The consequences of the COVID-19 pandemic are weighing heavily on much of the rated steel industry. However, S&P Global Ratings sees steel companies' starting points as the pandemic broke out as decisive for the path their credit quality takes in 2021. As the coronavirus pandemic continues, the companies' asset quality, location, and financial positions are determining their performance, rating resilience, and evolution. Distinct regional and national market dynamics have resulted in very different levels of stress on steel producers, but, as ever, strong financial frameworks and timely and effective actions can be critical defenses against market volatility. We don't anticipate or factor in further protracted or widespread lockdowns since they were eased midyear. Here, S&P Global Ratings takes a snapshot of the global industry before COVID-19, and summarizes some of the key industry impacts and responses. We also highlight our ratings on 12 large players. We then focus on the different regions and give an overview of what global dynamics mean for different markets.

Global Steel: China And The Rest Of The World

2019 was already challenging for most rated steel producers.   Global demand and production across key markets outside of China contracted, as more than two years of strong performance unwound in the face of high raw material prices and as demand softened, particularly in Europe and the U.S. In contrast, China powered on, expanding its huge share of both global production and consumption (chart 1).

Chart 1

China's production essentially meets its own domestic demand, which won't help exporters in other markets.   Even so, the 5% that is exported directly is the largest contribution of any country, which highlights the risk that relatively modest imbalances in China could have a disproportionate impact globally, as happened in 2016 and 2017. The nine largest net exporting countries are shown in chart 2 in absolute net tons exported and as a proportion of their production. These net exporters are also the largest exporters and producers, with the exception of the EU, which is a net importer. Taken together, they produce 90% of global steel, or 37% excluding China.

Chart 2

This dichotomy between markets and performance continued to a lesser extent in 2020 as COVID-19 took hold.   Although Chinese industry was the first to suffer from lockdown, monthly production fell below that of the prior year only in March 2020, by 1.7%. And so, because Chinese demand and production are relatively resilient and likely positive for 2020 as a whole, demand for seaborne iron ore has remained robust. Ore supply outages in Brazil and Australia have driven up iron ore prices, which has put additional pressure on blast furnace operators globally. Indeed, annual iron ore prices are set to average over $100 a ton for the first time since 2013.

In contrast with the case in China, lockdowns in the rest of the world caused a sudden collapse in demand, from car makers and other users of steel.   Producers outside China shuttered production, resulting in year-on-year production declines of 20%-30% in April, May, and June. Governments established furlough schemes to maintain employment, which alleviated fixed costs for some companies. How production resumes and various state support mechanisms are unwound will be critical for the transition back to steady operations. The benefits of recovering revenue may initially be at least partly absorbed as companies begin bearing their operating costs and iron ore prices remain strong.

We assume the downturn induced by COVID-19 will be less severe for the steel industry and producers than the financial crisis in 2009 was.  In part, this reflects the relatively prompt economic rebound in China, given its importance for the industry. In other regions it is also because the sector did not have far to fall compared with 2008. For example, in 2009, European GDP contracted by slightly more than 5% and demand for steel collapsed by 40% before bouncing back by about 25% in the following year. Steel production in Europe collapsed by 35% to about 140 million metric tons (Mt) in 2009 from the industry's peak in 2007 (about 210 Mt). The subsequent recovery hasn't seen production come even close to those 2007, pre-crisis levels. There has already been a sharp rebound in prices and performance for some, including mini-mill operators in North America.

Other than revenue, a key factor for profitability is average utilization.   Without sufficient demand, production can't increase or resume. Less production at a given plant or in a region implies suboptimal utilization. In 2018, European industry produced 160 Mt of steel, before demand reduced in 2019, representing a healthy utilization rate of about 84%. We estimate that, at the current production level, the utilization rate is about 70%-75% (slightly below 70% in 2009). If some of the capacity were to remain idle for a longer period, utilization for the assets in operation could be higher, and the steel industry could recover more quickly than if all assets resumed operations.

