Nucor Corporation's (NYSE:NUE) steel mills ran at 69% of their capacity through the first nine months of the year. That's a big drop from a year ago and highlights one of the biggest issues facing U.S. steel mills today.
Steel mills aren't cheap to run
A steel mill is a large and expensive manufacturing facility. But forget the money spent to build it, that's gone. The bigger issue is the money required to run it. Although there are a lot of variable costs involved in operating a mill, simply getting one pound of steel out of a mill has a base cost and it's not chump change. Money spent on employees, electricity, insurance, and fuel, among many other bills, add up quickly.
Clearly no steel mill would operate to make one pound of steel. But it takes the example to the extreme, which is that the more steel that's made the further those base costs of just opening the doors gets spread around and the cost per unit of steel produced declines.
Which is why it's troubling that Nucor's mills are running at just 69% of capacity so far this year. That's down from 78% through the first nine months of last year. And, looking quarter over quarter, the third quarter's 69% capacity utilization was down from 81% in the third quarter last year. The 69% quarterly utilization was also down sequentially from the second quarter, which saw 73% utilization.
Just to give you a sense of the impact, the company noted that, "Total steel mill energy costs in the third quarter of 2015 increased approximately $2 per ton compared with the second quarter of 2015 due to decreased steel production volumes and the resulting reduced efficiencies." (Emphasis mine).
An industrywide issue
And Nucor isn't alone. Steel Dynamics, (NASDAQ:STLD) noted that its utilization rate fell from 87% in the second quarter to 82% in the third. That third quarter figure was down from 90% in the year earlier period and around 95% in the second quarter of 2014. So Steel Dynamics is doing a better job at keeping its mills busy than Nucor, but it, too, is suffering from falling utilization rates.
Even Schnitzer Steel Industries, Inc (NASDAQ:SCHN) which actually saw a sequential quarter increase in its steel mill utilization in the calendar third quarter (the company's fiscal fourth quarter) is seeing year-over-year declines. Strong construction markets on the West coast boosted utilization to 74% from 69% in the calendar second quarter. That 74%, however, was down from 76% in the same period a year ago. Schnitzer is tiny compared to Nucor and Steel Dynamics and is benefiting from strength in a single market, its larger brethren will likely need an industrywide shift to see their mills' capacity factors turn around.
Tap on effect
The headlines are filled with news about Chinese overcapacity pummeling steel prices around the world. And that's absolutely true. To give an idea of the scale of the issue, Nucor John Ferriola provided this example: "In the first 8 months of this year China's global steel exports surged 27% to 72 million tons. They are on track to exceed 100 million tons, which is greater than the total U.S. steel production last year." No wonder steel prices are under pressure.
But increasing imports into the U.S. market are also satisfying demand that mills like Nucor, Steel Dynamics, and Schnitzer would otherwise be filling. In other words, there's two problems in one going on. Steel prices are low and the overcapacity that's causing that is also causing U.S. mills to run below optimal levels putting upward pressure on the cost of production.
To be fair, the mills are working hard to keep costs in check. But as you are watching steel prices, don't forget to keep an eye on utilization. It's a one-two combo punch that is making a bad situation even worse right now.
Reuben Brewer has a position in Nucor. 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.