Russian Provocations Could Change the Future for These 2 U.S. Steel Mills

Russia continues to make waves in the global energy market. Will it give steel maker Nucor an even greater edge or end up destroying the company's competitive advantage?

Jun 18, 2014 at 1:02PM

Russia has taken over Crimea and signed a natural gas deal with China. The word "war," cold or otherwise, has been bouncing around in the media. Will Russia's provocations lead to even higher natural gas prices in Europe and, thus, give Nucor (NYSE:NUE) an even greater fuel-based advantage?

Gas is cheap... for Nucor, anyway
Natural gas is relatively cheap in the United States. Nucor has specifically discussed the benefits of this. For example, Jennifer Diggins, director of public affairs at Nucor, highlighted the value of cheap gas last year, stating that it, "...helped [Nucor] continue to build and expand throughout this very difficult economic time." Increased domestic drilling and export limitations have left the United States with a glut of gas and low prices.

Nucor's Diggins was specifically talking about a $750 million investment to open a mill in Louisiana. "We would not have ever been able to make an investment like that if the price of natural gas had stayed where it was six or seven years ago." Nucor uses mini-mills and electric arc furnaces to make steel, largely from scrap, a process that uses electricity and natural gas.

(Source: Alfred T. Palmer, via Wikimedia Commons)

So while competitors in Europe and elsewhere are dealing with a very uncertain energy future because of Russia's Crimea move and subsequent gas deal with China, Nucor is sitting pretty. In fact gas is so cheap right now that Nucor halted its own drilling program so it could save $400 million in capital spending this year. It was just cheaper and easier to buy gas than drill for it.

AK Steel's not that lucky
For a comparison of success, just look at AK Steel (NYSE:AKS). AK Steel has lost money in each of the past five years. Worse, AK Steel's first quarter loss of over $0.60 a share suggests that trend isn't turning anytime soon. Nucor has remained profitable in nine of the last ten years, posting its only loss in 2009—at the end of the global recession.

Part of the problem AK Steel faces is fundamental to its business; its steel mills use blast furnaces. Although both metallurgical coal and iron ore are relatively cheap today, the process is simply more costly than a mini-mill. To add insult to injury, AK Steel has significant legacy costs related to unions and pensions, too.

Images

(Source: U.S. EPA)

So Nucor's advantage is notable both versus foreign competitors and domestic ones. However, Russia's actions likely won't hurt AK Steel, but they could help it become more competitive versus Nucor if the U.S. starts to export natural gas. Many drillers would like to see that happen so they can sell their product at the higher foreign prices.

Will the U.S. ride to the rescue?
This is part of the reason why Nucor is pushing for a measured approach to the export of natural gas. The company doesn't want its advantage over competitors to disappear. In fact Nucor is one of the companies behind the group America's Energy Advantage. It advocates against the export of natural gas and estimates that sending gas overseas could drive the domestic price up as much as 50%.

A price increase of that magnitude would put a crimp in Nucor's profit margins. Although the company's ability to remain profitable is impressive, the mid single-digit profit margins of recent years are less than half of what was achieved a decade ago. So every penny counts right now. Unfortunately for Nucor, the Russian story is being taken up as a reason to speed up the export of natural gas.

All eyes on Russia
Although it's easy to dismiss Russia as a politically backward nation, you have to respect the importance it plays in the energy space and beyond. Nucor's "energy advantage" could become even stronger if Russia's move raises gas prices in foreign markets. But if the United States starts to export more of the fuel to counter Russia, Nucor could watch its advantage slip (perhaps ship) away. That, in turn, would help competitor AK Steel. Russia and Crimea may seem like stale news, but the ripple effect could be huge. Keep watching this issue.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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