The severity of this COVID-19 crisis has not had a commensurate severe impact on credit ratings.   The modest number and scope of rating actions to date can be explained by some companies' ample rating headroom before COVID-19; some companies' cost flexibility, including governments' financial support schemes for workforces; and also prompt decisions taken to idle capacity. We revised our outlooks to stable from positive on Russian steelmakers NLMK (BBB-/Stable/--) and Magnitogorsk Iron and Steel Works (BBB-/Stable/A-3) and to negative from stable on Swedish steelmaker SSAB (BB+/Watch Neg/B) and subsequently placed the ratings on CreditWatch with negative implications. We affirmed our rating on global player, ArcelorMittal (BBB-/Negative/A-3) with a negative outlook. We revised our outlook on thyssenkrupp (BB-/Stable/B) to stable on expected weaker cash generation. In April, we lowered our rating on Tata Steel (B+/Negative/--), which had limited headroom going into COVID-19, by one notch to 'B+' with a negative outlook. We revised our outlook on Nippon Steel Corp. (BBB/Negative/--), to negative, largely due to the heavy debt burden from its Essar acquisition and worsening operating performance. In April we also revised the outlooks on the three steel companies we rate in Brazil, Companhia Siderurgica Nacional (CSN; B-/Positive/--), Gerdau (BBB-/Stable/--), and Usinas Siderúrgicas de Minas Gerais (B+/Stable/--), to negative from stable, amid a decline in production and demand of more than 40% in March and April. However, we have already revised the outlooks back to stable and even to positive for CSN, thanks to sound demand for long steel in the country and the favorable price environment for iron ore, which benefits these integrated companies.

After a tumultuous first half of 2020, we project a recovery in steel demand and production during the second half and into 2021.   This is in line our economic projections of a global GDP decline of 3.8% for 2020 reverting to growth of 5.3% in 2021 and broadly consistent with World Steel Association forecasts (see table 1).

Table 1

The industry still needs to address regional and local overcapacity, in Europe and North America in particular.   Transactions such as ArcelorMittal's deal with Cleveland-Cliffs in North America don't necessarily remove steel capacity from the market, even if consolidation of steel producers and ore supply have the potential to improve competitive dynamics. Equally, investors' and policy-makers' increasing focus on environmental, social, and governance (ESG) issues will weigh most heavily in Europe and North America, given the industry's massive energy intensity and emissions. The pandemic has only heightened stakeholders' awareness, but most players' capacity to invest is clearly hampered at present. Scrap recycling is already widespread and some companies have targets for CO2 reductions and net zero dates. We note huge investment and likely policy support would be needed for a green steel transformation, for example by replacing blast furnace production with direct reduction of iron ore using hydrogen.

Ratings On Selected Large Global Steel Companies

Table 2 highlights key performance metrics and rating expectations for 12 major global steel companies. Below the table, we outline the market context, dynamics, and prospects for these and other producers.

Table 2

Asia Pacific

Table 3

India

Indian steel companies' operational performance rebounded strongly in the second quarter of fiscal 2021 (fiscal year ends March 2021), whereby the recovery has so far surpassed our expectations following a weak first quarter hit by the COVID-19 lockdowns. The recovery has been demand led, with an almost doubling of domestic steel consumption quarter on quarter, even despite second-quarter consumption remaining around 10% lower than a year earlier.

We believe pent-up demand contributed to the sharp rebound, for example, sales to the automotive sector were higher than average as the sector ramped up once lockdowns began to lift. We expect some moderation in performance, even though the recovery in underlying demand appears to be stronger than we previously anticipated.

Steel production and sales from Indian majors were down around 24% year on year with an about 30% drop in domestic demand. Surplus production was directed toward exports. Exports also decreased to around 30% in the second quarter of fiscal 2021 versus around 50% during the first quarter for Indian majors. This is significant because export margins are lower (by about US$50-US$60 per ton). Nevertheless, Indian steelmakers are forecasting their full-year volumes will likely be close to those of fiscal 2020, despite expected production losses in the first quarter of fiscal 2021 related to COVID-19.

