The resilience of steel: Navigating the crossroads

| Article

Despite unprecedented volatility, the first half of 2022 remained strong for steel players, with prices and utilization higher than historical levels and unprecedented levels of EBITDA margins across most regions. This cycle was driven mainly by positive demand outlook that followed the recovery from disruptions caused by COVID-19, as well as infrastructure spending that was both long overdue and anticipated as part of the recovery stimulus.

However, several signs of market slowdown began to appear in early 2022. As a result, steel demand outlooks have been revised downward: in April 2022, the World Steel Association’s short-range outlook was less optimistic than the one from late 2021, and its October 2022 demand forecasts for 2022 and 2023 saw downward revisions of 2.7 and 1.2 percent, respectively.1 Reasons for this include the ongoing war in Ukraine, waves of COVID-19-related lockdowns in China, and supply chain disruptions, as well as the overall macroeconomic situation, including repercussions from persistently high inflation and rising global interest rates. In steel markets, EBITDA margins and the margin over raw materials (MORM) have significantly declined from previously unseen highs, mainly due to negative market expectations and high energy prices, and players have reacted by idling capacities. In fact, more than 30 million metric tons per annum (MTPA) of capacities have idled in Europe in the second half of 2022, while approximately half of those capacities have been brought back online in 2023 when margins slightly recovered.

As the steel industry continues to progress into 2023, we expect this level of volatility to be sustained across the entire value chain. In response, this article lays out four strategies that can help steel players navigate the years to come: preparing for the decoupling of steel markets, strengthening the raw-material supply chain, focusing on capital expenditures and the balance sheet, and doubling down on technological agility.

The steel value chain: A market deep dive

Although prices reached record highs in 2021, Russia’s invasion of Ukraine created supply chain disruptions and uncertainties that caused them to spike further (Exhibit 1). For most commodities, such as metallurgical coal, iron ore, and pig iron, the market has stabilized since then as demand has slowed, especially in China.

The steel value chain has recently experienced a period of high volatility.

The strong rebound from effects of COVID-19 has driven record EBITDA margins in Europe and the United States since 2021, largely fueled by stimulus packages from around the world. During the initial waves of COVID-19 lockdowns in 2020, steel stocks and supply chains were emptied and production capacities idled; when demand later rebounded, supply couldn’t keep up, which pushed prices higher. Meanwhile, structurally lower margins in China were driven by the country’s more competitive and regulated market and were affected by renewed COVID-19 outbreaks in 2022. The outlook remains fragile over the longer term, with downside risks for margins amid a cooling global economy.

For most commodities, such as metallurgical coal, iron ore, and pig iron, the market has stabilized as demand has slowed, especially in China.

Although steel players were largely able to maintain healthy utilization levels during this time, the following warning signs have emerged, particularly in Europe:

  • Slowing demand. The third and fourth quarters of 2022 saw a substantial decline in steel demand, which more than offset the positive dynamics of the first half of the year. The latest outlooks on 2023 demand remain negative.
  • Declining profitability and MORM. In addition to slowing demand, higher energy prices are creating pressure on margins, with natural-gas and electricity prices in particular reaching record highs. Since the heights of 2021 and the first half of 2022, EBITDA and MORM have declined, primarily due to the industry slowdown and energy prices. They are currently back to long-term average levels.
  • Dropping utilization. More than 30 MTPA of steelmaking capacity idled in Europe in the second half of 2022 in reaction to the decrease in steel demand and in an attempt to stop prices from falling further. (With a slight price recovery in 2023, some of these capacities have been restarted, as steel players are becoming increasingly flexible in managing their capacity utilization.)

Long-term implications of the steel value chain

Over the next ten years, three key trends could shape the steel industry. First, forecasts show an unevenly distributed slowdown in global steel demand across regions and industries. The “normalization” of demand in China—which would effectively end decades-long rapid growth—could be partially offset by growth in Southeast Asia and India, and slowdown in construction could be offset by growth in energy and transportation, leading to regional overcapacities and imbalances. Second, decarbonization is expected to ramp up at varying paces across regions. Finally, economies will likely continue to experience supply chain disruptions, including those resulting from COVID-19 outbreaks, the low-cost-gas shortage, and the continuing war in Ukraine and sanctions on Russia.

