S&P Industrial Metals Jan2008

8/6/2019 S&P Industrial Metals Jan2008

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January 17, 2008

Industry SurveysMetals: Industrial

THIS ISSUE REPLACES THE ONE DATED JULY 12, 2007.

THE NEXT UPDATE OF THIS SURVEY IS SCHEDULED FOR JULY 2008.

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Leo J. LarkinSteel & AluminumAnalyst

CURRENT ENVIRONMENT..................................................................1Steel eased in 2007Steel profits should rise in 2008Merger activity accelerated in 2007BHP rocks the steel marketAluminum profits disappoint in 2007Aluminum price and profits likely to decline in 2008Aluminum consolidation heated up in 2007

INDUSTRY PROFILE...............................................................................9Economic cycles and long-term trends drive metals

INDUSTRY TRENDS ..................................................................................9Thin-slab technology recasts steel sheet marketHigher scrap prices to limit minimill expansionsConsolidation takes hold in domestic steelGlobal view: foreign competition looms largeAluminum glut abatesChinas aluminum industry key to conditions in 2008 and beyondImports remain a challenge for US steelmakers

HOW THE INDUSTRY OPERATES ..............................................................17Steel: evolving to surviveAluminum: still vertically integratedEconomic cycles drive demandEarly cycle, late cycleThe Internets roleRegulation

KEY INDUSTRY RATIOS AND STATISTICS....................................................23Steel and aluminumSteelAluminum

HOW TO ANALYZE AN INDUSTRIAL METALS COMPANY .............................24Key revenue and cost factorsThe income statementBalance sheet data

GLOSSARY .............................................................................................31

INDUSTRY REFERENCES.....................................................................33

COMPARATIVE COMPANY ANALYSIS ..............................................35


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VOLUME 176, NO. 3, SECTION 1

THIS ISSUE OF INDUSTRY SURVEYS INCLUDES 1 SECTION.

Standard & Poors Industry Surveys


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Conditions in the US steel industry deterio-rated in the first nine months of 2007 due toweakness in three key markets. According todata from the American Iron and Steel Insti-tute (AISI), a trade association, US steel con-sumption (domestic shipments plus imports,minus exports) decreased to 97.6 milliontons, down 12.5% from 111.5 million tonsin the comparable year-earlier period. In con-trast, consumption in 2006 increased 7.7%.

Shipments for the first nine months of2007 declined to 79.7 million tons, from84.3 million tons for the first nine months of

2006. Total imports fell to 26.1 million tonsfrom 35.0 million tons. Through December15, 2007, production totaled 102.4 milliontons, versus 104.8 million tons in the compa-rable period in 2006; the industrys capacityutilization rate for the period in 2007 was86.0%, versus 87.5% a year earlier.

According to AISI statistics, shipments toconstruction and distributor markets de-

creased 2.9% and 11.6%, respectively, forthe first nine months of 2007 from the com-parable year-earlier period.

Given that nonresidential building con-struction rose 17.3% for the first 10 monthsof 2007, according to the US Census Bureau,

we are surprised that shipments to the con-struction industry fell. If anything, we wouldhave expected to see a low single-digit riseor, at worst, shipments that were flat with2006. On the other hand, distributors liqui-dation of inventories and reduced shipmentsto this sector in the first nine months of2007 had been expected because their inven-tories reached excessively high levels in thelatter part of 2006.

Shipments to the auto market for the firstnine months of 2007 fell 1.0% from the sameperiod a year earlier. Total motor vehicle salesfor the first 11 months of 2007 decreased1.7%, while production through November2007 was down 2.3%. We surmise that sincesales and production were roughly in balanceduring this period, this factor may have less-ened the impact of lower vehicle sales onshipments to the auto industry.

The industrys downturn is apparent inaggregate financial results for the four lead-

ing domestic steel companies for the firstnine months of 2007. These firms, whichStandard & Poors follows as a proxy for in-dustry performance, are AK Steel HoldingCorp., Nucor Corp., Steel Dynamics Inc.,

and United States Steel Corp. Collectively,

CURRENT ENVIRONMENT

Steel eased in 2007

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I N D U S T R I A L I N D U S T R Y S U R V E Y

US STEEL PRODUCTION, CAPACITY, UTILIZATION, AND CONSUMPTION

NET USPRO- SHIP- APPARENT PRODUCTION

OPERA- CAPACITY DUCTION MENTS EXPORTS IMPORTS SUPPLY* IMPORTS TOTAL WORLD AS % OFTING AS % OF PRODUCTION TOTAL WORLD

YEAR RATE (%) MILLIONS OF TONS SUPPLY (MIL. TONS) PRODUCTION

2006 87.9 123.6 108.6 108.6 9.7 45.3 144.2 31.4 1,366.3 8.0

2005 85.8 119.8 102.8 103.5 9.4 32.1 126.2 25.4 1,256.2 8.2

2004 93.8 116.3 109.1 112.1 7.9 35.8 140.0 25.6 1,178.2 9.3

2003 84.9 121.6 103.3 106.0 8.2 23.1 120.9 19.1 1,069.2 9.7

2002 88.8 113.6 101.0 100.0 6.0 32.7 126.7 25.8 996.5 10.1

2001 79.2 125.4 99.3 98.9 6.1 30.1 122.9 24.5 937.5 10.6

2000 86.1 130.4 112.2 109.1 6.5 38.0 140.5 27.0 934.4 12.0

1999 83.8 128.2 107.4 106.2 5.4 35.7 136.5 26.2 869.7 12.3

1998 86.8 125.3 108.8 102.4 5.5 41.5 138.4 30.0 856.8 12.7

1997 89.4 121.4 108.6 105.9 6.0 31.2 131.0 23.8 880.6 12.3

1996 90.7 116.1 105.3 100.9 5.0 29.2 125.0 23.3 826.9 12.7

*Consumption.

Sources: American Iron and Steel Institute; International Iron & Steel Institute.


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ANUARY17,2008/METALS:INDUSTRIALINDUSTRYSURVEY

these companies accounted for 43.7% of in-dustry shipments in 2006.

For the four companies in our proxygroup, average revenue per ton (revenues di-vided by shipments) rose to $803 for the firstthree quarters of 2007, from $716 for thesame period of 2006. Shipments declined to35.5 million tons, from 36.1 million tons,but revenues rose to $28.3 billion from $25.9

billion. Operating profit declined to $3.6 bil-lion from $3.9 billion a year earlier.

The rise in revenues for our proxy group re-flected higher revenue per ton along with theimpact of acquisitions by United States Steeland Nucor. In our view, the proxy group real-ized increased revenue per ton as higher con-

tract prices and a more lucrative product mixoffset lower spot prices for steel. (The averagerealized price per ton reported by steelmakersis a blend of spot and contract prices.) Howev-er, higher costs and lower shipment volume re-

sulted in a decline in profits at both UnitedStates Steel and Nucor, and caused aggregateprofits for our proxy group to decline. In con-trast, both AK Steel and Steel Dynamicsrecorded higher shipment volume and in-creased operating profit for the period.

Mild industry recovery seen in 2008As of late December 2007, Standard &

Poors was forecasting real GDP growth of1.9% in 2008, versus growth of 2.2% esti-mated for 2007. We look for a rebound in

demand from two of steels three most im-

portant markets, and, on that basis, we ex-pect a 1.0% to 3.0% increase in the volumeof tons shipped in 2008, an improvementfrom the projected decline of 5.0% in 2007.We believe that distributors will rebuild in-ventories in 2008, and we look for flat toslightly higher shipments to the constructionmarket in 2008. In addition, we project a de-cline in imports in 2008, which should en-

able domestic companies to gain marketshare. Partially offsetting these positive fac-tors is a forecasted decline of 3% to 4% inshipments to the auto industry.

Service centers. We project that ship-ments to distributors will increase by 2% to

3% in 2008, following an expected decreaseof 11% in 2007. In our opinion, inventorylevels at distributors reached unsustainablylow levels in 2007 in contrast with the veryhigh levels attained in late 2006. Since Sep-

tember 2006, distributors have steadily liqui-dated steel inventories.

In our view, expected GDP growth of1.9% combined with very low inventories in2007 should prompt distributors to rebuildinventories in 2008. According to the MetalsService Center Institute (MSCI), an industrytrade association, distributor steel inventoriestotaled 12.10 million tons at the end of No-vember 2007, or 3.0 months of supply,which is considered normal. At the 12.10

million ton level, inventories were 27% be-

low year-earlier levels and were at the lowest

US SHIPMENTS OF STEEL PRODUCTS, BY MARKET CLASSIFICATION(In thousands of net tons)

MARKETS 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Appliances 1,635 1,729 1,789 1 ,907 1,820 1,714 2,018 2,035 1,895 1,781

Automotive 15,251 15,842 16,771 16,063 14,059 13,988 15,883 16,574 13,031 14,003

Construction 15,885 15,289 18,428 20,290 21,543 20,536 23,787 21,926 15,858 17,544

Containers 4,163 3,829 3,842 3,708 3,232 3,237 3,028 2,973 2,504 2,535Converting & processing 11,263 9,975 11,309 12,708 10,311 9,710 9,448 8,151 7,559 8,531

Electrical equipment 2,434 2,255 2,267 2,055 1,684 1,341 1,099 1,075 1,088 1,227

Machinery 2,355 2,147 1,722 1,784 1,456 1,402 1,178 1,434 1,300 1,360

Oil & gas 3,811 2,649 2,151 2,885 2,953 2,098 2,112 2,504 2,056 2,459

Svc. centers & dist. 27,800 27,751 28,089 30,108 27,072 27,473 28,551 33,812 23,213 23,706

Other domestic &

comm'l equip. 992 1,086 939 1,136 734 851 589 715 575 5 56

Other 4,911 4,672 3,748 3,832 3,198 3,041 2,425 2,627 1,854 2,207

Nonclassified 12,748 12,640 12,738 9,725 8,342 12,342 12,962 15,079 29,950 29,632

Exports 2,610 2,556 2,408 2,849 2,536 2,267 2,894 2,479 2,592 3,068

Total shipments 105,858 102,420 106,201 109,050 98,940 100,000 105,974 111,384 103,474 108,609

Source: American Iron and Steel Institute.