From a credit perspective, although the operational trend provides some cause for optimism, we expect credit metrics to recover more gradually. This is because Indian steel companies already were highly leveraged going into the pandemic.

Japan

We expect the recessionary conditions produced by the COVID-19 pandemic to significantly reduce steel demand in Japan in fiscal 2020 (year ending March 31, 2021). Japanese steelmakers' capacity utilization has markedly fallen in response to the drop in steel demand. For example, because of this, Nippon Steel lowered production to about 60% of its capacity in April-June. We expect a gradual recovery in steelmakers' output and earnings in the second half of fiscal 2020 and we believe domestic demand for steel products will gradually recover in the second half of fiscal 2020, particularly in the key auto and manufacturing sectors.

As demand recovers, we expect Japanese crude steel output to recover after hitting bottom in the first half of fiscal 2020. However, despite the recovery in the second half, we still see crude steel production in Japan decreasing by about 20% year on year in fiscal 2020. Moreover, our recovery path envisages crude steel output remaining below pre-COVID-19 levels until fiscal 2021, at least. We believe the credit quality of Japanese steelmakers will likely suffer downward pressure, as a result, including that of Nippon Steel, the world's third-largest producer of crude steel.

We also believe Japan will reduce export volumes about 15%-20% in fiscal 2020 compared with fiscal 2019, thereafter increasing by 10%-15% in fiscal 2021, in line with domestic crude steel production. We see Japanese steelmakers focusing on production for the domestic automotive and manufacturing sectors. Therefore, although we expect the ratio of exports to domestic tonnage to increase slightly this year, in our view exports will likely remain at about 40% or below. In fiscal 2019, the export ratio was about 35%.

South Korea

We expect Korean steelmakers' performance for the second half of 2020 to remain subdued primarily due to COVID-19-driven weak demand, particularly as regards the automotive and shipbuilding sectors.

In our view, the second quarter of 2020 was likely the market bottom because it was hardest hit by widespread lockdowns. We envisage a modest recovery continuing from the third quarter of 2020 on the back of a rebound in automotive demand and steady steel demand from China. A gradual recovery also coincides with our expectations that the pace and scope of recovery in 2021 will be more modest than in 2020.

Still, the pace of recovery remains at risk, given that global containment of COVID-19 is low. Elevated iron ore prices will also probably hamper Korean steelmakers' turnaround.

We expect a modest reduction in South Korean domestic production in 2020 of about 5%-10% of companies' pre-COVID-19 production guidance. South Korean export volumes remain closely linked to global industry demand drivers. For Korean steelmakers, overseas automotive steel demand should have more of an impact on export volumes.

China

We expect China's steel demand will register growth in the low single digits in both 2020 and 2021, in contrast to the general decline elsewhere in 2020. China's earlier recovery from COVID-19 and government stimulus measures especially for infrastructure provided for the earlier recovery. China's crude steel production remained resilient in the first 10 months, and grew by 5.5% year on year (see chart 3).

We expect production and utilization rates to remain robust, at more than 80% in the second half, supported by demand growth. However we believe steel margins will be under pressure for the rest of the year, given elevated iron ore prices, before improving in 2021 based on what we assume will be moderating iron ore prices (see chart 4). Yet the solid domestic demand should better position Chinese steel mills against international peers to pass through at least part of the higher costs to customers. Major steel mills have remained profitable this year, although profitability is weaker than in 2019. We believe the government will adhere to supply-side reform and that further consolidation of steel mills will provide some support for Chinese steel margins.

The key risk is a new wave of infections leading to further economic lockdowns that would dampen demand. In that case, we may see similar trends as in February and March, when production remained generally flat but demand slumped, which resulted in surging steel product inventories that required steel mills to fund working capital needs. We see global trade restriction as having minimal impact on China's steel demand because demand is primarily driven by domestic consumption. Exports account for only about 5% of China's steel production, so tariffs have not been a material factor. Worsening prospects for international trade may, again, prompt the government to increase domestic spending, which will support steel demand.