Responding to these trends will likely require steelmakers to make bold long-term decisions amid uncertainty and volatility and to coordinate with suppliers, financing institutions, vendors, and governments.

With this in mind, the aforementioned key trends could have significant implications for the steel value chain.

Markets are decoupling, and international trade is becoming increasingly important

Moderate overcapacity will likely persist on a global level, but substantial shifts in some regions could affect trade flows. China will likely see an increased overcapacity due to a substantial decrease in demand over the coming decade, which could result in increased exports competing with local production in developing Asia and the Middle East and North Africa (MENA). In the former Soviet Union, there are two effects: first, a portion of capacities in Ukraine have been damaged; second, Russia will likely experience a drop in steel demand in both local and foreign markets, mostly due to sanctions.

Green-steel demand growth will likely outpace supply. Moreover, a portion of supply could come from regions with low-cost energy, such as MENA, creating an additional trade flow to key green-steel-consuming regions, such as the European Union.

The massive energy requirements for green ironmaking could swing the location of new capacities toward regions with lower energy costs, such as Brazil, MENA, and Spain.2Safeguarding green steel in Europe: Facing the natural-gas challenge,” McKinsey, June 21, 2022. At the same time, local-employment preservation in Europe, longer distance to customers, long lead times, and geopolitical complications are sample factors that could negatively affect perspectives of Brazil or the Gulf States as potential green-steel suppliers for the European market. As new capacities are built, some separation of ironmaking and steelmaking will likely occur, changing the steel industry’s geographical footprint.

In general, there has been a tightening of global trade over the past decade. After a spike in 2018 due to the United States’ introduction of Section 232 and other countries’ subsequent retaliatory measures, the number of trade restrictions related to steel imports continued to grow slowly but steadily. In the future, however, because of overcapacity and different paces of decarbonization, even more protective measures, such as the Carbon Border Adjustment Mechanism (CBAM), are expected.3

Margins are moving toward ‘pockets of growth’ and ‘areas of scarcity’

Although demand growth is expected to slow down or stagnate in some regions, particularly due to the decline in major industries and sectors such as construction, pockets of growth may still develop, driven mainly by the energy and transportation sectors. Similarly, amid even slower growth, there will likely be “areas of scarcity” in product groups with constrained supply, such as high-performance steels, electrical steel, and wide plates for wind towers.

Although demand growth is expected to slow down or stagnate in some regions, pockets of growth may still develop, driven mainly by the energy and transportation sectors.

Significant growth in renewable-energy projects is expected in Europe, particularly following the natural-gas shortage. In the United States, higher investment in so-called green projects is expected following the Inflation Reduction Act, which was signed in August 2022. This could positively affect steel demand in areas related to the energy transition, with a demand for finished steel of approximately 40 metric tons per megawatt (MW) for solar and approximately 150 metric tons per MW for wind (for example, plates for wind turbine towers). New business models and mobility shifts are also likely to keep propelling the growth in the transportation industry.

Meanwhile, global demand for low-CO2 steel is expected to grow tenfold over the next decade from approximately 15 million metric tons in 2021 to more than 200 million metric tons by 2030, representing more than 10 percent of total steel demand in 2030. It will then further grow to approximately 25 percent of total demand in 2040. With these points in mind, total green premiums could reach $200 to $350 per metric ton by 2025 and $300 to $500 per metric ton from 2025 to 2030.4Capturing the green-premium value from sustainable materials,” McKinsey, October 28, 2022.

The deficit for high-quality metallics is tightening

Decarbonization will likely affect the iron metallics mix (Exhibit 2). For example, the growing supply of direct-reduced iron (DRI) and obsolete scrap will substitute for carbon-intensive hot metal or pig iron from blast furnaces. In addition to higher end-of-life volumes, obsolete-scrap supply growth will be driven by higher prices (elastic collection rates). DRI supply will be driven by announced decarbonization projects, especially in Europe, where some of the producers will rely on premelter technology due to low availability of high-quality raw materials. That said, the energy crisis in Europe, as well as availability of capital expenditure financing and the tightness of the vendor market, could delay current decarbonization plans in the short to midterm.

Decarbonization will cause shifts in the metallics mix, with major increases expected in scrap and direct-reduced iron.

