The European Union (EU) has been scaling back its aggressive environmental targets. But not enough for some, including heavy energy users like steel manufacturers. Now the European Parliament is asking the EU to rethink how its rules will impact this vital industry. The troubles facing European steel are exactly the reasons why you should like U.S. steel makers Nucor (NYSE:NUE) and Steel Dynamics (NASDAQ:STLD).
Making energy too expensive
The best way to curtail the use of something is to make it prohibitively expensive to use. That's the general idea behind the EU carbon trading schemes meant to reverse, or at least slow, the pace of global climate change. The impact of such schemes, however, effects different industries in vastly different ways.
For example, a software company wouldn't care too much about carbon trading, but a steel manufacturer that uses large amounts of carbon fuels would. The carbon scheme design makes it less desirable to operate a steel making facility in Europe. Mills are already closing down. Weak demand in the struggling region is playing a role too, but it just highlights the impact of increased costs.
That's why some key U.S. steel companies are, perhaps, in a better position than the market seems to believe. For example, Nucor and Steel Dynamics use scrap to make steel. This process uses a lot of natural gas. With relatively low natural gas prices in the United States, this pair is receiving a little extra boost on the cost side of the ledger.
In fact, Nucor was attempting to control its natural gas costs when it partnered with Canadian driller Encana (NYSE:OVV) to ensure low-cost access to the fuel. But Nucor recently called off the drilling planned for 2014 because natural gas prices were so low that it was cheaper to buy the gas than drill for it. Although cold weather has pushed gas prices higher, Nucor has yet to announce a resumption of the drilling program.
Steel Dynamics uses the same mini-mill manufacturing processes as Nucor, so it too is benefiting from low gas prices. The interesting thing is that both Steel Dynamics and Nucor have remained profitable despite a weak U.S. economy and difficult steel market. Steel makers using coal as a primary input like AK Steel (NYSE:AKS) and U.S. Steel (NYSE:X), haven't been able to keep themselves out of the red.
More than just gas
To be fair, AK Steel and U.S. Steel face legacy costs that don't impact Nucor or Steel Dynamics to nearly the same degree. Heavy unionization at AK Steel and U.S. Steel being the most notable. However, using cheap gas and the lack of a carbon trading scheme clearly help this pair when looking at U.S. steel companies from a global point of view.
And that's a huge leg up when it comes to defending market share from foreign imports. AK Steel CEO James Wainscott, for example, noted in his company's third quarter earnings conference call that, "we've seen America become the world's dumping ground for electrical steel." Electrical steel is a key product for AK Steel, but the sentiment of that comment is echoed throughout the U.S. steel industry.
China is often highlighted as the major problem, with Nucor CEO John Ferriola pointing to the country's at least 300 million tons of "excess steel capacity" as a major concern. And it isn't just the U.S. market where that excess Chinese steel shows up.
A combination of positives
No wonder the European Parliament is concerned about the region's steel industry. Increasing costs, relatively weak demand, and competitive pressures from low-cost imports paint a grim picture for EU steel makers. Although U.S. players have to deal with their own set of issues, many of which are similar, Nucor and Steel Dynamics stand out from the competition. Indeed, no carbon schemes to deal with and relatively low natural gas prices are keeping the pair competitive in the face of a tough market.