Steel Market Update and apparently other steel-related periodicals published articles earlier this week regarding comments made by Lourenco Goncalves, CEO of the service center chain – Metals USA – during their conference call with analysts. SMU received a “letter to the editor” from an executive with an well-known international trading company regarding the comments made by Mr. Goncalves about the steel industry.

The author of the letter requested he not be identified. Even so, SMU believes the views of the author are not isolated and reflect the views of many in the steel industry. Here is what he had to say:

“John,

I’m sure you have seen the remarks from Lourenco Goncalves in AMM dated July 27. I do not represent any mill, as I am with an international trading company. He constantly blames mills for pricing issues in the market. Sometimes I think he wants to be the “Dan DiMicco” of the service center industry. He states that mills are reducing prices via “foreign fighters, ghost fighters, or course correction deals”. Who knows what that means?

If he is inferring that mills will reduce prices when confronted with lower foreign pricing, I don’t think that is the case. What mills are reducing their prices in hopes of keeping out foreign steel? I don’t know any. It is just supply and demand, and it is not that complicated.

Despite consolidation, there is still a bigger supply of steel than demand most of the time. Integrated mills have to make long-term difficult decisions about starting up or shutting down blast furnaces. They [integrated mills] still have pretty high fixed costs that put pressure on them to maintain a certain minimum level of operations. Large service centers know that, and they can put downward pressure on mills by dangling large amounts of tons in front of them.

I don’t think it is a matter of placing blame on mills or service centers. Rather, it is a fact of life that there are a large number of service centers in the market, and they may all have different reasons for prices given to their end-use customers and how they buy their steel. Some, maybe many, have to make decisions based upon cash flow. They may not be able to sit on inventory while hoping prices go up. Mr. Goncalves blames mills for chasing low prices, but there has not been enough consolidation in the service center industry to maintain pricing discipline either. He cites “basement traders” for chasing orders at low prices. Maybe that basement trader can be successful using toll processors at low prices. Why should they [basement traders] have to invest in bricks and mortar if they don’t have to? He [Mr. Goncalves] says they walk away from low priced business. That may be a good decision for them, but apparently other service centers may not be doing the same thing.

When I worked at a large integrated mill years ago, there were a couple of sayings I remember: 1. “You can’t kill a dead snake”. This usually applied to mills that stayed in business that should have shut down, not just changed names. 2. “You don’t cure prostitution by being the only virgin on the street.” This was usually mentioned when pricing was going down and you chose not to meet pricing and lost business. The bottom line to me is that you better be the low-cost quality producer in order to survive whether you are a mill or a service center. Even if you are the low-cost quality producer, you may need to have deep pockets at times.

Mr. Goncalves also says that pricing power has shifted to the miners and their influence is underestimated. I don’t think that is the case at all. Ask any purchasing manager buying iron ore if miners’ influence is underestimated. It is not underestimated; it is just that there may not be any short-term alternative. The big three iron ore companies have extreme pricing power that is not going to be easily changed.

I believe it is just supply and demand. Carrying more inventory is not the answer. Buying and selling steel is a negotiation between the buyer and seller. You need to know the other guy’s BATNA (best alternative to a negotiated settlement). If an end-use customer can get a processed product cheaper, he is probably going to do it unless he feels the long-term need for supply outweighs the lower pricing. If you are a service center selling him, you better know his BATNA and ask the right questions. If a service center customer can get master coils cheaper, he is probably going to do it unless he also feels the long-term need for steady supply outweighs the lower pricing. Sometimes, they will do both by purchasing a portion of their needs via CRU contractual pricing, and some on spot. The mill’s sales guy needs to know that customer’s BATNA and ask the right questions.

I’m not saying the mills (both integrated and electric) don’t sometimes make the wrong decisions. Everyone makes wrong decisions, but those decisions are mostly a result of supply and demand being out of balance and people not understanding their negotiating partners’ BATNA.

Just my 2 cents.”

Steel Market Update encourages a healthy debate within the steel community and we welcome your comments and opinions on the subjects raised in the above letter or, perhaps you have another topic which you find compelling and needing to be shared with the industry. You can do so by sending an email to: info@steelmarketupdate.com