It did not take long for Butch Welsch to respond. “Steel prices,” answered the owner of Welsch Heating and Cooling, without hesitation. “I can’t believe how much it has gone up.”

The St. Louis-area contractor purchases, on average, a truckload of steel once a month from one or two local wholesalers (American Metals or Three States) and one or two national warehouses (Majestic or Freedom). The steel is used to fabricate its own rectangular ductwork and fittings. The jump in price from mid-December 2007 to February 2008 was 28 percent. “A concern is that we buy out all round pipe and fittings and know that their prices will have to go up eventually as well,” said Welsch, looking ahead.

Rising health care costs. Gasoline prices inching higher and higher. Now this surprise. “We heard rumblings regarding increases a few months before,” said Welsch. “It was nothing definite and certainly not the size that occurred.”

What to do?

“Our only saving factor is that we are quoting a considerable amount of commercial work, which right now is not quite as cutthroat as residential,” answered the concerned businessman. “Also, in the replacement market, the percentage of the job affected by the steel increases is not significant.”

Not all can say this, especially manufacturers. With many insiders forecasting that this year could very well be the year global steel prices hit new peaks, the future is not necessarily bright. One manufacturer, Air System Components (ASC), even contacted The NEWS, requesting that this publication publicize the impending price escalation of steel. ASC corporate headquarters in Richardson, Texas, is home for multiple marketing brands that operate as independent companies. This includes Titus and Krueger brands, along with Tuttle & Bailey.

“In 2004, a similar increase caught many companies flat-footed and ruined the year for them,” wrote the company’s president, David Gau.

More than a few have already announced a price increase, citing the jump in steel price. Worthington Cylinders, a supplier of pressure cylinders headquartered in Columbus, Ohio, recently announced a 4 percent increase on all steel portable and fuel gas cylinders. “Significant increases in steel and propane have made it necessary for us to pass on an increase to the market,” said Dusty McClintock, vice president of sales and marketing.

It’s the sign of the times.

WHY THE JUMP?

If you can understand the sudden jump in bread prices, you can understand the hike in steel. It all comes down to the ingredients for each. To make bread, one needs wheat. However, wheat is not in abundance because, in part, farmers are growing less of it and more corn since it is the key ingredient of ethanol. Add to that the growing appetite for wheat from developing countries, and the supply is strained.

The math equation is the same for steel. Japanese and South Korean mills and Brazilian mining giant Vale agreed to a 65 percent jump in the price of iron ore, the major ingredient in steel making, in annual contract talks. In addition to skyrocketing raw material, add energy and freight costs and you have yourself sticker shock for steel.

“In our view, steel prices will remain high because underlying raw material costs continue to rise,” JP Morgan analyst Jeff Largey told Reuters.

AK Steel Corp., based in Ohio, added a $230-per-ton surcharge to electrical steel product orders shipped in January. The steel producer said the surcharge was based on raw material prices and the cost of energy used to make its products.

Most of the major U.S. steel mills announced price increases that went into effect last fall. Some of the increases were only about 3 percent, but it was the first time that prices had gone up in several months.

Currently, some steel suppliers are limiting quotes to about three months. They aren’t sure what the prices will be after that, according to companies that buy large amounts of steel. “That’s the biggest wild card for manufacturers in 2008,” Glen Tellock, president and CEO of Manitowoc Co., and chairman of the Association of Equipment Manufacturers, told the Milwaukee Journal-Sentinel recently. “People just don’t know what steel prices are going to do.”

Emerging industrial countries, such as China and India, have complicated global steel markets and have made them harder to predict. Instead of staying steady, Lehman Brothers analysts have said steel-making costs will go up, not down, as much as 25 percent this year. The mills, in turn, will be expecting to pass on higher raw material costs by raising their prices for finished products.

“All four of our potential suppliers are rumoring two more price increases between now and the middle of the year,” said Welsch, adding those increases could be anywhere between 5 to 20 percent.

Not that he is getting any sympathy from homebuilders, who have their own problems. “Interestingly, I had a meeting late this afternoon with the biggest builder in the St. Louis area,” said Welsch. “I explained the info regarding steel price hikes and what we have heard regarding additional increases. Their basic response was, ‘Sorry about that, but we are losing money selling houses by giving large discounts, so we would like you to give some type of additional discounts or we will try to find someone else to whom to give the work.’”

GUESS WHAT'S COMING?

Again, what to do?

“The options are to raise prices or forgo profits,” answered Gau. “The frustrating thing about these sharp and unexpected increases is they create an adversarial position between manufacturer, distributor, and contractor. All involved should pass these legitimate cost increases on to the end user, but often fear of competitor inaction leads each party in the channel to unnecessarily bear the burden of these worldwide market fluctuations.”

ASC uses steel service centers to support its seven facilities in North America. It needs the steel for its grilles, registers, diffusers, terminal units, and fan coil products. According to Gau, the cost input of steel represents 25 percent of the company’s income statement.

