimulus money flowing to well connected state enterprises, rather than commercially minded, job creating mediumsized companies
Recent Price Discrepancies Aluminum Prices, cents per pound 170 150 130 110 90 70 50 2005 2006 2007 2008 2009 U.S. SHFE LME Aluminum Market Premiums, cents per pound 30 25 20 15 10 5 0-5 -10-15 2005 2006 2007 2008 2009 U.S. Market Premium SHFE Market Premium China s demand for raw materials recently is causing a premium in some traded commodities We expect the premium on the Shanghai Future Exchange to reach $25/mt by the end of 2009 Can the package keep demand alive until recovery arrives?
Steel Premium Gap Reverses on LME LME Steel Prices (US$/metric tonne) 625 575 525 LME already showing premium for Far East markets over Mediterranean steel 475 425 375 China was a net importer of steel in March and April 325 275 225 10/2/200811/16/200812/31/20082/14/2009 3/31/2009 5/15/2009 Far East Mediterranean Traded goods on LME show shorter periods of premium adjustment
Steel Premium Gap Closes Premium gap inverting for some products in May Europe still faces small premium Hot rolled is one of most heavily traded products, making reactions to premiums faster Less heavily traded products follow on a lag Plate prices take longer to adjust Hot-Rolled Sheet in Coils ($/Metric Tonne) 1400 1200 1000 800 600 400 200 0 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Europe North America China Steel Plate ($/Metric Tonne) 1800 1600 1400 1200 1000 800 600 400 200 0 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Europe North America China
Trends in Steel Spot Prices Typically, Western steel prices chase Asian prices down in a downturn Asian producers, specifically in China, undercut prices in North America and Europe Western producers forced to follow the trend down in order to move product When steel prices rebound, however, it is likely Western prices will lead the increases When demand returns, Western producers can use quality and geographic advantages to start implementing price increases
Steel Lead Times by Region Lead times drive prices Falling lead times are bellwether for rising prices Lead Time - Hot Rolled Sheet (Weeks) 20 18 16 14 12 10 8 Lead times in China hover in much higher range Typical delivery end point is further away Turkey saw major spikes in lead times as prices were peaking, but generally lead times there are the lowest However, this will be concentrated heavily on long products 6 4 2 0 17/04/06 21/08/06 25/12/06 30/04/07 03/09/07 07/01/08 12/05/08 15/09/08 19/01/09 US Northern Europe Southern Europe Turkey China Lead Time - Cold Rolled Sheet (Weeks) 18 16 14 12 10 8 6 4 2 0 17/04/06 21/08/06 25/12/06 30/04/07 03/09/07 07/01/08 12/05/08 15/09/08 19/01/09 US Northern Europe Southern Europe Turkey China
What Happens When Government Spending Ends? Goals of Stockpiling Restore profitability Hedge against declining value of dollar assets China already showing weakness in steel as government acts via tax rebates to boost exports again Net import position was result of slashed exports Spending falters & stockpiling wanes So what does this mean for China s producers? Western demand not returning in coming months Local demand was artificial
Demand for Raw Materials China s increased demand is a result of the stimulus package Industrial focus means premiums become common for necessary raw materials, even among globally traded commodities Government policy, rather than consumer demand, drives demand Is this sustainable? Government Spending Keeping Economy Afloat (Percent) 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Government Expenditure Private Consumption
Can Chinese Consumers Pull it Off? Consumption Share of GDP 2009 (Percent) Consumption Share of GDP 2019 (Percent) 2009 2019 0 20 40 60 80 China European Group of 4 United States 0 20 40 60 80 China European Group of 4 United States Can 900 million Chinese consumers replace 900 million U.S. & EU consumers? Consumption in China makes up less than 40% of GDP, compared to 70% in the U.S. and just under 60% for the Big Four in Europe We do not expect major shifts in consumption patterns over the forecast horizon
Fundamentals Suggest Only Temporary Strength Half of Chinese spending on materials is local governments stockpiling inventory to support prices Unsustainable spending growth Government spending masks weakness Total exports expected to continue falling through 2009Q3 Steel exports fell by 60% from January to April Exports dominated by Guangdong, Jiangsu, and Shanghai Real Exports Remain Weak (Percent change from a year earlier) 40 30 20 10 0-10 -20 2000 2002 2004 2006 2008 2010 Total Value of Commodity Exports (Millions US$) 1400000 1200000 1000000 800000 600000 400000 200000 0 2004 2005 2006 2007 Other Heilongjiang Xinjiang Uygur Hebei Beijing Liaoning Tianjin Fujian Shandong Zhejiang Shanghai Jiangsu Guangdong
What About Structural Differences? Input Cost Breakout, Machinery Manufacturing, China Share 2008 2009 2010 2011 2012 Costs 8.1-5.5 2.0 3.2 4.5 Compensation 17% 10.9 7.6 7.6 9.6 10.8 Steel 23% 18.4-14.9 4.9 1.5 3.6 Supplies 12% 3.4-0.9 0.9 0.8 1.7 Equipment and Parts 20% 1-7.9-4.5-0.5 1.3 Chemical and Allied 4% 5.1-8.6 1.6 2.7 2.9 Wire and Cable 4% -1.6-26.6 4.4 13.6 15.3 Overhead 19% 5.9-0.8 0.1 2.3 2.8 Downstream goods can take advantage of cheap labor inputs Average hourly earnings for China in 2008 were less than 10% of those earned in the US Despite large wage growth, cost advantages continue
Bottom Line Regional price discrepancies in raw materials are in large part due to China s stimulus package These are expected to be short-lived and not worth pursuing Regional price discrepancies based on more structural conditions are worth a look Turkey s Steel Production Intermediate goods
Thank you Katherine Lewis Director, European Pricing and Purchasing katherine.lewis@ihsglobalinsight.com