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since November 1997. Consequently, we an-ticipate that distributors likely ceased liqui-dations by the end of 2007 and will add toinventory by the middle of the first quarter

of 2008.

Autos. As of late December 2007, Stan-dard & Poors projected that unit sales oflight vehicles would decline in 2008, to 15.5million units, from 16.1 million units esti-mated for 2007. Given this projection, webelieve that steel shipments to this sector willdecline 3.0% to 4.0% in 2008, versus a pro-jected decline of 2.0% in 2007.

Year-to-date statistics on the auto industryseem to indicate that production and salesfor motor vehicles remain roughly in bal-ance. In our opinion, this balance mitigated

the impact of lower sales on steel industryshipments to the sector. Through November

2007, total vehicle sales were down 1.7%,and total auto production was down 2.3%.For the Detroit Three (formerly the BigThree) US auto companies, the balance be-tween production and sales was less favor-able than for the industry in the aggregate.For the Detroit Three, vehicle sales declined7.5% through November, while productiondecreased just 4.0% through November.

Thus, assuming that the Standard &

Poors forecast for lower sales in 2008 is cor-rect, this suggests to us that the DetroitThree auto companies will be cutting vehicleproduction and selling out of inventorythrough the end of 2007 and into early2008. Combined with the aggregate industry

sales decline that Standard & Poors envi-sions in 2008, we look for reduced auto pro-duction and increased vehicle sales out ofinventory. In turn, lower motor vehicle pro-duction will likely result in another decline insteel shipments to the auto sector in 2008.

Construction. We anticipate flat toslightly higher shipments to the constructionmarkets in 2008 following an estimated de-cline of 2.5% in 2007. This forecast is basedon our assumption of a continued upturn inthe private nonresidential sector of the con-struction market.

While Standard & Poors does not have aspecific forecast for this subset of nonresi-

dential fixed investment, we anticipate con-tinued gains in the sector in 2008. In our

view, the nonresidential sector of the con-

struction market bottomed in 2003, when itdeclined 5.2% from the level in 2002. Ac-

cording to statistics compiled by the US Cen-sus Bureau, private nonresidential spendingincreased 9.2% in 2005 and 16.2% in 2006.Through October 2007, private nonresiden-

tial spending was up 17.3%.

Steel imports likely to decline again in 2008We project that imports of finished steel

(total imports, minus imports of semifinishedsteel purchased by domestic producers forfurther processing) will decline by 10% to12% in 2008, following a projected decreaseof 24% in 2007. We see imports declining in2008 for two reasons.

First, we anticipate that increased costsfor raw materials and shipping in 2008 will

make the US market less attractive for for-eign producers. Since US-based companiesare less dependent on outside suppliers for

raw materials than most of their overseascompetitors, higher raw materials place for-eign producers at a cost disadvantage. This,when combined with the rising cost of ship-ping, makes it very difficult for foreign com-panies to take share from US companies byundercutting US companies on price. Conse-quently, we see these higher costs leading toanother drop in imports in 2008.

Second, we believe that a continuing declinein the US dollar in 2008 will make importedsteel more expensive and reduce exports to theUnited States. In 2006, the value of the USdollar, as represented by the trade-weightedFinex US dollar index, fell 10.7%. (Finex isthe New York Board of Trades currency op-

tions and futures department; the trade-weighted dollar index provides a generalindication of the dollars international value bymeasuring the exchange rates of the US dollaragainst six major world currencies.) Through

late December 2007, the US dollar index wasdown another 8.4%. The most likely result ofa further dollar decline in 2008 would be mar-ket limitations to the amount of steel being im-ported into the United States. Given ourexpectation of rising raw material and ship-ping costs, we look for another decrease insteel imports in 2008.

Steel profits should rise in 2008

Following an estimated profit decline of

7% in 2007, we anticipate that aggregate


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profits for the four companies comprisingour industry proxy will post a 5% gain in2008. This expectation reflects our forecastfor increased volume, firmer spot steel prices,

and higher steel contract prices.In our opinion, a combination of invento-

ry rebuilding by distributors, firm demandfrom construction markets, and lower im-ports will result in higher volume and anoth-er increase in average realized prices. Weexpect that greater shipment volumes andhigher prices will more than offset the in-crease in raw material costs in 2008.

In addition, lower costs for integrating ac-quisitions should aid profits. Three of thecompanies in our proxy group made largeacquisitions in 2007, and we anticipate thatcosts associated with these mergers will de-

cline in 2008.

Merger activity accelerated in 2007

In 2006, several significant mergers andacquisitions took place in the steel industry.Arcelor SA completed its unsolicited takeoverof Canadian steelmaker Dofasco Inc. for$4.85 billion in March. This was followed in

June by the merger of Mittal Steel Co. NVand Arcelor to create the worlds largest steelcompany. On a smaller scale, Steel Dynamics

completed its acquisition of Roanoke ElectricSteel in April 2006 for $281 million, raisingits capacity to five million tons (from fourmillion) and increasing its capacity to producesteel joists and decking.

In 2007, steel industry merger activity ex-ceeded the pace seen in 2006. In January,

Russian steelmaker Evraz SA acquired Ore-gon Steel Mills, a Portland, Oregonbasedproducer of specialty steel, for $2.3 billion.In March, India-based Tata Steel Ltd. com-pleted its acquisition of UK-based Corus

Group Plc for $12.4 billion. That samemonth, Nucor completed the acquisition ofHarris Steel Corp. for $1.45 billion, and pri-vately held Esmark Inc. and Wheeling-Pittsburgh Steel Corp. announced an agree-ment to merge in a transaction valued atsome $300 million (Esmark completed theacquisition on November 27, 2007). In June,United States Steel acquired Lone Star Tech-nologies for $2.1 billion. On July 18, 2007,SSAB Svenskt Stal AB of Sweden completed

its acquisition of IPSCO Inc. of Lisle, Illinois,

for $7.7 billion. On October 16, 2007, Steel

Dynamics completed the acquisition of pri-vately held OmniSource Corp., a scrapprocessor and trading company, in a transac-

tion valued at some $1.1 billion. On October31, 2007, United States Steel completed itstakeover of Canada-based steelmaker Stelco

Inc. for some $1.2 billion. On November 19,2007, Quanex Corp. announced that itwould sell its steel bar business to GerdauS.A. as part of a restructuring.

We see merger activity continuing in2008 given the combination of low bor-rowing costs, high stock prices, and the largeamounts of cash being generated by manysteel companies although the size andnumber of acquisitions may fall short of2007s high level. Another factor we seeprompting mergers is what appears to be a

secular rise in raw material costs. Steel pro-ducers need to become larger in order tocope with this challenge, and we see this as acatalyst for continued merger activity. Final-ly, despite all the transactions in 2006 and2007, the industry remains fragmented, bothdomestically and internationally; therefore,we see room for additional mergers on thatbasis as well.

The return of vertical integration?Future merger activity could differ slightly

from the recent past in that steel companiesattempt to become more vertically integrat-ed. Instead of buying other steel producers,mergers between service centers and steelcompanies may come back into vogue in theUS market. For example, the merger of Es-mark Inc. and Wheeling-Pittsburgh Steelcombines Esmarks service centers with

Wheeling-Pittsburghs steel production. Partof the large contraction that occurred in theUS industry in the 1980s and 1990s involvedthe separation of service centers from steel

producers. The Esmark/Wheeling-Pittsburghmerger is a clear change in trend, butwhether such transactions become pervasiveremains to be seen.

In addition to buying service centers, an-other aspect of vertical integration in mergeractivity is apparent in the takeover of Om-niSource by Steel Dynamics. Traditionally,steel minimills relied on outside scrap ven-dors for their raw material needs. The SteelDynamics purchase of OmniSource may rep-

resent a trend toward becoming less dependent

on outside vendors. In short, it represents an


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attempt to become more vertically integratedvia mergers.

BHP rocks the steel market

On November 8, 2007, BHP Billiton Ltd.,

the worlds largest miner of base metals,stunned the steel industry by announcing anunsolicited offer to acquire Rio Tinto PLC(another base metals mining company) in anall-stock transaction valued at $153.2 billion,based on the closing stock prices of both com-panies on October 31, 2007. On the verysame day, directors of Rio Tinto rejectedBHPs offer, stating that it significantly under-valued Rio Tinto and its prospects. A mergerof the two companies would create theworlds second largest iron ore mining compa-

ny and add to what is already a highly con-centrated oligopoly for shipped iron ore.Currently, BHP, Rio Tinto, and Vale (formerly

Companhia Vale do Rio Doce) account for75% of all shipped iron ore.

