ACHRNEWS

Steel Prices Cause Industry Chain Reaction

April 22, 2004
WASHINGTON - Recently, Arthur Franklin received a phone call from a contractor in the Carolinas with a request for 300,000 pounds of steel, the equivalent of seven truckloads.

Franklin is the third generation owner of S. Franklin & Son Inc., a sheet metal and HVAC distributor located in Fairfield, N.J.

According to Franklin, the contractor was in desperate need of the steel in order to finish a government job that had been set at a fixed price. This contractor was making her way up the East Coast, calling suppliers and distributors for help.

Unfortunately, Franklin & Son couldn't help the contractor. Even more unfortunate is the fact that examples like this are proliferating throughout the HVACR industry.

A shortage in steel has caused prices to skyrocket, creating an industrywide chain reaction. In order to absorb the costs, higher prices are passed down to contractors, who, in turn, are forced to pass the costs on to customers.

But high prices are not the worst of it.

In some cases, steel has become a precious commodity that contractors can't even get their hands on.

An undersupplied world market and mill consolidations have contributed to rising steel costs, leading some contractors to consider reopening bids on some projects.

The Big Picture

The high cost of steel is not new for the industry. In December, President Bush repealed tariffs on imported steel, a move that many thought would stabilize prices. But instead of getting better, the steel situation has gone from bad to worse.

Franklin, also a member of the Heating, Airconditioning, and Refrigeration Distributors International (HARDI), has been monitoring the steel situation and has been helping to educate HARDI members on what is going on and what distributors can do.

According to Franklin, there are several reasons for the situation, but it comes down to one overall factor.

"The problem is more demand than supply," he said.

Mill consolidations; a booming economy in China; a shortage of coke, a necessary material for steel production; and a shortage of scrap metal, also used for steel production, are just four reasons why supply is limited.

Both HARDI and the Sheet Metal and Air-Conditioning Contractors' National Association (SMACNA) have kept a watchful eye on the fluctuation of steel prices and how prices are affecting members.

According to HARDI and SMACNA, the growing Chinese economy has increased the need for raw materials.

"Since the Bush administration removed steel tariffs, a comparatively free global steel market currently exists," said Tom Soles Jr., executive director of SMACNA.

"China's rapid economic expansion, coupled with the comparatively weak United States dollar, has led to an undersupplied worldwide steel market, resulting in severe and widespread shortages of steel and price increases of up to 40 percent."

Not only is China importing large amounts of steel, but also coke. Coke is made from coal, and Franklin explained that coke supplies are already short in the United States. A fire at the Pinnacle Mine near Pineville, W.V., is partially responsible for the lack of coke.

Franklin also explained that mill consolidation over the last few years has put many mills out of business, resulting in a lack of steel production.

Many manufacturers faced with the rising cost of steel and other commodities, such as copper, have been forced to pass along the costs to consumers.

The Impact

S. Franklin & Son has encountered seven price increases on the steel it buys since January. According to Franklin, the result is more than doubling his cost.

Franklin is not alone. SMACNA has reported that members from across the country have seen enormous increases. As of February 2004, SMACNA members in Georgia reported a 33-percent increase in steel prices.

"In Pittsburgh, contractors re-ported having problems purchasing steel in February 2004," said Soles. "They indicated that prices for various steel products had gone through the roof - up to a 60 percent increase - and many suppliers were telling these contractors that they can guarantee only 50 percent of the total order."

Soles also said that similar problems were coming in from members in the Northeast and Ohio. "These contractors feared they'd have to reopen or reconsider bids on many projects," he said.

But steel prices are not just affecting contractors and suppliers. Manufacturers are also feeling the impact of volatile steel prices.

Lars E.W. Nilsson, a member of the SMACNA board of directors and president of Lindab Inc., reported that his company paid 28 cents per pound for 24-gauge galvanized steel. Lindab is now paying over 48 cents a pound, a 76-percent increase.

Nilsson explained that the U.S is not the only country seeing increases in steel, but it is seeing some of the highest increases. He said that Europe has seen 10-percent to 20-percent increases on steel prices, while the United States has seen increases between 30 and 70 percent.

According to Nilsson, this not only causes frustration over high prices, but poses problems for marketing products. "There is no way for us to go out in the marketplace and price something past 30 days," he explained.

