Can Natural Gas Save This Troubled Industry?

The past few years haven't been kind to U.S. steelmakers, who have languished due to weak domestic demand, depressed prices, and heavy foreign competition, especially from China.

But cheap and plentiful supplies of natural gas could help revive profitability among some steelmakers by helping reduce costs. Indeed, a handful are already building or thinking about building plants that would use natural gas instead of coal to purify iron ore, the main ingredient in steel. Let's take a closer look.

Steelmakers' woes
Since the global financial crisis five years ago, U.S. steel output has fallen about 3.5%, as compared to a 14% increase globally. Not surprisingly, U.S. steelmakers' profits have suffered and losses have become commonplace in the industry.

U.S. Steel (NYSE: X  ) , for instance, reported a larger than expected loss of $73 million in the first quarter due to an 11% plunge in sales and a 3% drop in shipments, while AK Steel Holding (NYSE: AKS  ) , an integrated producer of flat-rolled carbon, stainless and electrical steels, and tubular products, reported a net loss of $9.9 million, or $0.07 per diluted share, in the first quarter.

But low natural gas prices are spurring some steelmakers to invest in direct reduction plants, which use natural gas to convert iron ore pellets into high quality direct reduced iron, or DRI, a product which is then combined with scrap and melted to produce steel.

The allure of cheap gas to make DRI
Austrian steelmaker Voestalpine plans to construct a $740 million DRI plant in Texas that would be capable of producing some 2 million tons of DRI per year, of which half would be shipped to Austria to be made into steel.

Similarly, Nucor (NYSE: NUE  ) , one of the largest U.S. steelmakers, is close to finishing up a new DRI plant in Louisiana that will be able to process roughly 2.5 million tons of DRI pellets a year. Given that Nucor has a production capacity of approximately 27 million tons, that 2.5 million ton increase would represent a 9% increase to the company's total capacity.

And since the Louisiana DRI facility will cost about half as much to build as a blast furnace and coke making facility, it should help the company improve its gross margin. Indeed, Nucor's CEO, John Ferriola, said the new DRI plant will be "a game-changer to Nucor's cost structure for high-quality iron".

But there's a caveat. While using natural gas to make DRI may be a game-changer for Nucor and other companies employing "mini-mill" electric arc furnaces, it may not have much use for other steelmakers, especially those that use blast furnaces.

Take U.S. Steel, for instance, which is currently mulling over the costs and benefits of partnering with Republic Steel to construct a DRI facility adjacent to that company's plant in Lorain, Ohio. But while such a joint venture could help cut costs at the company's Ohio operations, CEO John Surma recently remarked that it is still a far from constructing such a facility.

The bottom line
All in all, there are limitations to how much natural gas can be used in blast furnaces. Furthermore, using DRI in a blast furnace often requires more electricity during smelting than simply using scrap, according to industry experts, including European steel and iron behemoth ArcelorMittal (UNKNOWN: AM.DL2  ) , one of the biggest producers of DRI in the world.

Therefore, for companies with access to ample supplies of scrap, using DRI in a blast furnace may not make much financial sense. So while the shale gas boom bodes well for steelmakers that can use the cleaner-burning fuel to power "mini-mill" electric arc furnaces, its benefits for other steelmakers are less clear.

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