Finance, Marketing & Operations
The Steel Price Dilemma
Update Oct 2004
By Bill Ray
"Nobody saw it coming” is the statement heard time and again. Producers are now painfully aware of January, February and March price increases. In some cases, April steel deliveries were priced upon shipment. You can't run a business that way. Where is steel price going over the remainder of this year? How do you bid work? What steps can be taken on fixed price contracts that are underwater? Is there a silver lining to this bad news? This article provides some answers.
A brief review: Reinforcing steel prices feel like they are very nearly double the year ago levels. The immediate cause for the increase is supply bottlenecks: Energy prices are up sharply. There was a coal mine fire that had the effect of reducing supplies of coke, A key steel mill in South Carolina shutdown. The price for steel scrap is way up, due to buying by China.
Steel expansion in China relies on scrap
Where is steel price going from here? Start with the fundamentals. There is continuing excess production capacity in North American steel mills. American mills rely heavily on scrap, and those that don't are often obsolescent. Offshore steel mills are the low cost producers in a worldwide commodity business. Precasters can quickly grasp the implications of this because many precast markets are commodity in nature. Commodity prices are volatile, and subject to intense competition. Price is set by the low cost producer.
Imported steel sets the price, and we have become dependent upon it. Indeed, the American economy generally has become dependent on imports of all kinds and this has resulted in an ever-weakening dollar exchange rate. Here is the key, the weakening dollar is not likely to improve and steel prices are not likely to go back to where they once were.
Price forecasting is more art than
science. Here is the conventional wisdom: We are probably at
the peak right now. Various supply and demand factors are kicking
in. For example, ships to move scrap are proving to be a bottleneck.
Coke production is being restored. There is some stockpiling going
on, aggravating the current shortage. 
Today's
prices are encouraging new capacity and restart steel production.
Some work has been canceled or delayed. The normal reinforcing steel
shipping season runs through summer. In the future, export restrictions
may be placed on scrap, but don't count on that.
Steel prices are expected to ease later this year, but will not return to old levels
The price of scrap is volatile, and a leading indicator of future steel price trends
After year end, we will probably see some pullback in prices. Scrap prices continue to be volitile. At the time of this update, (October) some steel producers have been quoted saying the prices are at their cyclical "peak." Analysts who study such things say that some of the price increase in bar, mesh, and strand is likely to go away next year. But that still leaves a big increase in place and prices sharply higher than they were at the beginning of 2004.
Quoting work requires that you hedge steel price. Most steel suppliers will quote only up to 30 days. Press for longer commitments. I say an escalator clause is a must in contracts that extend 6 months or more, even if it makes your bid “nonconforming.” Private owners have flexibility on price escalators. Every major industry association has endorsed price escalators. The Federal Highway Administration (FHWA) has endorsed escalators on new work [only.]
Escalator clauses come in two varieties. In long lived contracts, you can, and must, convince the owner or GC that an escalator is preferable to a risk premium in the bid. Remind your customer that, if prices go down, the escalator will work in their favor.
- Price index escalators adjust contract price based on a published index. These are imprecise but easy to administer. There is no agreement on the best index to use. Engineering News Record publishes a construction steel index. Don't use scrap steel price, it is way too volatile. Really, it is best to avoid this type of escalator.
- Quoted steel price based on your actual steel invoices vs. your quote at bid time. These are the fairest in theory, but are subject to bidding games and thus contract administration problems. This method is best for the producer and should be included in all long lived negotiated work.
Stockpile Another way
to hedge is to stockpile the steel required for the job. I recommend
that this be done only if the owner will pay for the reinforcing steel
as a stored material on your yard. The producer should not have to
carry more than 30 days steel inventory. There is not a futures market
in steel so standard hedging, like candy makers use to lock in the cost
of sugar, is not available to precast producers.
.American
steel mills compete in a world wide commodity market
Don't speculate in steel. I talked to a manager who purchased 50 tons of nails as a way to hedge the price of reinforcing steel. He doesn't use nails in his business. Maybe the nails were a bargain, maybe not. Speculation is high risk. For sure it is a distraction from the main event, running the business.
Legal considerations come to the fore in any losing contract. Here is a checklist.