BHPs proposed merger has triggered vigor-ous opposition from steel industry federationsin China and Japan on the grounds that thecombination would injure steel companies bycreating an overly concentrated iron ore indus-try. In addition, the International Iron andSteel Institute (IISI) an industry trade asso-

ciation based in Brussels issued a statementon November 19, 2007, asking regulatory au-thorities to prevent the planned merger on thegrounds that the combination would be con-trary to the public interest. BHP has tried todefuse steel industry opposition by pointing

out that the proposed merger would result inthe elimination of competition for increasinglyscarce transportation assets and thereby im-prove delivery times to customers.

On December 1, 2007, Rio Tinto issued astatement that said it would speak with BHP,

provided BHP was prepared to raise its offer.Rio Tinto subsequently reiterated its rejec-tion of BHPs offer in a December 27 letterto Rio Tinto shareholders in which the com-pany said that BHPs offer undervalued RioTinto and its prospects. As of late December2007, there had been no formal discussionsbetween BHP and Rio Tinto.

Aluminum profits disappoint in 2007

For the first three quarters of 2007, the

four largest North American aluminum

companies Alcan Inc., Alcoa Inc., Cen-tury Aluminum Co., and Kaiser AluminumCorp. which Standard & Poors followsas a proxy for industry performance, re-

ported an operating profit of $5.74 billion,versus $5.71 billion a year earlier. Rev-

enues increased to $45.1 billion from$42.1 billion, while shipments declined to8.08 million metric tons from 8.12 millionmetric tons.

In our view, the increase in revenues re-sulted entirely from a higher aluminumprice. We believe that a higher price offsetthe decline in shipment volume. The alu-minum price as measured by the indus-trys main benchmark, the London MetalExchange primary (or ingot) price aver-aged $1.25 a pound for the first three

quarters of 2007, versus $1.14 a poundfor the same period in 2006. However, due

to the impact of lower volume and in-creased raw material costs, margins con-tracted, and aggregate profits werevirtually unchanged despite a 9.6% in-crease in the average price of aluminumand a 7.1% rise in revenues.

We think that shipment volume decreaseddue to lower motor vehicle production and asharp decline in housing starts in the US. In-creased demand from aerospace and from

the rest of the world partially offset theweakness in the auto and housing segments,and may have tempered the decline in ship-ment volume. Through October 2007, globalconsumption was up 9.4%, led mostly byChina. For the same period, aluminum de-

mand in the US fell 9.3%.The increase in the aluminum price

in 2007s first three quarters comparedwith 2006s first three quarters likely re-flected tighter supply early in 2007 andstronger demand outside the United States.

According to statistics compiled by theWorld Bureau of Metal Statistics, a UK-based metal publishing company, totalcommercial stocks (the sum of metal ex-change inventories and aluminum held byindividual nations) stood at 2.79 millionmetric tons at the end of March 2007, ver-sus 2.96 million metric tons a year earlier.We believe that this reduced level of com-mercial stocks, along with a market deficit

of 315,000 metric tons at the end of 2006,and higher global demand led to an in-

crease in the average price of aluminum.


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Aluminum price and profits likely todecline in 2008

Based mostly on our expectation for an av-

erage aluminum price of $1.15 in 2008 (versusan estimated average price of $1.25 in 2007),as well as lower shipment volume, we antici-pate lower sales and profits for aluminum

companies in 2008. As was the case in 2007,US demand for aluminum in 2008 will likelydecline due to weakness in two key markets,along with less vibrant economic growth. As oflate December 2007, Standard & Poors wasprojecting real US GDP growth of 1.9% in2008, versus growth of 2.2% (estimated) in2007. Standard & Poors also forecasted a de-cline in unit sales of light vehicles to 15.5 mil-lion in 2008, from 16.1 million estimated for2007, and a precipitous drop in housing starts(1.02 million units in 2008, versus 1.35 million

estimated for 2007).

Partly offsetting the impact of slowergrowth and a decline in key markets is ourexpectation for a continued upturn in de-

mand from the aerospace market, alongwith increased economic growth in the restof the world.

Another critical factor that could mitigatethe negative impact of reduced US demand

on prices and profits is the behavior of Chi-nas aluminum industry. In our view, Chinastransition from being a net importer of alu-minum from 1993 through 2001 to a netexporter in 2002 has been a drag on the alu-minum price and aluminum industry profits.In our view, had China remained a net im-porter of aluminum, or had its domesticsupply and demand been in balance, thealuminum price and industry profits wouldhave been higher in recent years. Moreover,

while the price of aluminum has been rising

steadily since 2002, it has dramatically

WORLD PRODUCTION OF REFINED ALUMINUM

(In thousands of metric tons)

UNITED UNITED WORLDYEAR STATES CANADA FRANCE GERMANY KINGDOM NORWAY INDIA AUSTRALIA CHINA RUSSIA TOTAL

2006 2,281 3,051 440 516 360 1,422 1,105 1,932 9,349 3,718 33,952

2005 2,480 2,894 442 648 368 1,376 942 1,903 7,806 3,647 32,021

2004 2,517 2,592 451 668 360 1,322 861 1,895 6,689 3,594 29,922

2003 2,704 2,792 443 661 343 1,192 799 1,857 5,547 3,478 28,001

2002 2,705 2,709 463 653 344 1,095 671 1,836 4,321 3,348 26,076

2001 2,637 2,583 461 652 341 1,068 624 1,784 3,371 3,302 24,436

2000 3,668 2,373 441 644 305 1,026 649 1,762 2,794 3,247 24,418

1999 3,779 2,390 455 634 270 1,020 621 1,719 2,598 3,146 23,710

1998 3,713 2,374 424 612 258 996 545 1,626 2,335 3,005 22,654

1997 3,603 2,327 399 572 248 919 547 1,490 2,035 2,906 21,798

Source: World Bureau of Metal Statistics.

WORLD CONSUMPTION OF REFINED ALUMINUM(In thousands of metric tons)

UNITED UNITED WORLDYEAR STATES CANADA SPAIN FRANCE GERMANY ITALY KINGDOM JAPAN CHINA RUSSIA TOTAL

2006 6,150 854 620 713 1,823 1,021 401 2,323 8,648 1,047 34,053

2005 6,114 803 624 719 1,758 977 353 2,276 7,119 1,020 31,711

2004 5,800 760 603 749 1,795 987 439 2,319 6,043 1,020 29,9642003 5,667 736 596 754 1,916 956 302 2,235 5,178 802 27,606

2002 5,509 747 533 762 1,690 850 428 2,010 4,115 990 25,370

2001 5,230 743 508 746 1,580 756 433 2,014 3,492 786 23,721

2000 6,161 800 526 782 1,491 780 576 2,225 3,499 748 25,059

1999 6,158 777 494 774 1,439 735 597 2,112 2,925 563 23,312

1998 5,814 721 436 734 1,519 675 579 2,082 2,425 489 21,825

1997 5,390 644 430 724 1,558 654 583 2,434 2,260 469 21,797

Source: World Bureau of Metal Statistics.


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lagged the increases in the price of other base

metals, such as copper and nickel.In 2006, for the fifth time in as many

years, China had a surplus of production

over consumption: 701,000 metric tons, upfrom a surplus of 687,000 metric tons in 2005.However, the increase in the surplus in 2006was the smallest since China became a netexporter in 2002. This contraction in thesurplus was solely the result of much higherconsumption. Notwithstanding a news reportin the China Daily newspaper in December2005 that 23 of that nations largest smelters

planned to cut production by some 250,000metric tons, production increased 19.8%in 2006 versus a 16.7% rise in production in2005. Consequently, there appears to havebeen very little letup in Chinas production.

However, in the first 10 months of 2007,Chinas surplus of production over consump-

tion totaled 220,000 metric tons, down from590,000 metric tons in the comparable year-earlier period, as sharply higher demand off-set increased production. As long as thesurplus continues to shrink for the balance of

2007 and persists in 2008, via an increase inChinas domestic consumption, this shouldhelp offset lower US demand and prevent acollapse in the aluminum price. Of course,an acceleration in output or a decline in Chi-nas consumption could cause the surplus toexpand and exacerbate the impact of a pro-jected decline in US demand on the alu-minum price in 2008.

Based on the decrease in the surplusthrough October 2007, along with the com-

paratively small rise in the surplus from

2006 over 2005, we are cautiously optimistic

that efforts by the Chinese government to re-duce exports and their negative impact onthe world market are beginning to take hold,

albeit with a lag. Before 2004, aluminum ex-ports received a 15% tax refund. Beginningin January 2005, the Chinese government

cancelled the 15% export tax refund andplaced a 5% tax on exports of aluminum.We believe that these actions had the effectof shifting overseas sales back into the do-mestic market in 2006. If our assumption iscorrect, the decline in the surplus of domesticChinese production over domestic consump-tion seen through most of 2007 should con-tinue in 2008.

Aluminum consolidation heated upin 2007

Aluminum industry consolidation pickedup in 2007 with the formation of United

Company Rusal on March 27, 2007. Thenew company was formed through a three-way merger combining Russias OAO Rusal,the worlds third-largest aluminum producer,with Sual Group, a Russian aluminum pro-ducer, and Glencore International AG, aSwitzerland-based trading company. Follow-ing the merger, United Company Rusal be-came the worlds largest aluminum company,

with annual aluminum capacity of some fourmillion metric tons and alumina capacity of11 million metric tons.

On May 15, 2007, Atlanta-based NovelisInc., the worlds largest producer of alu-minum rolled products, was acquired byIndia-based Hindalco Industries Limited for

some $6 billion. Hindalco is one of Asiaslargest producers of primary aluminum; thecompany also produces copper.