China's GDP returned to 4.9% year-on-year growth in the third quarter of 2020 from the 6.8% drop in the first quarter. Our economists forecast full year growth of 2.1% in 2020 and acceleration to 6.9% in 2021. China's economic activity hit bottom in February and started to climb starting in March. We believe this growth will continue in the fourth quarter. Among the key drivers for steel demand, infrastructure investments dropped by 30% year on year in the first two months of the year, but this has turned into a 0.7% increase for the first 10 months of the year. We expect this will continue to improve in the fourth quarter as the government boosts infrastructure investment to support the economy.

Likewise, property investment has recovered from the 16.3% year-on-year decline in the first two months to 6.3% growth in the first 10 months. The government will continue to control the property market. We do not think it will stimulate the economy through the property sector because the government has long emphasized that property is for living rather than speculation. Automotive sales have also climbed back up to 13% growth in October from the approximately 80% drop in February, but our automotive team forecasts a 6%-9% full-year decline for this sector in China. Steel product inventory has been falling from its peak in late March, although it is still greater than that in prior years.

Environmental protection remains a top priority of the Chinese government. Apart from environment-focused actions to tackle emissions and climate change, we believe the government will continue to tighten emission standards as a way of supply-side reform to phase out steel mills that are unable to keep up with new requirements, therefore upholding the healthy development of the industry.

Chart 3

Chart 4

Europe, the Middle East, and Africa

Chart 5

COVID-19 took a heavy toll on European steel companies and the slow pace of the rebound might lead to more casualties

In our view, the ugliest part of the crisis should be behind us, but a dramatic rebound in performance is far from certain. In the first half of 2020, European steel industry demand collapsed by 18.7% against the first half of 2019 (which was already a weak year compared with the strong 2018, when total production was 68.3 million tons). During the second quarter, the majority of the EU was under lockdown. European steelmakers responded very swiftly to the sharply lower order intake, reducing and idling capacity so that production in the quarter fell 25%.

The third quarter of the year already signaled some recovery from the trough in the second quarter as production contracted by about 15% compared with the same period in 2019. In our view, the last quarter of the year will likely show further but only modest recovery, because more countries enforced new restrictions to fight the second wave of COVID-19. Overall, we expect a 15%-20% year-on-year contraction for the full year, but worse if some of the measures are extended into December.

Looking beyond 2020, depending on the responses to this second wave of COVID-19, we continue to assume demand for steel will trend upward in 2021, and, under a slightly more optimistic view than our base case, could even reach normal production levels by the last quarter of 2021. We assume 2021 steel demand in Europe will be 5%-10% below the 2019 level (in April we assumed a 2% contraction). In part, we expect that the recovery will be helped by government stimulus programs, such as Next Generation EU, an expected €750 billion support package that will likely target steel-consuming sectors. Another important checkpoint would be in June 2021, when the current European safeguard measures expire. Our base case assumes extension of the current system, as well as the extension of Section 232 of the U.S. Department of Commerce's Trade Expansion Act.

In our view, the health of the automotive industry will continue to be a key driver for the steel industry in Europe, making up about 25% of the demand for steel. Current high unemployment rates do not auger well for new car purchases. In June 2020 the EU registration of new passenger cars totaled only 950,000, a 22.3% year-on-year drop, although still an improvement over the year-on-year drop of more than 50% in May.

Construction is the primary user of steel, making up about 35% of overall demand, and was also affected during the lockdowns. However, this market is showing one of the strongest recoveries.

The current challenging industry conditions in Europe are expected to change the competitive landscape. Some of the news in 2020 includes:

• Liberty Steel, which in 2019 bought some of ArcellorMittal's steel assets in Central and Eastern Europe, made an offer to purchase thyssenkrupp's steel division. This offer comes after Liberty won approval to acquire two steelworks in France. If Liberty is able to make a further transaction like this, it could emerge as another steel champion.
• Tata Steel Europe's warning that it might not be able to continue as a going concern, and may need U.K. government support to keep running its business. In parallel, TATA has announced its intention to sell its Dutch assets, and SSAB is currently negotiating the terms (see "SSAB 'BB+' Rating Placed On CreditWatch Negative On Steel Industry Recovery Woes And The Potential Tata Steel Deal," published Nov. 23, on RatingsDirect).