- Legal review is a must on any losing contract. This is not the time for do-it-yourself. If the contract is large, get a second opinion. Each contract is unique. If you signed a well written contract, your lawyer probably will not find a way out. But, ask him to find some good negotiating levers.
- Force majeure, “Acts of God” beyond the control of contracting parties. Typically this language provides only for time extensions and not for price relief.
- Vendor breach of price If you signed a fixed price contract for a job relying on a steel vendor price commitment, you may have a case. Primary steel manufacturers probably have some exposure too. Litigation may be impractical. First, reconcile with the owner and the job, and then deal with your vendors.
- Commercial impracticability is the legal doctrine that says a contract can't be enforced if it is impossible to perform. Perhaps you have been told about this legal concept. Don't spend a lot of time on it. I am sorry to report that this doctrine wasn't very helpful in the 1973 oil price spike, a comparable event
An Action Plan Upside-down
fixed price contracts are a huge problem for some producers. Bridge
producers are particularly hard hit but there are other producers that
have big fixed-price contracts they can't live with.
Here is a list of options that may be helpful as a checklist to make sure
you are considering everything. Producers have successfully used
the items in this checklist to their advantage. If you are underwater
in a contract, look this over carefully. These are ideas here that
are proven to be effective.
- Make a deal Ask the owner for relief. It is in everyone's interest to find the middle ground that avoids a default, bankruptcy, or cancellation. If you take a walk, the options for you are not good but the options for the owner and GC are also not very good. For this reason, the Associated General Contractors (AGC) endorses renegotiation. See if you can get the owner and the GC at the same negotiating table to cut through game playing. Some state DOT’s would like to renegotiate upside down roadwork but the FHWA will not participate financially in the Federal share.
- Ask for help from your non-steel vendors. To get through a certain contract, you should be able to ask for and get significant price help from most of your other vendors for that job. That is the voice of experience speaking.
- Employee give backs are not out of bounds if survival is at stake. Most employees in the airline industry today are working because they gave up something. Many other industries are the same.
- Delay starting a losing job as long as possible. Gives you more time to make something happen. Prices may improve enough to make it work.
- The Go-ahead Decision on a losing contract should take on a formal structure. Take it to your Board if that is appropriate. Alternatively, form a management team to participate in the decision. Make it formal so that you are certain that every possibility has been considered.
- Bonding Company input on a loser will be needed if you are quoting bonded work.
Problem or Opportunity
Every problem is an opportunity.
Some producers in the short run have very serious problems with certain
fixed price contracts. All producers have the opportunity to bid
work intelligently during this unstable period, gaining good contracts
and avoiding expensive mistakes. Most producers have a big opportunity
to benefit from the increased competitiveness of precast compared
to steel systems.
The silver lining If that's
the bad news, is there a silver lining? Yes indeed, and an important
one for management!
- Bridge producers have seen an improvement in their competitive standing compared to their chief competitor, steel bridge beams. Similarly with poles, and a lot of other products.
- Concrete pipe has become more competitive compared to corrugated steel and iron pipe. This is a longer run opportunity.
- Structural producers generally have seen their competitive position improved compared to steel building systems. This is the right time to be looking at market initiatives for total precast systems
- Producers have been responding to requests for quotation. Seek out business that benefits from your new competitive position.
- Think hard about new markets also. For example, bar joists specifically have been affected with sharply increased price and reduced availability. Similarly steel studs, just to name two. There are new markets you could enter. Ask your contractors and specifiers for ideas.
The precast advantage. Finally,
remember that among our greatest strengths are:
- Speed of erection, and one-stop shopping. Steel construction has a checkered history of missed dates and fabrication delays. That's going to get worse, maybe a lot worse. Consequently, trades coordination will be negatively affected.
- On time completions. Most precast producers can point to a good record of on-time completions,
- Engineering We provide excellent job engineering support and
- Turnkey lump sum contracting is a big advantage you can offer.
This is the time to sell the whole package.
So in summary, the last few months have been difficult for some producers and a big challenge for all of us. Some experiences of those producers are summarized here. They provide some good points to consider. In the future, we should focus on our new and improved competitive position. There will be a big payoff for the alert producer.
Precast columns can replace
steel
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