On November 15, 2007, Rio Tinto PLCcompleted its takeover of Alcan Inc., the

worlds third largest aluminum producer, inan all cash transaction valued at $38.1 bil-lion. Rio Tinto topped a hostile cash andshare offer by Alcoa Inc. to acquire Alcan for$27.8 billion. Following the merger, Rio Tin-to is the worlds largest aluminum producerand the worlds second largest alumina pro-ducer. (As mentioned earlier in this section,BHP Billiton is attempting to acquire RioTinto in an all-stock transaction.)

We believe that BHP will ultimately pre-

vail in its attempt to acquire Rio Tinto, al-

beit at a higher price that includes a cash

ALUMINUM SHIPMENTS TO MAJOR US/CANADIAN MARKETS*(In millions of pounds)

2000 2001 2002 R2003 R2004 2005

Building/construction 3,204 3,297 3,447 3,432 3,692 3,693

Transportation 7,947 7,028 7,518 7 ,804 8,509 8,683

Consumer durables 1,692 1,439 1,522 1,498 1,585 1,561

Electrical 1,704 1,513 1,493 1,433 1,583 1,657

Machinery & equipment 1,496 1,476 1,427 1,452 1,610 1,664

Containers & packaging 4,992 4,961 4,979 4,941 5,098 5,115

Miscellaneous industries 645 812 925 843 827 740

Total domestic 21,680 20,526 21,311 21,403 22,904 23,113

Exports 2,816 1,984 2,433 1,988 2,048 2,482

Total 24,496 22,510 23,744 23,391 24,952 25,595

*Includes imports of ingots and semifabricated metal; US only before 2001. Latestavailable. R-Revised.

Source: The Aluminum Association.


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component. In addition, we surmise that theproposed new company would have to divestsome of its iron ore assets in order to elimi-nate antitrust concerns.

In our opinion, a merger with BHP is acompelling proposition given the large sav-

ings that a combined company could achieve.Merging the two companies would create amuch larger entity that would have greaterpower to negotiate favorable terms from sup-pliers. A merger would also make large costreductions possible via the elimination of du-plication in mining locations where bothcompanies currently operate. Further, com-bining the companies would reduce competi-tion for increasingly scarce transportationassets and improve delivery to customers. Fi-nally, the merger would give Rio Tinto expo-

sure to oil and natural gas, which it lacks asa standalone company.

If the proposed merger is completed, thenew company would become the worldslargest producer of aluminum and copper,and the second largest producer of iron ore.In addition, the planned merger wouldmake the aluminum industry more concen-trated than ever. We estimate that UnitedCompany Rusal, Alcoa, and Alcan togetheraccounted for 43.6% of primary global alu-minum production in 2006. Collectively,

Alcoa, Alcan, and Rusal accounted for36.6% of global output in 2000. On a proforma basis, which assumes that BHP hadacquired Alcan and Rio Tinto in 2006,United Company Rusal, Alcoa, and BHPwould have accounted for 54% of global

primary aluminum production in 2006.In our view, consolidation of the indus-

try is a positive development. The concen-tration of production in the hands of fewer,more financially able companies should re-sult in greater price and production disci-

pline. A more concentrated industry islikely to resist radical price cuts at thetrough and over expansion at the peak ofthe cycle. In turn, this should result in lessvolatility in sales and profits over thecourse of the business cycle.


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Steel and aluminum are the dominant prod-ucts of the US industrial metals sector. How-ever, the manufacturing processes and scalesfor these two metals are quite different. Thealuminum industry is concentrated and oli-gopolistic. The steel industry is more frag-mented, and steelmakers are smaller than

aluminum companies. For example, in 2006,the two largest North American aluminumproducers accounted for 28.0% of the worlds

primary aluminum production, whereas thetwo largest North American steel companiesaccounted for just 3.8% of global steel out-put. However, the steel industry is undergoinga technological and structural transition, andcompetition together with rising costs forraw materials is forcing consolidation.

INDUSTRY TRENDS

The primary factor affecting near-termperformance of the industrial metals industry

is economic growth, as measured by realgross domestic product (GDP). Industrialmetals companies are highly dependent onthe fortunes of the cyclical auto and con-struction industries. In 2006, those two in-dustries accounted for 33.3% of US directsteel shipments, according to data from the

American Iron and Steel Institute (AISI), atrade association. For the US and Canadianaluminum industries, the transportation and

construction markets accounted for 47.3%of shipments in 2006. Containers (mostlybeverage cans) and packaging are also criti-cal markets for aluminum, accounting for19.7% of shipments in 2006. (The industryssensitivity to economic cycles is discussedfurther in the How the Industry Operatessection of this Survey.)

Against a backdrop of economic cycles, the

most important long-term trends shaping theindustrial metals industries are related to newmanufacturing technology, consolidation, for-eign competition and imports, and raw materi-als costs. These trends will exert significantinfluence on the direction of industrial metalscompanies for the foreseeable future.

Thin-slab technology recasts steelsheet market

Since the 1960s, changes in manufacturing

technology have revolutionized the US steelindustry. In the late 1980s, the advent ofthin-slab casting technology a refinementof continuous casting allowed minimills tocompete in the carbon sheet and strip prod-ucts market, the last market fully controlledby the integrated producers. (Continuouscasting is described in this Surveys How theIndustry Operates section.) The importanceof these products to industry revenues is ap-parent: in 2006, carbon sheet and strip prod-ucts totaled 57.4 million tons, or 52.4% of

total industry shipments.

INDUSTRY PROFILE

Economic cycles and long-term trendsdrive metals

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LARGEST NORTH AMERICAN ALUMINUM COMPANIES(Ranked by 2006 revenues, in millions of dollars)

COMPANY 2004 2005 2006

Alcoa Inc. 23,478 26,159 30,379

Alcan Inc. 24,885 20,320 23,641

Century Aluminum 1,061 1,132 1,559

Kaiser Aluminum 942 1,090 668

Source: Company reports.

LARGEST US STEEL COMPANIES(Ranked by 2006 revenues, in millions of dollars)

COMPANY 2004 2005 2006

Nucor Corp. 11,377 12,701 14,751

United States Steel Corp. 9,917 9,739 10,407

AK Steel Holding 5,217 5,647 6,069

Steel Dynamics Inc. 2,145 2,185 3,239

Source: Company reports.


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Nucor Corp., currently one of the largestdomestic steelmakers and the nations biggestminimill operator, was the first minimill firmto use thin-slab casting to make flat-rolled

sheet products. After SMS Schloemann-Siemag AG of Germany developed a thin-

slab casting machine, Nucor pioneered theuse of the machine at its plants in Craw-fordsville, Indiana, and Hickman, Arkansas.The machine uses a funnel-shaped mold tosqueeze molten steel down to a thickness of1.5 to 2.0 inches. This eliminates the needfor the primary stands to reduce the typicallyeight- to 10-inch-thick slabs produced byconventional casters.

Nucors Crawfordsville mill initiated thethin-slab casting process in August 1989.Subsequently, the company added another

thin-slab, flat-rolled plant in Hickman,Arkansas, in 1992, and a third such plant in

Berkeley County, South Carolina, in 1996.Nucors successful entrance into the flat-

rolled market prompted a number of otherminimill operators to follow suit. As of De-cember 2007, three other US-based firmswith thin-slab casting plants were producingsteel: Gallatin Steel Co., Steel Dynamics Inc.,and North Star BlueScope Steel LLC. Togeth-er, they have added some 6.6 million tons ofsteel to the market.

Following Nucors acquisition of TricoSteel in July 2002, and with increased outputat its other plants, Nucors flat-rolled sheetcapacity increased to 10.8 million tons, or19.6% of the domestic carbon flat-rolledmarket at the end of 2006, up from zero be-

fore August 1989.

Higher scrap prices to limit minimillexpansions

While Nucor and other minimill operators

have taken sizable market share from integrat-ed companies, future gains will be limited dueto an apparent secular rise in the cost of scrapsteel. Since its beginnings in the 1960s, the USminimill industry has been able to make rawsteel at a lower cost than its integrated rivals.This competitive advantage, along with lowerlabor costs, allowed the minimill operators toundercut the integrated companies on priceand drive them out of nearly every market ex-cept flat-rolled carbon sheet.

From December 2001 through November

2004, scrap costs rose dramatically. The

scrap price, as measured by the Factory Bun-dles Index (a benchmark series tracked byAmerican Metal Market), was $298 a ton inDecember 2007 down from the record

high of $442.50 per ton seen in November2004, but above the levels of 2003 and 2002.

The main catalyst for the generally higherprices appears to be searing demand fromChina. The high cost of scrap has trimmedthe minimills cost advantage in raw steelproduction. This has forced the minimill op-erators to keep prices high and will limittheir ability to take market share by under-cutting their integrated rivals.

Higher scrap costs also have increased thecost of raw steel production for integratedmills. The impact is not as great, however,because their primary raw material is pig

iron. Integrated companies typically useabout a 3-to-1 ratio of molten pig iron to

scrap and, thus, are less sensitive to risingprices for scrap. For minimills, in contrast,scrap accounts for nearly all their raw mate-rials costs. Consequently, rising scrap has alarger negative impact on minimills and re-duces their financial attractiveness. Standard &Poors believes that higher scrap costs willremove much of the incentive to constructnew minimill flat-rolled plants in the fore-seeable future.