The situation is much the same for McQuay. The company has introduced two price increases on products since steel prices started to rise. In fact, the company reported that it first started seeing significant increases in January 2004, when hot-dipped galvanized steel took a 15-percent increase.

At this point, raising prices on products is the only move for some manufacturers.

"We have always been committed to keeping our prices competitive, using internal cost reductions and productivity initiatives to offset inflation," said Ron Hanlon, vice president of sales and service for McQuay. "But the cost increases in steel and other commodities, such as copper, have exceeded our ability to offset them with internal reductions and productivity."

And manufacturers are unsure if prices have peaked and when declines could be on the way.

"We haven't seen any signs of stabilization," Hanlon said. "Some of our steel suppliers have in-formed us that the market is so volatile that they can't foresee what will happen in the next several months in terms of both price and availability of metal."

Nilsson said that predictions are hard to make, but he believes prices could stabilize by the third quarter of 2004. But even if prices begin to settle by that time, Nilsson feels that prices will still be high, at least 25 to 30 percent higher than a year ago.

Organizations such as SMACNA and MCAA are working to focus congressional and administrative attention on the volatile steel market. SMACNA’s legal counsel has drafted suggested guidelines for assessing how a firm might be affected by this issue, noting that certain clauses in contracts could help protect a contractor if steel is unavailable.

Working Toward Resolution

It may seem as though the industry has its hands tied, but that is not stopping some individuals and associations from taking action.

For instance, SMACNA along with its alliance partners, the National Electrical Contractors Association (NECA) and the Mechanical Contractors Association of America (MCAA), is working to get congressional and administrative attention on the issue.

Soles said that a letter from the alliance was sent to the White House, the U.S. Senate, and the General Services Administration (GSA).

The issue also received attention at the recent Construction Alliance National Issues Conference in Washington. Rep. Don Manzullo, chairman of the House Small Business Committee, headed a panel discussion on the legislative, regulatory, and contractual actions contractors can take to defend against losses from rapidly escalating commodity prices.

"SMACNA's legal counsel also drafted suggested guidelines for assessing how a firm is affected by this issue," said Soles. "Members are urged to sit down with their legal counsel and analyze all of the contracts and terms of their company."

Soles explained that certain clauses in contracts could help protect a contractor if steel is unavailable. For example, force majeure clauses - or "act of God" clauses - can protect a contractor when events occur that is outside his control.

Other clauses include impossibility of performance, impracticability of performance, as well as other defenses, such as "mistake" and "frustration of purpose."

"For members facing rising steel prices, SMACNA has prepared a sample price escalation clause containing language that increases the contracted price proportionately to reflect the entire increase in the cost of raw materials or component costs," said Soles.

The Gas Appliance Manufacturers Association (GAMA) has found another solution to help members. GAMA recently joined the Emergency Steel Scrap Coalition. The Washington-based group is comprised of industry associations and steel-consuming companies. The law firm of Wiley, Rein, and Fielding serves as the coalition's legal counsel.

More than 1,300 U.S. companies and associations have joined the coalition, which was launched only a few months ago.

"This is unique in that it is steel consumers working with steel producers," said Timothy Brightbill, one of the coalition organizers.

According to Brightbill, the price of scrap has eased a bit.

"Prices have come down $30 to $40 a ton and may come down a bit more," he said.

But Brightbill also points out that price levels are still way off course. "Prices are still triple," he said. "We don't see things returning back to their historical levels any time soon."

As a member of the coalition, companies are expected to contact government officials about the steel situation, assist the coalition in providing information to help in the crisis, and by making contributions to help in legal and lobbying efforts.

In return, the coalition pledges to undertake a number of activities, including economic analysis and lobbying efforts.

One of these efforts would include filing a petition with the U.S. Secretary of Commerce. According to the coalition, a trade law exists that can prohibit the export of goods.

There are five statutory tests that must be met before this type of action could take place, including proof that the exportation of steel must be stopped to protect the economy from being drained of scarce materials.

Brightbill said that the coalition is close to making a decision in regards to filing the petition. He noted that after the petition is filed, the Department of Commerce must investigate the problem and issue a decision in less than four months.

For more information on the Emergency Steel Scrap Coalition organization, visit www.scrapemergency.com.

Publication date: 04/26/2004