“We had some suspicion that an increase might be forthcoming when we could not get commitments for the third and fourth quarters,” said Gau, noting that the company had to absorb a 20 percent increase in steel costs from December 2007 to February 2008. “The immediacy of the increase was a surprise to everyone.”

Gau expects the price to increase in the 30 to 33 percent range, but then settle back into the 25 percent range over 2007 average price levels. Not that such news is encouraging.

“I think contractors need to continuously canvas vendors for information on commodity pricing, pay attention to newsletters, read the press about what’s going on in the world around you, and if you are heavily into the fab or specialty metals areas, find some alternative online newsletters that address these markets in broad, global terms,” said Guy Gast of The Waldinger Corp., headquartered in Des Moines, Iowa. “The old adage, ‘Read to lead,’ applies here.”

Gast said his company has attempted to avoid wholesale shopping, preferring to build a relationship with a warehouse that can provide his business with excellent service and consistent product at competitive prices.

“They may not always be low, but they will be within a half cent on the most aggressively priced items - and we seem to avoid the occasional returns for damaged goods, white rust, slipped coil, etc.,” said Gast. “So for the past few years, we’ve bought mostly from North States Steel, and we deal with a dedicated account representative there.”

For several years leading up to mid-2005, Waldinger bought large blanket orders, typically 500,000 to 1 million pounds, locking in the price and terms. It only took delivery of truckload quantities, and it only paid as it went.

“That allowed us to fix our prices. Our last blanket prior to fall 2005 was at an average price of $0.23 per pound,” he said.

In the fall of 2005, after prices cycled upward and upward, Waldinger concluded that it would no longer benefit from blankets, meaning the vendors would simply be including escalation to reduce their exposure to mill increases.

“Thus, we went on the ‘spot’ market, buying the current price, and we did consistently price check,” said Gast. “During that period, especially in the first half of 2007, we occasionally ran across some great deals, as a warehouse attempted to move several truckloads of coils, or clear some random lots.”

How much Waldinger acquires depends upon the stability of the market, said Gast. At the end of January, the company bought between 300,000 and 400,000 pounds, “enough to get us through about two months or a little more, based on the understanding that there are going to be upswings for a few months.

“Otherwise, through last December, we were buying pretty much hand to mouth, in truckload quantities,” said Gast. “The reason we didn’t buy more at this time is that we felt that the market would fall in April, and we didn’t want too much locked in at higher prices. As we bid work, we adjust our pricing, so if the market goes up, we will be able to react and minimize the exposure down the road.”

Even though most of the steel price hike has jumped over the last 30 to 45 days, Gast was not necessarily surprised over the development. “We stay in touch with the vendor,” he explained. “One of our hopes in aligning with limited major vendors is that we get better information on what direction the market is going.”

In Gast’s estimation, fabricators are the ones with the biggest exposure, since the steel makes up such a large part of their pricing. “If I were them, I’d be attempting to shift risk, include escalators, push deliveries up, or otherwise minimize my exposure,” he said.

Yet, for the typical contractor, steel seems to be a monumental concern. “But I wonder if some of that is misplaced,” questioned Gast out loud.

To illustrate his point, he wanted to know about a contractor that was bidding a large office building, say around 250,000 square feet of space, with a selling price - HVAC sheet metal contract, with equipment - of around $2.5 million. That building might have anywhere from 150,000 to 200,000 pounds of ductwork and fittings in it. Thus a swing in metal prices of as much as 20 percent would mean the contractor was paying up to 10 cents more per pound than he estimated, assuming that he allowed no escalation in his bid.

“That means he’s got escalation exposure of $15,000 to $20,000,” said Gast. “Relative to his selling price, that’s only about one-half of 1 percent. While that is a lot of money, it seems to me to pale by comparison to the other risks of projects. That same project could have a field labor budget of $400,000 to $500,000, including labor, tools, equipment, vehicles, rent, cranes, and all the other directly related expenses controlled by the superintendent.

“So a 3 percent to 4 percent overrun in field labor-budgeted expenses could easily equal the risk of steel. Labor cost increases at the rate of almost 5 percent annually and thus, any delay in the schedule that moves the sheet metal contractor’s work into a higher wage period could affect the labor cost by as much as $10,000, assuming that half of the direct labor cost moved into a higher wage period.”

Estimating errors, or a lack of commitment to managing crew cost, easily equal steel price escalation, he said. “It is realistic to think that contractors aren’t including some allowance for the escalation they might experience,” said Gast.

“If a contractor made an assumption on this job that steel prices would rise radically - perhaps 10 percent - well, then he’d only suffer half the loss, $7,500 to $10,000. Again, this is not a really large amount considering the size of the contract. And frankly, if he was successful in selling this job, he could attempt to place a blanket order for the steel to hedge his bets.”

Publication date: 03/31/2008