Only one minimill flat-rolled plant has en-tered the market in recent years. The $880million plant was financed and built by ajoint venture company named SeverCorrHoldings LLC and began production in Au-

gust 2007. The mills capacity is 1.5 milliontons and it will sell its products to the auto-motive, building, agricultural, pipe and tube,and appliance industries. Ultimately, thecompany plans to increase its capacity to 3.4million tons. Only one other minimill pro-ducer, Indiana-based Steel Dynamics, is con-

templating the construction of additionalminimill flat-rolled capacity. The companyhas stated that it might build another flat-rolled steel plant if scrap costs moderate.

Consolidation takes holdin domestic steel

The severe downturn in the US steel indus-try that began in 1998 and minimills gainsin the sheet steel segment forced domesticfirms to consolidate and implement dramatic

cost cutting. Industry concentration intensified


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in May 2003, with the acquisition of bankruptBethlehem Steel by International Steel GroupInc. (ISG) and United States Steel Corp.stakeover of bankrupt National Steel. In July

2002, Nucor acquired the assets of Trico Steel,renaming it Nucor Steel Decatur LLC.

The combined shipments of AK SteelHolding, Nucor, Steel Dynamics, and UnitedStates Steel accounted for 43.7% of domesticsteel shipments in 2006. By way of compari-son, eight companies accounted for about50% of the domestic market in 2001.

In past downturns, bankrupt producersused the reorganization process to cut costsand to emerge from bankruptcy as indepen-dent companies with lower debt and nearlythe same amount of production capacity. In theprocess, however, they retained their pension

and healthcare liabilities (the so-called legacycosts), which made them unattractive for ac-

quisition. LTV Corp. is an example of a com-pany that emerged from bankruptcy (in 1986),but was not acquired because it retained itslegacy costs.

The severe deterioration of the industrysfinances since 1998 with some companiesunable to generate enough cash to continueoperating under the protection afforded bybankruptcy forced an involuntary reduc-tion of capacity and set the stage for consoli-

dation. For example, after entering Chapter11 bankruptcy protection in December 2000,LTV ran out of cash and ceased operations inDecember 2001. Subsequently, W.L. Ross andCo. LLC, a private investment firm, acquiredLTVs assets in April 2002 and renamed the

company International Steel Group. BecauseISG purchased the assets and not the ongoingbusiness of LTV, ISG was not obligated to as-sume LTVs pension and retiree healthcarecosts. This made the acquisition possible.

Similarly, the assumption of the pension

plans of Bethlehem Steel and National Steelby the Pension Benefit Guaranty Corp.(PBGC) in late 2002 cleared the way forthese two companies to be acquired. (ThePBGC is a federal corporation that insuresthe employee benefits of participating com-panies.) Although the PBGCs actions re-moved the pension liabilities of BethlehemSteel and National Steel, both retained theburden of healthcare expense and generally

high cost structures. This, combined withthe companies burdensome debt, made it

impossible for either company to emerge

from Chapter 11 bankruptcy as an indepen-dent entity.

Can merged integrated steelmakers competewith minimills?

While the newly-merged integrated com-

panies will enjoy lower cost structures thanbefore due to their more flexible work rulesand lower employment levels, it remains tobe seen if they can match Nucors low coststructure and high profit margins. ISG oper-ates its plants with a union work force, al-though it is managed based on the Nucormodel. ISGs president and chief executive,Rodney Mott, is a former executive of bothUnited States Steel and Nucor. Mr. Mottoversaw the launch of Nucors thin-slab, flat-rolled carbon plants in Hickman, Arkansas,

and Berkeley County, South Carolina.Since ISG began operations in May 2002,

it has produced 90% of the amount of steel

made by LTV with less than one-quarter ofthe hourly employees needed previously. Inaddition, it has just three layers of manage-ment, compared with LTVs seven, as report-ed by online newsletter Morning Call inearly November 2002. Finally, because W.L.Ross and Co. purchased the assets and notthe ongoing business of LTV, ISG was notobligated to pay the pension and other re-

tiree benefits of LTV, which put it at atremendous advantage compared with theother integrated steel companies.

Based on the terms of the contracts thatISG negotiated with its work force, it ap-pears to us that the company will come muchcloser to matching Nucors labor costs than

will United States Steel. ISGs legacy costs con-sist of funding for a postretirement medicalplan, which covers a limited number of em-ployees under its current labor agreements un-til December 15, 2008. ISG will not provide

similar coverage for employees who retire afterthe current labor agreement expires.

ISGs other legacy costs consist of fund-ing for a defined benefit pension andpostretirement benefit plan that it inheritedfrom the acquisition of an interest in aniron ore mining joint venture. This planwas inherited as a result of ISGs takeoverof Bethlehem Steel. At the end of 2004, theplans pension and healthcare obligationstotaled $260.7 million, and the unfunded

liability for the plan totaled $174.3 million.

In contrast, at the end of 2004, the combined


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pension and other postretirement obliga-tions for United States Steel amounted to$10.7 billion, and its unfunded liability forthese obligations totaled $2.6 billion. ISGs

contribution to the pension plan in 2004was $1 million, versus United States Steels

contribution of $330 million. These twoplans constitute the extent of ISGs expo-sure to the burden of defined benefit pen-sion and other postretirement plans. (Adefined benefit pension plan involves a con-tractual promise to pay a specific amountof retirement income to an employee, usual-ly based on the length of employment andsalary level. Such plans generally are fund-ed entirely by the corporation and areamong its liabilities.)

ISG has instituted a defined contribution

plan for most of its hourly work force. Foreach union employee, the company con-

tributes $1.50 for each hour worked to apension trust fund managed by the UnitedSteelworkers Union. The contribution rep-resents the full extent of the companys lia-bility. Unlike a defined benefit plan, ISGsplan does not promise to pay a specificamount of retirement income to an em-ployee. Nor does it involve the manage-ment of any pension assets or require theaccrual of pension expense and pension lia-

bility. However, ISGs plan is not as flexi-ble as Nucors defined contribution plan;unlike Nucor, ISG must contribute even ifthe company is not profitable.

Following its acquisition of National Steelin May 2003, United States Steel retained a

defined benefit pension plan. However, be-cause of a new labor agreement that accom-panied the merger, the plan does not coverthe National Steel employees who were re-tained after the acquisition. In addition, theplan is closed to all new employees. The for-

mer employees of National Steel will be cov-ered by a defined contribution plan virtuallyidentical to that provided by ISG: NationalSteel employees will receive pension benefitsthrough the Steelworkers Pension Trustbased on United States Steels contributionfor each employee for the number of hoursworked. Thus, United States Steels pensionexpense will be lower in the future than itwas before the National merger. Neverthe-

less, the retention of the plan places UnitedStates Steel at a labor cost disadvantage rela-

tive to ISG and Nucor. In April 2005, ISG

was acquired by Arcelor Mittal (then knownas Mittal Steel Company NV), the worlds

largest steel company.In March 2007, AK Steel Holding, the

third largest integrated producer in the US,concluded the last of a series of new labor

contracts aimed at eliminating what the com-pany estimates is a $40 per ton cost disad-vantage vis--vis its competitors. Followingimplementation of these contracts, the com-pany believes that it will have effectivelycapped its pension and healthcare costs. Inaddition, the new agreements will enable AKSteel to reduce the number of job classifica-tions from about 1,000 to seven, in an effortto become more efficient.

In our opinion, work force reductions,work rule changes, and contract changes lim-

iting pension and health care costs that haveoccurred since 1998 will enable Mittal andother integrated companies to compete moreeffectively with Nucor. In addition, Nucorsdecision to source about one-third of its met-al feedstock internally will raise its level offixed costs and, in effect, make it a more in-tegrated operation.

Consequently, we think that the gap incost structure and profit margins betweenNucor and its integrated rivals will be farnarrower than at any time in the past. If this

proves to be correct, we believe that Nucorwill not be in a position to aggressively cutprices to gain market share as it did in the

1980s and 1990s. Thus, if Nucor gains mar-ket share at the expense of the integratedcompanies in the future, it will do so at amuch less rapid rate than in the past.

Nucors fixed costs will not approachthe level of the integrated mills or Mittals.In addition, costs for equipment outagesare greater for integrated companies. Com-bined with Nucors labor cost advantage,

we believe that Nucor still will retain anoverall cost advantage and achieve higherprofit margins over the course of the busi-ness cycle.

Nucors labor cost advantage is particular-ly important in the context of balance sheetstrength and its impact on the cost of capital.

For example, in addition to their outstandingfunded debts, Mittal and United States Steelended 2006 with unfunded pension and oth-er postretirement benefit liabilities totaling$2.6 billion and $2.0 billion, respectively. In

contrast, Nucor had no such unfunded liabil-


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ities at the end of 2006, since it does not of-fer its work force pension or other postretire-ment benefits.

Because it is not encumbered by these

kinds of obligations, Nucor will have lowertotal debt levels compared with its rivals. In

our view, this will permit Nucor to enjoy alower cost of capital, because its finances areless risky than those of its rivals.

Global view: foreign competitionlooms large

US steel and aluminum firms both facefierce competition from overseas producersand must contend with global overcapacity.However, international pressures have af-fected the industries competitive positions

quite differently.US aluminum companies constitute a major

force in the global industry, as they have for

some time. For example, in 2006, Alcoa Inc.accounted for 15.1% of global aluminum pro-duction. In contrast, the two largest US steel

companies accounted for just 3.8% of aggre-gate global steel output.

