Everything seems small compared to China. Take the US wire rod industry – China's annual wire rod production exceeds 80 million metric tons, more than 20 times the US' rod production.  In a country where the raw materials for wire drawing are so vast, you would think that sourcing would be a breeze. But you would think wrong. 

Chinese wire drawers, too, experienced significant challenges this year, and many did not survive. Firstly, China wasn’t immune to the rapid increases in rod prices that have been taking place since September 2007. And the Chinese wire market's challenges actually started even before the rapid rod price hikes,  when, a few years back, Chinese authorities finally succumbed to international pressure to reduce their steel exports. As a result, China started to lower its highly contentious but fully WTO-compliant VAT (Value Added Tax) rebates.  

Value Added Tax is a sort of sales tax. When a wire rod plant buys scrap or iron ore, they pay a VAT to their supplier. If the wire rod is exported, the company is entitled to get back the VAT that they paid. This is, at least in theory, how the VAT rebate works. China lowered the VAT rebate for wire rod down to 0% in April 2007, and what’s more, they further discouraged exportation of wire rod by adding an export tax of 15% in July 2007. 

With all of the export restrictions, you would think that all 80 million tons of rod would stay in China and depress the local market, but you would think wrong again. True, because of export restrictions  and massive rod production, China’s domestic wire rod prices are still the lowest in the world. We will get to current numbers later, but first, let’s review what has happened in the Chinese wire market since the beginning of the year: 

Even though the wire industry in China enjoys some of the lowest wire rod prices, it has been significantly affected by the price increases of 2008. Faced with skyrocketing iron ore and coke prices, wire rod mills had no choice but to increase their prices rapidly. In the meantime, consumption increased significantly in preparation of Olympic games in August 2008.  China spent a lot of money for infrastructure, which provided a huge boost to the economy. What’s more, the industry around Beijing was going to be idled in the months leading up to the games due to pollution control measures, and that meant companies had to work hard to make up for the lost time.  This flurry of pre-Olympic activity put China on overdrive in the winter and spring of 2008, resulting in an explosion of steel demand, with China pulling the rest the world steel markets along with it. 

Many wire companies in China are small- to medium-sized enterprises, if not mom-and-pop type of extremely low-tech, extremely inefficient shops. These companies lack capital for inventory and rely on local traders and distributors to deliver rod shipments just in time. When prices started to go up in September 2007, many wire companies were caught with low stocks. No one believed that prices would go up that much, so most companies refrained from buying steel. As a result, their inventories were drawn down further as the months proceeded and the price increases continued. Unlike the North American wire industry which deals with the mills directly, there are Chinese traders and distributors in between the mills and end-users which hold most of the wire rod stocks. These local traders that hold most mill inventories refrained from selling their stocks, as they anticipated making large sums of money with the increasing prices. With the traders holding onto their stocks, rod shortages developed and spot prices rose even more rapidly than the steel mill prices. 

China's wire industry is a low-margin business, and producers have a hard time passing increases in raw material costs onto their customers. The industry is not well-funded enough to go through a rough time like this for even a few consecutive quarters. Consequently, many wire drawers fell short on raw materials and had to reduce production or just close up shop during the raw materials shortage this year. 

Exporters of wire were further squeezed when the government reduced the VAT rebate for drawn and galvanized wire and subsequently added an export tax of 5%. In the meantime, appreciation of the Chinese currency, RMB, against the US dollar made Chinese exports less competitive. 

Because of these market dynamics, government export tax regulations, and also, increasing container and transportation costs, most first-tier Chinese wire products, such as bright basic wire and galvanized wire, are no longer being exported in a big way. In the spring of 2008, China's wire offer prices for the US were significantly higher compared to the previous year, and most offers dried up completely. What was left of the competitive Chinese wire products were blocked by antidumping investigations such as those brought on by the nail, hanger and threaded rod filings in the US. Circumventions both Chinese export taxes and US  antidumping duties,  Chinese wire is now finding its way to export markets for more value-added, downstream products like widgets, gadgets and tools, in which it still enjoys VAT rebates and higher margins. 

Coming back to the outlook for the balance of 2008 and beyond in China: When the Olympics started in August, inventories were high and consumption came to halt. It was as though all of China was on vacation and watching the games. But despite the high inventories of end products and low consumption, the wire rod mills outside the Beijing area kept on rolling. In August, a major oversupply of steel products was apparent and prices started to cave.

There are also other reasons why the demand started to drop off significantly. The public construction sector is cooling off as the central government is trying to suppress investments for various projects. China's other robust industries such as housing, appliances and automotive are all showing signs of slowing down. And what about the reconstruction work for the earthquake area, you may ask? According to best estimates, about 20 million tons, only a small portion of overall steel production, are needed for reconstruction efforts. Therefore, it will only have a minor effect on demand. 

Still, everything is relative when we talk about China. A slowing economy still means an amazing 9% annual growth, and therefore, demand will be plentiful in 2009 and beyond. Nothing will bring the dragon to its knees. The massive population still needs many luxury goods for the growing middle class, infrastructure and cars. In immediate terms, the tight market conditions and shortage of wire rod are now gone, and prices are softening.  But no matter how fast and furious this correction has been, it is not expected to last too long, and long term prospects are still very good. 

