Riding the steel roller coaster: rapid growth in China and a long-term trend of removing under-productive capacity in developed nations, has put steel prices on an upward run. It may take years before there's a substantive change, says Professor Anthony P. D'Costa, but eventually they will fall.

Suzuki scraps plans to boost production by 13,000 units ... Nissan announces plans to suspend production of some vehicles in 2004; may institute similar cuts in 2005 ... Toyota announces its Japanese suppliers running at capacity; will source more steel from South Korea and China ... Delphi announces drastic cost-cutting actions; cites rising commodity costs and lower vehicle production ...

The common culprit for these and similar announcements? Steel.

After years of overcapacity, which lead to global commodity pricing, steel producers are in the cat bird seat, able to exercise more control over the price of their product than at any time in recent memory. Much of the blame for this situation, if blame is indeed the right word, is placed at the feet of the growing Chinese economy, which was growing at a near-10% annual rate before its government began taking measures to prevent it from overheating. Nevertheless, it's still expected to expand at an annual rate of more than 5%. "As the Chinese economy booms there is a huge internal demand for steel. China--which has more steel-making capacity than Japan--is importing a lot of steel. Much of it is goes to adding infrastructure, the rest for meeting internal demand for products. This contributes to the global shortage of steel we see today."

The speaker is Anthony P. D'Costa, professor of Comparative International Development, South Asian and International Studies Programs at the University of Washington-Tacoma. He also authored the 1999 book, The Global Restructuring of the Steel Industry: Innovations, Institutions and Industrial Change. A word of caution: If you are looking for a fast resolution to the current pricing situation, you will be disappointed, especially since Japan and the United States are still in the midst of a contraction in overall in-country mill capacity that began in the 1980s.

"Steel companies are stodgy and slow," says D'Costa, "and the feedback mechanism also is slow. As a result, they are slow in terms of staking out opportunities, or reacting when conditions change." This is a two-edged sword, D'Costa readily admits, and one that has been at the center of the industry's boom-and-bust cycles. It is exacerbated by steel's position as an intermediate product, a material that is used in the production of finished goods. This prevents the industry from being as tightly integrated as it might prefer, since it doesn't control the creation and sale of the products made with its steel. That affects its ability to set prices.

Over the long haul, new steel mills will have to be built in order to meet China's demand, which will free steel capacity in the region to resume its previous path. "Steel makers look at this situation and don't expect their company's entry to lower prices by much--if at all," says D'Costa. "The problem is, you're not the only company thinking that same way." Eventually, global regional capacity will rise to the point where contraction, not expansion, will be the word on everyone's lips. It just won't be anytime soon.

Because steel mills take time to erect and reach full capacity, he believes the next five years will see steel companies with the market share and necessary investment capital expanding in China to meet the demand. Soon thereafter will be a short period of relative equilibrium marked by slowly falling prices. This will be followed by a period of price deflation. "Everyone will wait as long as they can to make the other guy remove his capacity from each overcapacitized market first," D'Costa states. "It's another reason change is slow in this industry." Until then, steel consumers will find themselves in a situation where demand for steel outstrips the ability to produce, and prices remain high.

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By Christopher A. Sawyer, Executive Editor