Moving forward, demand for high-quality ore-based metallics (OBM)—also known as scrap supplements—as well as prime scrap is expected to increase due to decarbonization targets of steel players, leading to high premiums. On this point, scrap is expected to become a more regionalized commodity, which could affect net import markets in the long term, particularly those of India, Southeast Asia, or Türkiye. As a result, steel players could lock in supply through joint ventures or vertical integration with scrap recyclers. In fact, there was a wave of such integrations in late 2021–22 in Europe and North America.

Global DR-grade iron ore demand is expected to be at a deficit of more than 100 MTPA by 2031, sustaining high premiums. Another emerging issue is the lack of existing high-quality-pellet capacity to meet this future demand worldwide. This means steel players will probably announce premelter capacities coupled with existing basic oxygen furnaces (BOFs) to enable the use of lower-quality pellets for direct reduction without significant subsequent cost and productivity penalties, reducing demand for DR-grade material and locking in supply through joint ventures or vertical integration with iron ore producers.

Capital expenditure efficiency is increasingly important

Even with only the projects already announced and without potential overruns, estimated capital expenditure needs are already almost twice as high as usual (Exhibit 3).

Companies have announced increased capital expenditures, mainly driven by decarbonization plans.

Although not all steelmakers have announced investments in electrolyzers or renewable-energy sources, they will likely become exclusive offtakers. Therefore, such capital expenditures, even if borne by others, can be counted toward the total debt of steelmakers, increasing their leverage ratio. Increased leverage during a time of rising interest rates might pose another challenge. For steelmakers to finance such ambitious capital expenditure programs, a systemic increase in profitability (such as through green premiums) or government support could be required.

Additionally, OEMs who manufacture shaft DRI or hot-briquetted-iron (HBI) equipment could become a potential bottleneck in scaling green steel over the next ten years. In fact, the pipeline of projects already announced will require about two times more projects commissioned in the coming years than the construction pace achieved earlier.

Energy-related capabilities are becoming increasingly important

Production of green steel will require significantly more power. In ironmaking, reductants such as coke, coal, and natural gas will likely be replaced by hydrogen (H2), which requires significant amounts of power to produce using electrolysis. In steelmaking, BOFs will either be replaced by electric-arc furnaces (EAF) or accompanied by premelters, also leading to higher electricity consumption. As a result, production of one metric ton of green steel using the H2-based DRI and EAF route will require more than 3.0 megawatt hours (MWh) of renewable power, while production of one metric ton of steel using a fully integrated blast furnace–basic oxygen furnace (BF-BOF) route currently requires about 0.1 MWh.

Navigating the years to come

To successfully navigate the industry’s current circumstances, steel companies can plan ahead along the following dimensions.

  1. Update the strategy in the context of markets decoupling

    As countries double down on barriers to protect the domestic steel industry from external overcapacities and slower pace of decarbonization (such as through the CBAM in the European Union5) or to provide subsidies to spur green projects (such as through the Inflation Reduction Act in the United States), friction in global trade flows is expected to increase even more, and markets may become increasingly decoupled. Companies should therefore prepare for a less globalized world by strengthening their supply chains and derisking the geographical aspects of their sales portfolios.

    Trade measures such as import tariffs or quotas and changes in demand and customer expectations might affect certain sales markets and (more specifically) product and geography niches, and company leaders can strategize accordingly.

    For example, the products mix can be upgraded to capture new niches—particularly in energy and transportation. One example is H2 Green Steel, a new entrant that targeted green steel for the automotive industry, which is expected to be a deficit market with substantial green premiums available for first movers. Other players that haven’t fully decarbonized are being more creative to capture green premiums and market share by introducing mass-balance green-steel certificates.

    It is fundamental for companies to plan their decarbonization paths by considering different scenarios and potential risks as well as how to mitigate them. In highly uncertain times such as these, in which decarbonization technologies are still not fully feasible and the world is trending toward a global recession, companies should carefully consider the technological path for decarbonization. They should also consider potential partners, such as technology and raw-material suppliers and finance providers, and the pace of investment and implementation.

    On this point, the technological path and pace for decarbonization can be optimized. One example would be a selection of steelmaking technology to convert DRI into steel. Although most announcements made about new capacities in Europe have EAFs as steelmaking vessels, some players have opted for a premelter furnace combined with existing BOFs. This latter technology selection is potentially more suitable for using DRI made with lower-than-DR-grade pellets, and because a deficit of DR-grade pellets is likely, there could be more premelter-BOF announcements going forward.

