A primer on the Steel Sector

The metal sector is broadly divided into 2, 

• Ferrous is a category of metal that has Iron in it, say Steel as an example
• Non-Ferrous is a metal, which does not have Iron content, Aluminum, copper, lead, nickel, Zinc etc. 

This article focuses on Ferrous & hence our discussion is around Steel.

To start, lets understand with how steel is made (its important).

Iron ore is mined, it is then first converted to Iron & Iron is then converted to Steel. There are 3 processes of making steel

• Blast Furnace
• Scrap Metal
• DRIP/Sponge 

Process 1 – Blast Furnace route  - 80-90% of steel production happens using this process.

• The powder Iron ore cant be directly used, as it would settle down in the blast furnace while heating it to make Iron
• So Iron ore powder with limestone is processed through the Sinter plant to make Iron ore lumps (balls)

Iron ore is oxide (FE2O3) and for it to be converted to pure iron, oxygen needs to be removed. So Iron ore lumps and coking coal are burned together in the blast furnace to remove oxygen and make Iron.

After the Iron is made, it is processed in either a Basic Oxygen Furnace (BOF) or Electric Arc Furnace (EAF) (saves burning of coal) to make Steel.

Process 2 – Scrap Metal

It is already waste Iron and hence it does not need to go through the Iron making process (Blast Furnace). It is directly converted into steel using the Basic oxygen furnace (BOF) or Electric Arc Furnace (EAF)

Process 3 – DRIP (Direct Reduced Iron) / Sponge Iron

Same like Blast Furnace process but instead of Coking Coal, Thermal Coal is used.

After the steel is made using any of the above 3 processes, the Steel is then casted into either Long Products (Rodes/Pipes used in construction) or Flat Products (Plates/Sheets or Coils of Steel used in making Cars, ACs, Fridge etc.)

When does the Metal Cycle work?

It’s all about China. China has 54% of the global trade. Whenever their GDP is expected to shrink (because of corona in current case), they start spending more on Infrastructure and hence metal demand goes up & hence prices.

What was happening for the last 2 years?

• China in 2020 started importing steel (instead of exporting) and in 2021 had put restriction on steel export and hence commodity prices (Steel & Iron Ore) were rising.
• Also, Iron Ore/Coking Coal prices (the raw material for making Iron, Steel) lately have gone up because of production disruption in Brazil (drought) & Chinas geo political stand on Australia and hence not importing from there. 
• So China is importing billets (another form of Steel) instead of Iron Ore

Why were stocks going up?

(1) Because of Steel prices going up internationally, margins of the steel companies were expected to go up

(2) But, there are 2 types of companies

• Steel companies who have their captive (own) Iron Ore mines (Tata Steel, Godawari, SAIL) 
• Companies which don’t have captive mines (JSPL – Partly integrated)

(3) Steel & Iron Ore both prices have gone up & hence the advantage is more for companies with captive mines as their raw material (Iron Ore) is captive and hence cost also dint go up and they could separately sell Iron ore at higher prices to the market.

(4) Reduction in China Export

Below graph shows how when china reduces exports (blue bars), the margins of steel makers go up (Red Line)

Why have stocks crashed now?

• Government increased export duty on iron ore and import duty on coal, both to make steel cheaper
• Government also increased the export duty on steel, forcing makers to sell locally.
• All in all, supply to increase domestically, prices to go down, reducing inflation.

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Kirtan Shah

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Credence Wealth Advisors