Because they have always had to obtainraw materials from overseas, US aluminum

companies have been global competitors, vir-tually since their inception. The top-tier US

company, Alcoa, has substantial overseasmanufacturing holdings and derives sizableportions of its sales and earnings from out-side the United States. In 2006, for example,overseas operations accounted for 43.5% ofAlcoas revenues.

The large overseas presence of the alu-minum companies makes it difficult to ana-lyze import data. What is classified ingovernment statistics as an import may be aproduct shipped to a US company from oneof its foreign facilities. Thus, import data do

not provide a completely accurate picture ofthe extent to which foreign companies are

penetrating or not penetrating the USmarket. What is clear, however, is that theglobal market is highly concentrated. Follow-ing Alcan Inc.s acquisition of Pechiney, three

US EXPORTS AND IMPORTS OF STEEL MILL PRODUCTS, BY GROUP(In net tons)

PRODUCTS 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

EXPORTS

Ingots, blooms, billets, slabs 210,320 233,204 138,159 112,394 140,397 112,741 233,147 283,914 335,463 219,381Wire rods 85,005 73,836 69,441 63,512 45,697 66,213 84,883 100,031 161,116 150,748

Structural shapes & piling 480,621 369,284 429,544 409,202 411,276 305,097 523,193 676,835 776,904 892,302

Plates 779,576 6 30,700 637,053 9 56,042 756,271 8 63,129 1,190,307 1,499,007 1,900,081 1,806,426

Rails & accessories 92,095 89,386 39,792 54,421 94,444 95,592 77,522 119,897 126,157 163,564

Bars & tool steel 835,268 769,879 741,131 808,488 770,336 813,827 913,995 987,177 967,657 1,103,981

Pipe & tubing 1,352,006 1,232,014 865,203 985,332 992,475 997,175 944,883 1,082,432 1,224,957 1,488,507

Wire & wire products 136,697 137,378 164,661 160,565 154,521 148,663 140,439 159,083 155,263 182,354

Tin mill products 410,011 321,356 337,222 376,670 278,240 256,478 337,016 326,634 315,780 240,755

Sheets & strip 1,653,990 1,662,566 2,004,225 2,602,713 2,500,166 2,349,642 3,774,293 2,697,885 3,429,840 3,479,503

Total exports 6,035,587 5,519,601 5,426,434 6,529,337 6,143,821 6,008,556 8,219,679 7,932,896 9,393,218 9,727,522

IMPORTS

Ingots, blooms, billets, slabs 6,358,322 6,775,848 8,579,716 8,555,945 6,439,977 8,843,717 4,816,330 7,419,288 6,916,502 9,319,702

Wire rods 2,236,642 2,366,198 2,765,030 2,971,481 3 ,013,003 3,490,415 2 ,166,277 3,774,189 2 ,506,381 3,046,072

Structural shapes & piling 1,140,842 2,994,206 1,549,615 2,142,523 1,144,291 883,072 647,468 735,870 738,079 1,146,470

Plates 2,938,609 5,175,987 2 ,496,580 2,544,363 1,657,071 1,817,084 1,120,298 2,064,063 2,137,656 3,415,523

Rails & accessories 238,190 337,270 284,436 274,851 237,421 240,597 170,532 244,963 237,105 352,233

Bars & tool steel 2,627,180 3,605,440 4,093,428 4,357,587 3,904,662 3,525,275 3,204,423 4,422,116 3,998,205 5,110,667

Pipe & tubing 3,030,239 3,680,855 3,053,329 4,190,694 4,577,412 3,864,238 3,826,000 4,907,243 5,731,293 7,544,035

Wire & wire products 654,650 697,391 738,482 737,162 686,795 768,271 756,562 945,423 855,709 903,397


Sheets & strip 11,294,366 15,229,191 11,304,837 11,457,080 7,731,515 8,759,085 5,977,680 10,758,558 8,415,038 13,685,606

Total imports 31,156,586 41,519,702 35,730,524 37,956,654 30,080,034 32,685,959 23,125,346 35,808,202 32,108,544 45,272,458



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producers accounted for some 39.2% of pri-mary global aluminum output in 2006.

Aluminum glut abates

From 1989 through 2006, the aluminum

market generally was in surplus, reflecting low-er demand caused by recessions combined withexcess supply. The global aluminum glut hadits roots in the breakup of the Soviet Union.Before that time, most of that nations alu-minum was used internally, primarily for mili-tary applications. The collapse of the Sovietgovernment caused a dramatic decline in do-mestic consumption, which made more alu-minum available for export. With a pressingneed to raise hard currency, Russia began toexport most of its output. This led to an over-

supply in the market and placed downwardpressure on prices. Exports as a percentage oftotal output peaked at 84.6% in 1996 and

gradually declined through 2006, as internalconsumption rebounded.

In 2002, China became the worlds largestaluminum producer and became a net exporteras well. In our view, Chinas emergence as a netexporter added to the global oversupply. From1993 through 2001, China was a net importer,according to data compiled by the World Bu-reau of Metal Statistics, a publisher of data on

the global metals industry.An increased supply from China, coupled

with a recession in the United States in 2001,resulted in the global aluminum market ex-periencing a surplus from 2001 through2003, following a deficit in 2000. The supply

deficit reappeared in 2004, as productionlagged behind consumption; in 2005, thedeficit narrowed, but it expanded again in2006 as consumption increased at a greaterrate than production. In 2006, there was adeficit of 315 metric tons, versus a deficit of

five metric tons in 2005 and a deficit of 337metric tons in 2004.

Chinas aluminum industry key toconditions in 2008 and beyond

In 2007, we think that the aluminum mar-ket experienced a small surplus (versus thedeficit seen in 2006) due to global demandincreasing less rapidly than supply. Accord-ing to Global Insight Inc., an economic fore-casting consultancy, global GDP growth is

expected to increase 3.6% in 2007, versus

GDP growth of 3.9% in 2006. If this fore-cast is correct, aluminum demand could trailthe rate of gain in 2006. Together with risingaluminum output, a small surplus could de-

velop and place downward pressure on theprice of aluminum.

In our view, the supply and demand foraluminum in China will be one of the mostimportant factors in determining whether theprojected aluminum market surplus for 2007will expand or contract in 2008 and beyond.As mentioned earlier, China became theworlds largest aluminum producer in 2002,and went from being a net importer of alu-minum to a next exporter in the same year.In 1993, Chinas production accounted for6.3% of global output; by 2006, China ac-counted for 27.5% of global output. Chinas

imports totaled 705,000 metric tons in 2000,whereas its exports totaled 701,000 metric

tons in 2006. We believe that this huge swingaccounts for the fact that the increase in theprice of aluminum since 2002 has been dra-matically outpaced by higher prices of otherbase metals such as copper and nickel.

Through October 2007, Chinas exportstotaled 220,000 metric tons, down from590,000 metric tons in the same period in2006. This large decline is a result of an in-crease in Chinas demand in excess of supply.

Through October 2007, Chinas productionwas up 36.1%, while consumption rose44.4%. Consequently, exports fell. However,the overall global aluminum market experi-enced a surplus of 398,000 metric tons for theperiod, versus a deficit of 326,000 metric tons

in 2006s first 10 months, as production out-side of China increased in excess of consump-tion. For all of 2007, it appears that Chinasexports declined. Whether exports will contin-ue to decline in 2008 remains to be seen. For2008, we anticipate that global demand will

trail 2007s growth rate. This expectation isbased on Global Insights forecast that globaleconomic growth in 2008 will be 3.4% versus3.6% estimated for 2007. In that context, adecline in Chinas exports in 2008 would helpmitigate a glut caused by less robust demandin the rest of the world.

Apart from world economic growth, alu-minum industry conditions beyond 2008 willdepend mostly on the developments in the

Chinese aluminum industry. Outside of China,the global aluminum industry has undergone a

large amount of consolidation. At the end of


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2006, three companies accounted for 39.2%of world primary output, up from 36.6% atthe end of 2000. With the merger of RusalLtd., Sual Group, and Glencore InternationalAG in late March 2007 to form aluminum gi-ant United Company Rusal, together with theacquisition of Alcan Inc. by Rio Tinto Ltd. inOctober 2007 (see this Surveys Current En-vironment section for more details), the alu-

minum industry outside China is now moreconcentrated than ever. Had these mergersbeen completed in 2006, three companies Alcoa, Rio Tinto, and United CompanyRusal would have accounted for about48.4% of world primary output in 2006.

By way of contrast, there were approxi-

mately 100 primary aluminum producers oper-ating in China in 2006. Aluminum Corp. ofChina, the nations largest aluminum company,accounted for just 22.3% of Chinas total alu-minum output in 2006. In short, while the

aluminum industry outside of China is becom-ing more concentrated, Chinas aluminum in-dustry remains quite fragmented. If the largenumber of Chinese producers ultimatelyshrinks due to consolidation, the world alu-minum market will become far less prone tothe chronic oversupply and depressed pricingover the course of future business cycles, inour opinion.

China pressures raw materials costsIn recent years, the emergence of China as

the worlds largest steelmaking country has

placed immense upward pressure on the pricesof raw materials, such as iron ore, ferrousscrap, coke, and coal. Chinas steel productionrose to 423 million metric tons in 2006, from100 million in 1996, according to statisticscompiled by the International Iron and SteelInstitute (IISI), a Belgium-based steel industrytrade association. Chinas production accelerat-ed dramatically in recent years, rising to 423

million metric tons in 2006, from 127 millionin 2000. Rising Chinese production has beenthe main reason for higher global steel produc-tion since 1999.

