More Ore Cheap Iron Fires Steel Profits

As the price of iron ore drops to new lows, Germany’s steel industry is firing up its ovens and the country’s companies are saving billions.
Where your BMW was born.

Iron ore is an important export commodity for China, Australia, Brazil and India. And the ferrous rock is undoubtedly the most important raw material for German industry, critical to the steelmakers who need massive amounts for their carmaker and machinery tools customers. The heart of German industry wouldn’t beat without iron ore.

With prices of the raw material at the lowest level in ten years, German steel companies are thriving. Last year, 43 million tons of iron ore were imported at prices as low as $50 and while prices have risen above $60 for the first time in two months, they remain far below the average of $150 over the past five years. In total, the cost of imported iron ore has fallen by $4 billion, or €3.52 billion.

The collapse in prices was triggered by classic oversupply. As demand was declining, particularly in China because of cloudy economic forecasts, mining giants Vale, BHP Billiton and Rio Tinto increasing production. “And the companies are still expanding their capacities,” said Werner Eisenmann of DZ Bank. “That means the surplus in supply will continue for a couple of years. That puts a curb on prices.”

The low iron ore price is notable relief for car manufacturers, but car buyers will see little benefit.

Meanwhile, a decision made in 2009 also is helping the steel companies. Since then, they have been signing short-term contracts with the mining companies and can take advantage of the oversupply. Previously, prices were fixed once per year.

The ore prices are welcome relief for steel manufacturers, who are struggling with an excess capacity. Gross profits at many ironworks – sales minus cost of materials – improved noticeably last year. However, the tumbling of ore prices is only dimly reflected on the balance sheet as the recent weakness of the euro has eaten a bit of savings again. At ThyssenKrupp, for example, a source noted, “This results in a limited easing of the burden on the cost side.”

Far more critical than the weak euro is that steelworks now must pass on a major part of their savings to customers, which is one reason for the popularity of short-term contracts. “Our customers are keeping an eye on the prices there,” said Heinz Jörg Fuhrmann, chief executive officer of Germany’s second largest steel producer, Salzgitter.

While the steel industry keeps plants running to capacity – thanks to strong demand from the automotive and machinery construction sectors – sales volumes will, at best, remain stable or even decline slightly due to lower revenues.

 

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If a major customer demands a discount, ThyssenKrupp and its rivals can hardly refuse. That’s life in times of overcapacity, said sources at Salzgitter. Thus, the price for a ton of hot-rolled steel strip sank within a year from €500 to around €400. In terms of a mid-size car that moves around a ton of steel, this means savings of about €100.

This is notable relief for car manufacturers, but car buyers will see little benefit. At BMW, for example, the cost of materials has been reduced by just one percentage point within the year, largely because a car is made out of many kinds of materials and components beyond steel.

It is no different with the machinery and engineering industry, which is the second largest consumer of steel products. “The price advantage gets lost in the value-added chain,” said the VDMA, the German engineering association, as each individual processor skims off a part of the price effect.

While German industry argues over the cost savings generated by low ore prices, a different resource allocation conflict is raging overseas. Major mine operators supplying about three-fourths of the iron ore needed worldwide are squeezing out smaller companies. Experts at Unicredit’s Metal Bulletin Research found that thanks to lower costs, they remain comfortably positioned. Production is profitable even when prices drop under $40 a ton. So far, an end to the price war is nowhere in sight.

Therefore, major suppliers such as the Brazilian company Vale plan to continue lowering expenditures. The production of a ton of iron ore costs Vale around $20, but the company wants to cut costs by another $2, or 10 percent. The world’s largest mining corporation, BHP Billiton, said Tuesday it would reduce costs in its iron ore sector by another 20 percent.

Thus, prices are likely to sink further. And customers in Germany have something to cheer.

 

Regine Palm and Martin Wocher cover industry for Handelsblatt. Alexander Busch and Wolfgang Drechsler contributed to this article. To contact the authors: [email protected] and [email protected]