    It is important to note that there is not yet a technology that would be a “silver bullet” when solving for decarbonization amid limited availability of high-quality scrap and iron ore. Therefore, we will likely see a mix of technologies, including carbon capture and storage, those aimed at reducing lower-quality iron ores, and, potentially, electrolysis. In these circumstances, careful consideration of strategic choices—and timing—is key.

    An additional aspect of decarbonization is the growing dependence of steelmakers on the energy sector. Steelmakers may face a lack of capabilities and knowledge needed to successfully navigate this domain while rethinking their strategy. Cost-competitive supplies of low-carbon power and H2 (and, temporarily, natural gas) are becoming increasingly important for steelmakers’ long-term success, and regions with structurally cheap energy—such as Australia, Brazil, and MENA—may become growing hubs for production and supply of green metallics and, potentially, steel.

  2. Strengthen the raw-material supply chain to secure the supply of metallics in the short and long term

    The supply of high-quality iron ore and metallics is expected to be tight over the next decade. It’s important, then, for steel players to limit the risk of a shortage of raw materials and of any price volatility that could negatively affect their production and profitability by securing supply through long-term partnerships or upstream integration. For example, Vale is building partnerships with several steelmakers to provide them with low-carbon metallics through the use of biochar in blast furnaces, the codevelopment of other low-carbon solutions, and the supply of higher-quality iron ore.

    Steelmakers in Europe and North America are also acquiring scrap processors to secure supply. For instance, SDI recently acquired five scrap-processing centers in Mexico, while ArcelorMittal acquired several scrap processing companies across Europe in 2022. Value chain relationships of a different nature also occur: Salzgitter and Ørsted entered a partnership in which Salzgitter will supply green steel for Ørsted’s wind farms. In turn, Ørsted will supply green power and hydrogen to Salzgitter to enable the production of that green steel and will also send end-of-life scrap back to Salzgitter for recycling. More partnerships like these are likely to close the critical-material loop.

  3. Improve capital expenditure management and optimize the balance sheet

    The cornerstone of decarbonizing the steel industry and supporting the energy transition is capital projects at a massive scale. To address the demand for zero-carbon energy, the pace of building out new wind- and solar-power plants (and a related grid) will need to be unprecedented during the next couple of decades, and the capacity of electrolyzers will need to increase by several orders of magnitude from today’s level. This will result in energy infrastructure investments growing globally at 5.9 percent per annum in real terms by 2030 (compared with stagnant spending from 2010 to 2021). In addition, a record number of DRI modules will need to be built during the next decade (Exhibit 4).

    The sheer scale of these projects—as evidenced by announcements of increased capital expenditures, coupled with a relatively tight and shallow vendor or OEM market and demand stress put on some of the critical components, such as permanent magnets for wind turbines (among others)—could lead to schedule delays and budget overruns. Therefore, the strength of capital expenditure functions (working hand in hand with procurement and finance) will become critical for steel players undertaking large capital investments.

    With these points in mind, steel companies can work to secure critical vendor capacity early in the process. They can determine how much “cushion” is needed in terms of project schedule and budget, maintain flexibility on the financing side, and mitigate or transfer delay and overspend risks (for example, to engineering, procurement, and construction contractors).

    Access to funding will also be critical to transition to the new sustainable business model at scale and pace. Public funds will likely play an important role in financing this transition.

  4. Double down on technological agility to adjust for more resilient operations

    One key insight that steel players have gained since the outbreak of COVID-19 is the ability to shut down and restart ironmaking and steelmaking capacity in response to uncertainty and declining demand. In doing so, many were able to avoid significant price drops, thus maintaining healthy levels of profitability.

    By investing in operational flexibility to adjust the production process for a changing raw-material mix, companies can also increase their resilience in the face of supply disruptions. Effectively managing capacity in response to market dynamics is beneficial because it allows companies to keep costs under control, while improved operational flexibility keeps operations running when disruptions occur or when volatility affects raw-material prices disproportionately.

Announced capital expenditure programs could be challenged by tight vendor and OEM markets.

The steel industry is at a crossroads, and the warning signs should not be ignored. Amid many competing sources of change and uncertainty, adopting the right strategy in the years to come—and knowing how and when to recognize the opportunities for resilience—will differentiate the leaders from the laggards.

Explore a career with us