We think the EU's push for a "net zero" carbon economy by 2050 will lead to more changes, including consolidation of small companies, along with closures of old and less competitive facilities.

The Russian steel industry, despite a 10% drop in domestic consumption in the first half of 2020, has been more resilient than Europe's, with an only moderate 3% decline in production, and an increase of almost 1% in September (see chart 6). Exports helped to keep utilization high, with Asian markets being Russian producers' key destination. Low ruble costs and integration into raw materials supported their profitability, although margins were lower than for domestic or European sales. Some producers found it profitable to export pig iron to Asia rather than steel to the far away U.S. There has been a strong rebound in domestic steel demand in the third quarter and we believe that, absent a severe impact from the second wave of COVID-19, full-year demand will be about 7% below the 2019 numbers, with recovery to pre-pandemic levels by year-end 2022.

Chart 6

Latin America

Steel markets have surprisingly rebounded since April

The bad news expected we expected in April, when demand for steel dropped more than 40% in most Latin American economies, didn't materialize. Instead, demand has gradually recovered. Overall consumption will be mixed in the region in 2020, but the largest economy, Brazil, will likely have a mild increase in steel consumption in the year, the majority in retail, but also getting a big boost from construction.

Our current view is that the region's largest six economies will face an 8.5% GDP contraction in 2020, enjoying collectively a modest rebound in 2021 (see table 4). We anticipate Peru, Chile, and Colombia will recover faster and more solidly, thanks mainly to timely and effective stimulus, the general containment of health care situations, and resilient export profiles (mainly metals in the case of Chile and Peru).

Table 4

We expect modest recoveries in 2021 for the region's largest three economies: Brazil, Mexico, and Argentina. Compared with June 2019, Brazil's June 2020 steel production shrank 22%, Mexico's shrank by 27%, and Argentina's was down 41%. Brazil's annual steel production sits around 32 million-33 Mt; Mexico's at about 18-19 Mt; and Argentina at around 4-5 Mt. The rest of the region's steel production is fairly small.

Although some importing countries, such as Chile and Peru, reduced volumes for the year, Brazilian steelmakers saw the apparent consumption (production plus imports minus exports) stop falling in June. This signals that the recovery may have started in July, boosted by the public construction that is performing strongly, despite the circumstances, while the demand for flat steel, mainly from automakers, should still see some volume decline in the year.

Recovery of flat steel production across countries remains uncertain and largely depends on macroeconomic trends and effectiveness of stimulus measures. Domestic prices have remained below international levels, which has enabled companies to adjust prices to somewhat compensate weak volumes and margins. Steel companies in general have also been able to export at attractive prices in real terms, thanks to currency depreciation, helping volumes dilute fixed costs.

North America

COVID-19 and ESG reshape big steel in North America

Several steel producers in North America face an arduous return to profitability if demand remains intractably weak, while the clash between modern and aging technologies remaps the competitive landscape. The cyclical drop in steel production in the U.S. is the third double-digit percent decline in about 10 years (with 15-20% decline expected in 2020), as the coincidence of COVID-19 and the drop in oil and gas investment piled onto already declining demand from construction and automotive. In addition, environmental factors like greenhouse gas (GHG) emissions are a bigger consideration than ever for marginal investment, laying bare the competitive gap between high-fixed-cost blast-oxygen furnace (BOF) producers and typically lower-cost electric-arc furnace (EAF or mini mill) producers. Finally, tariffs on imports to the U.S. ultimately provided little protection for BOF steelmakers. The industry outlook peaked when tariffs were introduced in March 2018, but profits, credit quality, equity prices, and employment all cratered by late 2019, before COVID-19.