As a result of the sharp rise in Chinassteel production, raw materials costs have in-creased dramatically. For example, Brazil-

based Vale (formerly Companhia Vale do RioDoce), the worlds largest iron ore miningcompany, increased the price it charges itssteel customers. Vales price for iron ore fineswas $14.95 a metric ton in 2002. The price

rose steadily through 2006, to $40.00 ametric ton. Similarly, the price Vale chargedfor iron ore pellets, which was $30.96 a met-ric ton in 2002, rose to $75.31 in 2006. Forthe first nine months of 2007, Vales price foriron ore fines was $44.92 a metric ton, ver-sus $39.47 for the same period in 2006.Vales price for iron ore pellets for 2007sfirst three quarters was $77.46 per metricton, versus $76.72 per metric ton for thesame period in 2006.

As this Survey was being prepared in

December 2007, it appeared that upward

US SHIPMENTS OF STEEL PRODUCTS, BY PRODUCT LINE(In thousands of net tons)

PRODUCTS 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Semifinished steel 7,927 7,216 6,369 6,219 4,181 4,439 5,060 3,661 3,220 5,102

Shapes and piling 6,029 5,595 6,134 6,657 6,880 6,673 7,405 7,819 8,062 8,652

Plates 8,855 8,864 8,200 8,914 8,797 8,689 9,325 10,811 10,250 10,827

Rails 731 784 501 654 499 597 571 667 698 800Other railroad products 144 154 133 159 145 194 177 213 216 216

Bars & tool steel 18,771 18,406 18,663 17,955 16,430 16,332 17,404 18,391 17,206 36,496

Pipe and tubing 6,548 5,409 4,779 5,385 5,376 4,808 4,597 5,328 5,096 5,426

Wire products 619 725 638 580 678 723 568 567 669 603


Sheetshot rolled 18,221 15,715 18,687 19,770 18,287 19,444 21,946 22,712 22,356 20,862

Sheetscold rolled 13,322 13,185 13,987 14,847 12,404 12,691 13,521 14,762 12,793 13,281

Sheetsgalvanized 18,300 19,380 20,747 20,506 19,207 19,655 19,738 21,072 19,352 21,049

Electrical sheets & strip 510 587 562 529 481 442 419 444 468 530

Hot & cold rolled strip 1,822 2,683 3,030 3,131 2,373 1,891 1,729 1,689 1,711 1,692

Net total steel products 105,858 102,420 106,201 109,050 98,940 100,000 105,974 111,384 104,971 108,609



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pressure on iron ore would continue in2008. According to several analysts quotedin a Financial Times article dated October23, 2007, a combination of strong demand

and tight supply could result in a 50% hikein the price of iron ore in 2008. The article

noted that spot iron ore prices had soaredover the past year. For example, spot pricesfor iron ore from India increased to $130 permetric ton from $53 per metric ton a yearearlier, while spot prices for iron ore fromAustralia and Brazil increased 39% and71%, respectively.

Besides sharply higher prices for iron ore,the ramp-up in Chinas steel production hasboosted the price of other raw materials in-puts such as coking coal. As noted in Mittals2006 Annual Report form 20-F, the price of

coking coal increased to $125 a ton in 2005,from $57 in 2004, due to strong Chinese de-

mand. Growth in the coal supply caused theprice to decline to $115 a ton in 2006. Thecompany also noted that in 2006, Chinassharply higher demand for iron ore and coalcontributed to a shortage of cargo ships andled to higher ocean freight rates.

In our view, the sharply higher cost ofraw materials will prove to be a powerfulcatalyst for more consolidation of the glob-al steel industry. While we do not expect

raw materials costs to rise at the searingrate seen since 2002, it appears to us thatthe secular trend for raw materials prices islikely to be up.

Given that three companies (Vale, BHPBilliton Ltd., and Rio Tinto PLC) account

for an estimated 75% of the seaborne ironore trade, steelmakers need to becomemuch larger entities in order to cut overallcosts and obtain better contract terms withtheir suppliers. By virtue of becoming larg-er through mergers and controlling more

steel production, the steel companies willhave greater power when it comes time tonegotiate contracts to buy iron ore andother raw materials. In addition, the finan-cial strength that normally results from amerger would give steelmakers the optionto become more self-sufficient in raw mate-rials. Greater financial resources resultingfrom mergers should enable companies todirectly source raw materials through ac-

quisitions, or become more vertically inte-grated through direct investment in iron

ore production.

In our opinion, the imperative to cutraw materials costs has been a strong moti-

vating factor in merger activity in recentyears. For example, we believe that Mittalsacquisition of the Kryvosizhstal steel assetsfrom Ukraine in October 2005 was moti-

vated in part by the desire to become moreself-sufficient in iron ore. Besides increas-ing its steelmaking capacity by 8.0 millionmetric tons, the acquisition gave Mittalone billion metric tons of iron ore reserves.

The imperative to cut raw material costsvia steel industry mergers and joint venturescould receive an additional impetus if BHPBillitons unsolicited bid to acquire Rio Tintoends in a deal (see the Current Environ-ment section of this Survey for more de-tails). A combination of BHP and Rio Tinto

would create the worlds second largest ironore mining company and add to what is al-ready a highly concentrated oligopoly in themarket for shipped iron ore. Such a mergerwould increase the formidable pricing powerof the iron ore mining companies and likelyhasten steel industry mergers as a response.

Imports remain a challenge forUS steelmakers

In contrast to the US aluminum industry,

only two steel companies CommercialMetals Co. and United States Steel haveoverseas steel plants. In general, the portionof steel company revenues derived from out-side the United States is minimal.

However, by way of contrast to the mini-mal presence of US companies overseas, theUS steel market itself is far more internation-

al now than at any time in the past. As a re-sult of merger activity that began in 1997,some 40% of current domestic capacity maybe foreign-owned by the end of 2007. More-

over, it is quite conceivable foreign owner-ship will continue to rise in the future.

Although foreign steel has taken a sub-stantial bite of the US industrys domesticmarket share since 1960, the domestic in-dustry was able to withstand record highimports of both finished and semifinishedproducts in 2006 and still prosper. For2006, total imports of steel were 32.0% ofapparent supply (equivalent to domesticproduction plus imports, minus exports),

versus 25.6% in 2005, according to AISI

statistics. Finished imports were 27.1% of


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finished supply, versus 21.3% in 2005.Semifinished imports (steel slab purchasedby the steel industry itself to meet its raw

materials needs) were 20.5% of total im-ports in 2006, versus 21.5% in 2005.Through the first nine months of 2007, to-tal imports were 26.8% of apparent supply,and finished imports accounted for 22.8%of finished supply.

In 1960, steel imports into the UnitedStates totaled 3.4 million tons, or 4.7% ofthe 71.5 million tons consumed in the nation

that year, according to the AISI. From 1985through 2006, imports ranged from a low of17.5% of annual consumption in 1990, to arecord high of 32.0% in 2006. Given the sizeof the US market and its generally less-restrictive import barriers, foreign steelmak-ers will continue to provide competition in

supplying the US market.The consolidation of the US domestic indus-

try has resulted in considerable cost reductionand an industry that is far more competitivevis--vis foreign rivals. Combined with a weak-

er US dollar, this should enable the domesticindustry to mitigate the impact of imports andcompete more effectively in the future. Despitethe fact that imports as a percentage of totalconsumption in 2006 exceeded 1998, and fin-ished imports as a percentage of finished con-sumption matched 1998, the domestic steelindustry achieved record profits in 2006. Byway of contrast, most of the industry reportedsevere losses in 1998.

In our view, the combination of rising costs

of raw materials and higher transportation

costs has considerably reduced the cost advan-

tages enjoyed by foreign steelmakers. This willmake it difficult for foreign producers to easily

undercut domestic steelmakers on price and toflood the market. While the emergence of Chi-na as a net exporter of steel in 2006 and be-yond could result in a global glut of steel, it ishighly unlikely that any nation, including theUnited States, will allow China to flood itsmarkets. While the United States has the fewestimport restrictions of any nation, US producershave occasionally had the US government im-pose restraints on imports in the form of quo-

tas, tariffs, and voluntary restraint agreements.We believe that any attempt by China toswamp the US market with surplus steel wouldgenerate demands for protectionist measuresand the filing of antidumping suits.

HOW THE INDUSTRY OPERATES

The industrial metals companies thatmanufacture steel and aluminum productsoperate in industries that are highly capital-

intensive. Aluminum companies are verti-cally integrated, meaning that they own thesources of raw materials, as well as theplants and equipment used to manufacturefinished products. Steel companies, oncehighly integrated, have become much lessso since the 1980s.

Operations concentrated on the raw mate-rials side of the industry are referred to asbeing in the primary, or upstream, end ofthe business. Those focused on finishing orprocessing are in the downstream portion

of the business.

WORLD STEEL PRODUCTION

UNITED WORLD UNITEDYEAR CHINA JAPAN STATES TOTAL CHINA JAPAN STATES

2006 423 116 99 1,222 34.6 9.5 8.1

2005 349 112 94 1,106 31.5 10.2 8.5

2004 274 113 99 1,039 26.4 10.9 9.52003 219 111 91 947 23.2 11.7 9.6

2002 180 108 92 882 20.4 12.2 10.4

2001 143 103 90 825 17.3 12.5 10.9

2000 126 106 101 828 15.3 12.9 12.2

1999 124 94 96 771 16.0 12.2 12.5

1998 114 94 97 760 15.0 12.3 12.8

1997 108 105 97 779 13.9 13.4 12.4

1996 100 99 94 730 13.7 13.5 12.9

Source: International Iron & Steel Institute.