Let’s talk about the numbers now. In early September '08 the difference between the US local price and Chinese domestic price reached an astonishing $500/mt with the US market at close to its peak of $1225/mt and China's average rod prices softening to $725/mt. With the price gap opening in this spectacular fashion, it is no wonder that there are, once again, cheap offers for wire rod from China. But there is one catch: Offers are for boron-added wire rod, which escapes the Chinese customs as “alloy steel.”  Instead of paying the 15% export tax for carbon wire rod, mills enjoy a 5% VAT rebate for these so-called alloy rods. For minimally adding an element which should not change the physical properties of wire rod, mills get away with an almost 20% advantage. There is talk that this loophole may close imminently. If it does, this will be a shot in the arm for the wire rod markets, and export prices may start heading in other direction again.

It has been quite a ride for both wire rod and wire market this year.  If there is one benefit of the '08 roller coaster ride for the Chinese wire industry, it would be the cleaning out of some of the inefficient wire mills from production. These wire mills should be gone for good. And that’s a good thing for both China, and for the rest of the world. 

It all started with a soft steel market in the fourth quarter of 2007. Wire rod and wire prices were both weak, and consumption and demand were both far less than was desired by producers. Then, due to the rising scrap price trend, came a few price increases for rod and wire, which started a chain reaction that has blasted rod prices up to the sky. What’s more, it appears that there is still some more fuel left in the tank for more of the same.

During the takeoff, many rod buyers were astounded at how quickly and radically the rules of the market had changed, reacting in the following five stages:

Ridicule: “What is the price you want? Who do you think I am? Rockefeller?”

Anger: “These suppliers must be crazy! How can he go up when my sales are so weak? They are looking to make a fortune at my expense. There is no way I can accept these new numbers.”

Denial: “Oh, there is just a lot of hype going on right now. When the dust settles, the prices will go down as well … I better wait a few more weeks.”

Anxiety: “Imports have disappeared! Domestic mills don’t have enough rods, and prices are  going up weekly. I am running out of steel! What am I going to do?”

Acceptance: “OK, it is what it is. I better get on the ball and buy what I need to cover myself.  But I’ll make sure that my sales guys don’t just give away our products at low numbers...”

OK, not everyone reacted in that exact order, but surely, many rod buyers have experienced at least some of these feelings. Almost all of them will tell you that they have never experienced anything like this before, not even in the phenomenal year of 2004. 

What makes this steel market unique is that this strong and relentless rally of prices is taking place in such a weak sales environment. And no, these market conditions are not unique to wire rod; the same sharp increases were also observed for other long and flat rolled products. All steel product prices across the board have made huge gains since the beginning of the year.  Let’s take a look at them for the purpose of comparison.

In comparison, rod prices have risen less than hot rolled coil prices this year, but more than rebar prices -- so don’t feel that the wire rod has being singled out. And as for why rod prices went up more than rebar, there are couple of explanations. First, unlike rebar, rod production in the US is only a fraction of the total consumption. Actually, in 2004, rod imports captured more than 50 percent of the market. North American rod mills have struggled to make money for years, so many of them eventually resorted to cutting production. However, 2007 saw the lowest import figures in more than a decade, and this trend has continued into 2008. 

With imports reduced to less than their normal volumes, the demand for American rod has turned around, and producers have started seeing decent interest from their customers. At the same time, they are very reluctant to crank up production to its maximum capacity, as this would require adding additional shifts and labor. And honestly, why would they mess with a good thing? Right now they are making more money with less production, and it seems that this situation will not change in the near-future.

While imports had a US market share of about 43 percent in 2006, the market share came down to 26 percent rapidly.  Why did imports go down so dramatically?  First of all, the weak dollar has made imports more expensive than the domestic prices. This has been routinely the case this year. Every single ton of imported rod has been sold at a higher price than the domestic material at the time of purchase. There is also talk that the American producers purposely kept their prices lower than the foreign prices in order to keep out the imports. The real reason, however, is that other major markets are hotter than the US market. In particular, the Middle East, CIS and Eastern Europe are experiencing a construction boom that has attracted most of the available export tons from around the world to those regions. Thus, the US market has become less and less relevant to international exporters. 

As of mid-June, US wire rod prices have reached a level of $1200 /metric ton, as a result of the  serious leaps that had taken place in every month of 2008 thus far. This level is now close to international market levels, or only slightly below them. While the slightly lower US prices will keep the imports out, the US prices will continue to rise until the end of the year, adjusting along with the international trend. And, worldwide, the price momentum is clearly still headed upwards. 

How about beyond 2008?  The relentless price rally of US wire rod prices and steel prices in general is, without question, a global phenomenon that is fueled by the improving economies and consumption of China, India, CIS and Eastern Europe. In addition, the weak US dollar is helping to keep out imports, and the production in North America is not expected to increase in a significant way in the next few years. Therefore, even though the American wire drawers are seeing less-than-stellar sales and more competition for their end products from overseas, they will have to endure a tight rod market and high rod prices for at least a few more years to come. 

Figures are in metric tons according to US ITC and Customs data