Even with a snap-back in domestic demand in late 2020 and 2021, lower-cost global steel production could cause a persistent glut, low prices, and low capacity utilization for the higher-cost steelmakers in the U.S. In the event the downturn extends beyond 2022, we expect near-terminal damage to some assets and competitive positions because of global cost pressures and ESG considerations as the industry aims to reduce high GHG emissions from carbon steel. A couple of years of low capacity utilization for BOF producers would accelerate asset rationalization, likely ceding yet more market share to lower-cost imports, mini-mill steel, and aluminum. Overall, we estimate that demand from key sectors will decline 5%-20% in 2020 and 2021 with a long path to recovery, likely remaining below 2019 levels until 2022. Combined, the automotive and construction industries account for more than two-thirds of steel consumption in the U.S., with machinery and energy accounting for another 15%, highlighting the industry's demand exposure to capital investment cycles.

Hot-rolled coil (HRC) prices have surged as demand has picked back up in the third quarter, but steel utilization rates have remained below pre-COVID-19 levels and inventories are at decade lows. Prices above $700 per short ton (/st) as of early November could yield breakeven EBITDA for some BOF operations, which is up from about $500/st earlier this year when these assets were bleeding cash.

Steel consumption was already slowing in late 2019 along with a pullback in U.S. industrial production, but demand collapsed in the early months of the pandemic. U.S. Department of Commerce data indicate that domestic steel production dropped below 5 million st/month in May and June 2020, or about 20% below the most recent trough in late 2015. Capacity utilization tumbled to 55%, dragging down second-quarter profits in this high-fixed-cost industry, but they recovered to 68% in the third quarter, and to nearly 80%-85% for EAF producers.

For the better-positioned mini mills, profitability could get a boost from robust automotive contract pricing for 2021 as they enter the contract pricing season with spot prices approaching $750/st. However, prices could be more volatile than usual, considering that demand from key markets could remain below 2019 levels until 2022 and steel production will increase as curtailed capacity and new builds come back online amid persistent global steel overcapacity (see chart 7).

Chart 7

The construction market in 2020 is holding up better than expected for steel producers in the U.S., with a rebound in residential construction and robust backlogs in the wake of lower demand in more steel-intensive nonresidential construction. Anticipated demand remains uncertain in 2021 and thereafter, due to the effects of the pandemic, and we believe it could remain below 2019 levels until 2023. Our base-case assumption is that U.S. automotive demand will remain about 10% below 2019 levels into 2021, with some production variability because of potential supply chain disruptions. Moreover, we expect a 30% year-on-year reduction in capital spending in the oil and gas sector, with weak prospects for a rebound as oil prices remain close to producers' average breakeven levels.

The competitive and credit gap between integrated steelmakers in North America and their mini-mill peers widens with each downturn, as integrated producers have failed to generate adequate returns during recent upswings to invest enough in asset renewal, if even defensively, ahead of this downturn. For example, the ratings on immediate peers United States Steel (B-/Stable/--) and Cleveland-Cliffs (B-/Negative/--), parent of AK Steel (not rated), highlight the precarious competitive positioning of these large, old asset bases, as do those on smaller Canada-based Algoma Steel (CCC+/Negative/--).

Both U.S.-based companies have proposed or undertaken transformative corporate development and financing to preserve viability. For example, United States Steel acquired 49.9% of mini-mill producer Big River Steel (B/Stable/--) with a view to acquiring 100% of this fast-growing, low-cost producer, all while boosting liquidity and capitalization with convertible debt, secured debt, and equity issuances in the last year. On the other hand, mini mills such as Nucor (A-/Stable/A-1), Steel Dynamics (BBB-/Stable/--), BlueScope (BBB-/Stable/--), and Commercial Metals (BB+/Stable/--), are better positioned to withstand cyclical downturns, thanks to their more flexible production footprints and lower cost asset profiles supported by largely resilient benchmark metal spreads (price of HRC steel minus the cost of scrap metal), enabling profitability at all points in the volatile steel cycle. This is demonstrated by a lower impact to credit quality this year at the same time as these producers are undertaking large capital investments.

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