PRODUCTION (MIL. METRIC TONS) AS % OF WORLD TOTAL


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Steel: evolving to survive

For the better part of the twentieth centu-ry, the steel industry operated in a verticallyintegrated fashion. This entailed massive cap-

ital investment to process coal, iron ore,

limestone, and other raw materials intomolten iron, which was then transformedinto finished steel products. It required hugeinvestments in processing plants and equip-ment, and in iron ore and coal mines.

The original method of steelmaking usedby integrated companies was the ingot teem-ing method, in which molten steel waspoured into a mold and allowed to cool inthe form of an ingot before eventually beingtransformed into a semifinished product: aslab, a bloom, or a billet. Today, however, a

method known as continuous casting is morecommonly employed. In this process, molten

metal is poured into a water-cooled mold, andthen drawn down into a series of rolls andwater sprays. The advantage of this processis that it yields the semifinished products slabs, blooms, and billets in a single step,saving energy and creating a better product.

Integrated steelmakers bear high costsThe integrated production process requires

expensive plant and equipment purchases that

will support production capacities rangingfrom two million to four million tons per year.Its capital costs are significant approximate-ly $2,000 per ton of capacity, compared withminimills $500 per ton. (Minimills are dis-cussed in more detail later in this section.)

For integrated steelmakers, raw materialsand energy comprise the majority of costs,

representing 60% to 65% of sales, followedby labor, at 22% to 25%. Costs per ton havebeen declining for integrated producers, butthey still exceed minimill costs. Lowering

these costs is critical in becoming more com-petitive because companies cannot count onhigher prices to ensure their profitability.

Integrated companies employ unionizedworkers, whose labor is more expensiveover the course of a business cycle than isnonunion labor. Union contracts prevent in-tegrated companies from reducing totalcompensation costs when demand and pro-duction decline. In addition, integratedcompanies incur legacy costs contrac-

tual obligations to pay pension and health

benefits to retirees. These obligations be-

came part of union contracts long beforeminimills emerged as a competitive threat.To the extent that minimills incur legacy

costs at all, they are far lower than that ofthe integrated companies.

As a result of the restructuring and con-

solidation that has taken place since 2002,legacy costs will become less expensive forintegrated steelmakers in the future. Accord-ingly, the labor cost advantage that minimilloperators have traditionally enjoyed, vis--visintegrated companies, will diminish.

US steel industry downsizesDue to increased steel imports, the advent

of minimills, and the reduced consumptionby the automobile industry, traditional USsteelmakers have lost a substantial portion of

tonnage.Demand from the US automobile industry

has been declining for decades. In 1973, di-

rect shipments of steel to the US auto indus-try totaled 23.2 million tons; data for 2006show that figure at 15.5 million tons. Themost recent high for shipments was 16.8 mil-lion tons in 1999.

Two factors were behind this decline. In re-sponse to greater demand for smaller, lighter,more fuel-efficient cars in the 1970s and1980s, the auto industry substituted aluminum,

plastic, and other materials for steel. In addi-tion, rising imports of foreign cars during thisperiod cut demand for US-produced vehiclesmade with US-manufactured steel.

Because high volume was critical to steel-makers ability to keep unit costs down, thedecrease in tonnage led to sizable losses. Bank-

ruptcies, plant closures, and mergers forced amassive contraction in the integrated steel in-dustry, substantially reducing the number ofintegrated steelmakers. In 1960, these firms ac-counted for 91.6% of US raw steel produc-

tion; in 2006, their share was 42.9%.

Steelmakers exit primary endTo cope with the decline in demand from

automakers, as well as to cut costs and com-ply with more stringent environmental legis-lation, the steel industry has become lessvertically integrated. Producers have cut backon the raw steelmaking end of their opera-tions, reducing their raw materials holdingsof coal and iron ore, and shutting down cokeovens, blast furnaces, and other primary

steelmaking equipment.


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Today, more than ever before in theirhistory, steel companies are buying rawmaterials (coke, coal, and iron ore) andsemifinished steel from outside suppliers.

At present, only United States Steel Corp.comes close to being self-sufficient in sup-

plying its own primary raw materials in itsdomestic operations. The use of outsidesuppliers is intended to cut fixed costs. Bydivesting raw materials holdings in coke,coal, and iron ore, companies can lowertheir asset- and fixed-cost bases. In theprocess, companies also have reduced thelabor costs associated with owning andmining raw materials. However, this strate-gy could backfire if the US dollar continueswhat appears to be a cyclical decline, rais-ing the cost of purchasing slabs and, thus,

of production.Indeed, the downsizing of the primary

side of steelmaking has been so extensivethat many integrated companies havefound themselves short of the primary ca-pacity needed to make molten steel intoslabs, the basic material of finished prod-ucts. Consequently, beginning in the early1990s, they substantially increased theirpurchases of foreign-produced slabs. In1992, semifinished steel accounted for14.1% of total imports; in 2006, it ac-

counted for 20.6% of total imports.Given the large increase in the cost of

slabs and other raw materials since late2001, as well as the recent consolidation ofthe domestic industry, we believe that the in-tegrated steelmakers may halt their efforts to

become less vertically integrated. In fact, wethink that the sharp rise in the cost of rawmaterials since 2001 could prompt compa-nies eventually to reverse course and becomemore vertically integrated. In our view, thiswould entail increasing holdings of coke,

coal, and iron ore.Although owning and mining these raw

materials would increase fixed costs, itwould give producers more control overtheir raw material costs. At the very least,rising raw materials costs will provide theindustry with an incentive to consolidatefurther. For example, in April 2005, Inter-national Steel Group (ISG) was acquired byMittal Steel Co. NV to form the worlds

largest steel company. (See the IndustryTrends section of this Survey for more in-

formation.) One of the reasons cited for

the merger was ISGs need to cut its rawmaterials costs.

Minimills step up productionMinimill steelmakers small regional

companies that make a limited number of

commodity steel products using a less capital-intensive process than the integrated steel-makers do have played a major role indisplacing those larger firms. According tothe American Iron and Steel Institute (AISI),an industry trade association, minimills ac-counted for 8.4% of total US raw steel pro-duction in 1960; by year-end 2006, theirshare was 57.1%.

Minimill companies vary in size, from one-plant operations with annual capacities of aslittle as 150,000 tons, to multiplant operations

with annual capacities of between 400,000tons and 22 million tons. Minimill operators

enjoy a labor cost advantage because their op-erations are largely nonunion. With nonunionlabor, compensation is often linked directly toproduction and profits. When production andprofits rise, so does compensation; conversely,lower production and declining profits resultin lower labor costs.

Minimill steel production methods donot require as much of an investment inraw materials and capital equipment as do

the production methods of integrated steel-makers. Because minimills use scrap metalas their raw material, they do not have tobuild and maintain blast furnaces, cokeovens, and equipment to handle other ma-terials. Thus, minimill operators have been

able to undercut integrated companies onprice, driving them out of many commodi-ty steel markets.

With the advent of thin-slab casting inthe late 1980s, minimills began to competein the flat-rolled sheet market, the indus-

trys largest and most lucrative segment.The invention of the thin-slab caster sub-stantially reduced capital requirements forproducing flat-rolled steel, removing themain barrier to entry into this market seg-ment. As a result, minimills have grown innumber, increasing competitive pressure inthe last remaining market segment domi-nated by integrated producers.

Recyclings roleIntegrated steel companies do not achieve

the kind of cost savings through recycling that


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aluminum companies do. While the integratedsteel industry does recycle internally generatedscrap steel and purchases scrap from outsidesuppliers, producers limit the amount of scrap

they use, partly because of their investments inproduction equipment that relies on traditional

sources of iron ore and coal.Rising scrap prices and product quality

are other considerations; high-grade scrapis expensive. Ford No. 1 bundles, a high-grade scrap used for making more expen-sive grades of steel and also a componentof the American Metal Market FactoryBundles Index, trade at a premium to thestandard No. 1 heavy melt. Prices for theFactory Bundles Index rose steadily fromDecember 2001 through November 2004.At the same time, the No. 1 heavy melt

price increased to record levels. As thisSurvey was being prepared in December

2007, it appeared that prices for the Facto-ry Bundles Index may have peaked in No-vember 2004 (though they remain wellabove the level seen in 2003), while No. 1heavy melt set a record in March of 2007.Iron ore, coke, and limestone make upabout three-fourths of the typical integrat-ed steelmakers materials; only about one-quarter is recycled steel scrap.

For minimills, recycled scrap is the chief

raw materials cost. Minimill operators pur-chase scrap from outside suppliers and,thereby, avoid the high fixed costs associatedwith sourcing their raw materials needs inter-nally. However, the rising price of scrap hasprompted several minimill firms to produce

raw materials internally via the productionof scrap substitutes. For example, in 2003,Nucor Corp., the nations largest minimilloperator, entered into a joint venture withVale (formerly Companhia Vale do RioDoce), the worlds largest iron ore company,

to produce pig iron in northern Brazil. (Pro-duction at the joint venture commenced onOctober 2, 2005.) Similarly, Steel DynamicsInc., an Indiana-based minimill operator, suc-cessfully recommenced the production of pigiron internally in November 2003. Conse-quently, the rising cost of scrap over timecould diminish recyclings role in the min-imill steelmaking process.

Distribution gets divestedThe steel industry has exited the sales, or

distribution, side of the business. In their

S&P Industrial Metals Jan2008

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