There is no shortage of tensions between the U.S. and China -- over human rights, hacking, copyright infringement, control of the South China Sea. But one of the oldest U.S.-Sino rifts is the battle over China's steel exports.
Now the International Trade Commission is investigating claims by U.S. Steel ( X ) that Chinese hackers stole secrets on a new lightweight steel that can be used instead of aluminum in automobiles. If the ITC approves sanctions, it could lead to an outright ban of Chinese steel imports, and it would be the first used in retaliation for Beijing-backed hacking in the commercial sector, according to the Financial Times .
U.S. Steel, the largest U.S.-based integrated steel maker, would get a boost if sanctions went into effect, along with Luxembourg-based ArcelorMittal ( MT ), the largest steel producer in the world, and AK Steel ( AKS ), according to Tom Balcerek, senior editor-steel at S&P Global Platts.
The U.S. government has already taken a stand against China "dumping" surplus steel on U.S. markets at below-production costs in order to increase its market share. In March, the Commerce Department issued preliminary duties of 265.79% on imports of cold-rolled steel from China. A final decision will be made this summer.
In May, the Commerce Department's International Trade Administration placed anti-dumping duties of 210%, and an anti-subsidy tariff of up to 241% on corrosion-resistant steel from China.
Steel factories in China tend to be state controlled. The state wants to keep low-skilled workers employed and tax dollars rolling in. The world's largest steel producer and consumer, China exported over 100 million tons of steel in 2015. That was 7% of total global production. Nicholas Sowar, global metals sector leader at Deloitte, estimates that China has 400 million to 500 million tons of surplus capacity.
"As China's economy slows down rapidly, they have to find a market for their steel," he said.
The U.S., EU and Latin America have become dumping grounds for China, though Beijing says it just has a competitive advantage over other producers.
Sowar disagrees, saying raw materials cost more for Chinese companies and they have to import raw materials including iron ore. Also, he questions the environmental costs of Chinese mills.
But Beijing this year pledged to trim 100 to 150 million metric tons of annual production capacity over the next five years. It's a process that requires shifting workers to less labor-intensive jobs and into other sectors as it cut 1.8 million jobs in the steel and coal trades. As of May, no declines in steel production were reported.
Duties Result In Supply-Driven Price Appreciation
The steel-producers group began gaining strength in the first quarter and has ranked in the top five out of the 197 IBD industry groups throughout Q2. Its 18 member stocks range around the globe, from Luxembourg-based Ternium ( TX ) to Brazil's Gerdau ( GGB ) and South Korea's Posco (PKX).
[ibdchart symbol="NUE" type="weekly" size="half" position="leftchart" ]It also includes younger, mini-mill plays like Nucor (NUE) and Steel Dynamics (STLD). Mini-mills use scrap steel as their main input and electric arc furnaces, rather than more traditional and less efficient blast furnaces. Mini-mills also aren't unionized, Balcerek explained, and have historically performed better than integrated companies.
[ibdchart symbol="STLD" type="weekly" size="half" position="leftchart" ]Steel prices have been climbing on optimism over U.S. restrictions vs. China and on speculation for steady demand in the automotive and construction markets. The price of hot-rolled coil steel was $460 per short ton in April 2015 before falling to its low point of $374 in December. It then rebounded to the psychologically important $500 mark in early 2016, and averaged $605 per short ton in May.
"The domestic steel demand outlook is relatively unchanged and steady, with the heavy equipment, agricultural and energy markets remaining weak, while automotive continues to be strong and construction recovers," said Steel Dynamics CEO Mark Millett in the Q1 earnings release.
In April, Steel Dynamics reported Q1 earnings and revenue above analyst expectations. Then, on Tuesday, the company guided its Q2 EPS to between 53 and 57 cents, well above the 48 cents that analysts expect on "improved metal spread and shipments." Management also said "the reduction in imported flat roll steel due to trade case actions has resulted in supply-driven price appreciation, especially for coated flat roll steel."
Nucor said it also expects Q2 results to be "significantly improved" from Q1 on higher prices for products. The company reported a lower-than-expected earnings gain in Q1 and revenue fell.
South Korea's Posco could have the biggest turnaround of the group, with earnings projected to advance 487% this year and 35% in 2017.
Assessing The Aluminum Threat
The auto market is one of the most important for steel makers, Balcerek said, and when auto demand is up, it pulls up the whole steel market. Sixty percent of AK Steel's product goes to the auto industry. U.S. auto sales were down in May, but analysts are still bullish on sales as the average age of a car on the road in the U.S. is 11 years old, suggesting that drivers are likely to be looking to invest in new models.
Aluminum has become a more serious competitor, replacing steel as a key metal in autos. Ford 's (F) F-150 is a breakthrough model for aluminum, reducing the weight of the truck by over 700 pounds. General Motors (GM) responded by saying it was committed to using steel in its Chevy Silverado.
Sowar said that fears over the rise of aluminum are overblown. Balcerek agrees.
"Steel has been the predominate auto-body metal for forever," he said. "Aluminum is lighter than steel, so car companies are looking at that to reduce weight, but aluminum is more expensive."
The construction market is another major buyer of steel. Construction spending fell in April, but is still up nearly 9% over the first four months of the year as spending on hotels and office buildings rises.
The possibility of the Federal Reserve raising interest rates will have an effect on construction. But Fed chief Janet Yellen backed away from any immediacy in the Fed's plans, and any increase will likely be small, according to Balcerek. He said indicators like the price of oil are more important in the near term.
One category of steel product is labeled oil country tubular goods (OCTG). This includes rolled products like drill pipe, connectors and tubing for the oil and gas industry. U.S. Steel said it built the first seamless drill pipe for the oil and gas industry before World War I.
But the long-running downturn in oil prices has slowed oil industry exploration and development, which is hurting the steel industry. Prices for J55 OCTG grade pipe were up to $1,400 per short ton in 2011, but came crashing down to $1000 in 2015 and are currently under $800 now according to Balcerek.
"The oil patch doesn't look like it's going to come back soon," he said even as oil hovered around $50 per barrel, up from lows below $30 earlier this year. If things stay stable for the next few months companies could return to drilling in January. But oil companies are hesitant to resume drilling until prices hold consistently above $50 per barrel.
Despite improving earnings outlooks, layoffs continue to sweep the industry as steel makers look to cut costs. In April, U.S. Steel said it would cut 25% of its salaried workforce in North America and cut workers at a mill in Slovakia.
Still Sowar is bullish on the steel industry if the implementation and execution of tariffs against China continue. But the economy remains a wild card, both in China and the U.S., and anything that threatens growth in the construction and auto industries could alter the industry's rebound.