03/07/14 – DRI production is changing the game for undervalued Nucor
This Steelmaker’s a Steal
In one sense, the steel industry can be considered a competition to see who can procure ready-to-melt iron units at the lowest cost. Whether the iron units are sourced from virgin iron ore, ferrous scrap metal, or high-iron-content complementary feedstock’s, iron-related unit costs are a major driver in determining a steelmaker’s position on the industry cost curve. Because steel products are largely undifferentiated and commoditized products, a steelmaker’s most likely route to earning an economic moat is by establishing itself as a definitive low-cost producer. Thanks in part to its direct-reduced iron production in Trinidad, Nucor already has access to low-cost iron units, and we give it a narrow Morningstar Economic Moat Rating. The company is also building out incremental DRI production in St. James Parish, Louisiana, and we believe it will further decrease its iron unit costs over our explicit forecast period.
Nucor manufactures steel using electric arc furnaces, which predominantly rely on ferrous scrap metal to provide iron units. EAFs are significantly less energy-intensive and offer more flexibility than their blast furnace counterparts, which often operate uninterrupted for years at a time and therefore are subject to a high degree of operating leverage.
Steel produced via EAFs is typically lower-quality and therefore not as ductile as steel produced via blast furnace. This is because recycled scrap metal is imbued with trace residuals of other elements to which it is exposed in production or in use. During the melting process, most residuals are oxidized and separated from the molten iron, although non-oxidizable residuals such as nickel, copper, chrome, molybdenum, and tin taint the purity of the steel produced, thereby making it more brittle and less workable.
Therefore, steel produced by EAF is typically associated with applications that require little additional processing; it is often used to produce structural beams, reinforcing bar, and other long-rolled steel products. With this in mind, steelmakers that employ EAFs tend to enjoy lower per-unit operating costs but are also limited as to the scope of products that they can offer.
This dynamic has led Nucor and other large-scale EAF operators to explore alternative methods of EAF steel production that allow them to manufacture more ductile steel, enabling them to compete across a wider platform of product categories. Historically, EAF operators have done so through the use of pig iron, pig iron nuggets, hot-briquetted iron, and direct-reduced iron. These high-iron-content complementary feedstock’s are combined with ferrous scrap metal to allow for the introduction of high-purity, low-residual iron units sourced directly from virgin iron ore into the EAF melt, thereby improving the quality and workability of the steel produced.
Although these complementary feedstock’s have been in use for some time and are also used by Nucor’s EAF peers, Nucor has established a clear competitive edge over its competitors through its in-house production of DRI. In January 2007, the company started up a facility in Trinidad that offers 2 million metric tons of DRI production capacity per year. The Trinidad facility quickly made an impact on the per-unit operating costs of Nucor’s steel mills, which was particularly helpful in 2008 and 2011 when ferrous scrap prices soared to new highs.
The company invested $750 million to build not only a second DRI production facility in St. James Parish, Louisiana, but also the infrastructure for a third facility at that site that would require an additional $600 million capital outlay if pursued. The two Louisiana facilities would each offer production capacity of 2.5 million metric tons of DRI per year, boosting the company’s total DRI capacity to 7 million metric tons per year. The first of these two facilities initiated production in December 2013, and early results have been very encouraging.
We estimate that a representative ton of steel produced solely by the use of DRI in an EAF could be produced at a unit cost of $324. This is roughly 15% below the estimated $380 per ton unit cost for steel produced via the use of pig iron.
Our input cost assumptions rely on our department forecasts for the raw materials employed in steel production. For iron ore, we anticipate that iron ore spot prices will average $95 per short ton (62% fines, CFR China) over our five-year explicit forecast period. We expect metallurgical coal prices to average $150 per short ton and natural gas prices to average $4.75 per MMBtu. Our midcycle 2018 price forecasts for these three raw materials are $93 per short ton, $166 per short ton, and $5.40 per MMBtu, respectively (in nominal terms).
Source – MorningStar.com