Is the Steel Industry Ready to Run?

Steel may not be something that you go out and purchase every day, but the consumption of steel probably could go toe-to-toe with oil for the title of "commodity that most directly reflects economic health." The prices for steel and its base products, such as iron ore, have been putting out several mixed signals in the past several months, but some recent developments could lead to some good times ahead. Let's look at what's going on and what companies are positioning themselves to take advantage.

Source: Cliffs Natural Resources Media Resources

Chugging along, thanks to China
It's a shame for steel manufacturers that demand wasn't better over the past few months, because prices for iron ore have hit four-year lows as recently as last September, and current prices are at 60% of what they were at the peak in September 2011. Several companies that are iron ore-heavy have suffered because of weak pricing, but this trend could end soon. During Cliffs Natural Resouces' most recent conference call, CEO Joseph Carrabba stated that iron ore inventory levels at Chinese ports and mills are at multi-year lows.

While there are signs that China is attempting to tap the brakes on its infrastructure development, others remain optimistic about the prospects for Chinese demand. Brazilian mining giant Vale , the world's largest iron ore producer, sees iron ore demand remaining steady despite the anticipated slowdown. It's so confident that the company is continuing with an expansion of its iron ore production.

Re-stocking the coffers and a steady appetite from China could be a welcome respite for these companies. Both Vale and Cliffs have a very high exposure to the steel industry, and the worries of a Chinese slowdown have led both companies shares to plummet so far this year.

VALE Chart
VALE Chart

VALE data by YCharts

Cliffs relies on 34% of its income from Chinese steel production and has suffered mightily since the acquisition of Consolidated Thompson back in 2011, which ultimately led to its major dividend cut at the beginning of the year. With Cliffs trading at only 57% of its tangible book value, the company could be headed for a rebound.

American creativity at its best
As much as China may be of assistance to the mining side of steel, it has been one of the banes of American steel manufacturers. Imports of cheap foreign steel have driven down prices in the U.S. and captured a large part of the market share. Today, about 26 million tons of steel are imported to the U.S. each year. To compete with this difficult market, companies have had to find newer ways to get ahead.

One company that's pioneering an interesting move in the American steel world is Nucor . The company is about to bring on two Direct Reduced Iron facilities in Louisiana. This scrap metal/new material hybrid facility is able to run on natural gas versus traditional coking coal, which provides a cheap energy source. What makes Nucor's move unique, though, is that the company has taken a 50% working interest in several natural gas wells with Encana .

By doing so, the company is shielding itself from higher natural gas prices that could potentially make these new facilities unprofitable should natural gas prices increase or steel prices were to sink any lower. Don't be surprised if other companies in the steel industry were to follow suit. ArcerlorMittal has more than 8.2 million tons per year of direct reduced iron capacity, and a large percentage of that is in North America, where natural gas is cheap in comparison with many other regions.

Getting government help
Even though some steel manufacturers are tightening their belts and getting creative, there are some signs that the American steel market is about to pick up. One possible sign is that residential construction has picked up modestly over the past couple of months. While this is not a market that gives a lot of love to steel, non-residential construction -- steel's bread and butter -- has historically followed residential construction with a lag of about nine to 12 months. So it's possible that we could see a pickup in non-residential construction right around the corner.

Also, the government may be stepping in to help with that pesky imports problem. The U.S. Departement of Commerce has opened a probe into illegal dumping practices from nine countries related to tubular steel products. This move, which also happened back in 2008 relating to China, could put higher import tariffs on imported tubular steel, which would open up about $1.8 billion of the market for U.S. manufacturers. While $1.8 billion spread among U.S. manufacturers might not move the needle too much, it certainly is a step in the right direction for many struggling steel companies.

What a Fool believes
Ups and downs of commodities like steel is the name of the game, and for every plummet there is a sub-sequential rebound. Will we return to the steel heyday of 2007-2008? Probably not. This period was probably best described by Nucor CEO John Ferriola, when he said it "was almost an artificial time period, created on steroids." He added: "I don't expect to see again. But if it approached 70%, 75%, 80% of the peak levels of 2007, we'd be pretty pleased."

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Fool contributor Tyler Crowe has no position in any stocks mentioned. The Motley Fool recommends Nucor and owns shares of ArcelorMittal and Vale. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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