Karachi, March 24, 2022 (PPI-OT): Steel: Rising scrap costs warrant further price hikes

The rising scrap prices have recently shown a sharp spike mainly due to geopolitical issues. Prices have increased ~28% since the start of the month, while prices have jumped by 45% since Mar-2021.

Despite swiftly rising raw material prices, local long steel manufacturers reflect strong pricing power so far by a cumulative of 55% price increase announcement in the last 12 months to maintain margins. For perspective, Every US$50/ton increase in scrap requires an increase of Rs12,000/ton in steel rebar price.

While some increment in the local rebar prices in response to higher scrap prices can be expected in the coming days, we believe potential increase in fiscal conditionality under the IMF program and lack of clarity on economic policies’ sustainability under ongoing local political noise would not make the cost pass smooth from hereon.

Rising scrap prices get an extra push

Scrap prices have shown a sharp spike in the last few days mainly due to geopolitical issues. Prices have increased ~28% since the start of March, while prices have increased by 45% since Mar-2021. China, Japan and Russia, the world’s top three steel exporters, have been facing pressure on Steel prices due to the supply chain disruptions since a couple of months. This was followed by the Russia-Ukraine situation, which exacerbated the situation as both countries are major global steel exporters. The Black Sea and Sea of Azov are being considered unsafe for cargo ships to pass through whereas air capacity in the region is also limited due to the war situation adding to the supply chain issues.

Test for pricing power of Local rebar manufacturers

Steel scrap is the major raw material (~60% of cost of goods manufactured) used in long steel production. Despite swiftly rising raw material prices local long steel manufacturers reflect strong pricing power so far by a cumulative of 55% price increase announcement in the last 12 months to maintain margins. Every US$50/ton increase in scrap requires an increase of Rs12,000/ton in steel rebar price.

We see ample room for growth in the steel sector from the considerably lower per capita consumption of steel in the country versus the rest of the world. Potential fiscal stimulus and mega infrastructure projects and dam projects in the pipeline would be key upsides for the graded long steel sector going forward.

Nonetheless, we expect fiscal constraints to continue exerting pressure, whereas conditionality imposed by the IMF for fiscal reforms might try to offset the positives. The recent local political situation and lack of clarity regarding the sustainability of economic policies would also have an impact on the demand outlook in the short run.

While some increment in the local rebar prices in response to higher scrap prices can be expected in the coming days, we believe the cost pass from hereon may not be as smooth and future profitability may be impacted.

While sanctions by European Union on Russian Steel manufacturers have affected their production; steel production has been halted by Ukraine as a result of serious security concerns. In addition, pandemic outbreak in China has also impacted steel production in the country. Prices could likely face a downward pressure if scrap prices ease in the latter half of FY23, however, the downward revision in our view would happen in a phased manner.