Domestic steel mills planning for Force Majeure amid higher costs.

Several Domestic steel mills are planning to invoke the force majeure clause and renegotiate short- and long-term contracts with customers following a surge in raw material costs.

Coking coal prices are up 96% and domestic Iron ore prices are up 12% year-to-date.

Steel mill's Gross margins have fallen by 62% this year as compared to 2021 levels. (currently,??INR 11/Kg as compared to Avg margins of INR 31/Kg in 2021)

Higher Raw Material Cost:

In the last two months, there has been a sharp rise in steel raw material cost, particularly coking coal due to a combination of factors like storm season in Australia impacting coal production; Russia-Ukraine conflict impacting supplies from Russia due to sanctions, and improving steel production globally, resulting in higher demand.

Coking Coal:

Russia is a major producer of coking coal after Australia, contributing around 16% of global supplies. Due to sanctions on Russia by the West following the attack on Ukraine, trading with Russia has become difficult and major importers like South Korea, Japan & others have to rely more on Australian supplies. But due to the wet season in Australia, supplies have got impacted resulting in tightness in the global market. Coking coal prices have increased sharply by 90% from around USD 368/Ton at end of 2021 to currently trading around USD 700/Ton. Moving forward, coking coal prices are expected to remain higher as demand is expected to remain strong but the upside may be capped as the wet season is coming to an end in Australia and supplies are expected to improve.

?Iron Ore:

Similarly, International Iron ore prices have increased by 18% YTD as Chinese steel production has improved gradually with ease in environmental norms. Post-March, operating rates are further expected to improve as Para Olympics & Annual Two sessions have now ended. However, the rising covid case in China is expected to impact production in the near term, keeping iron ore prices in check. On the domestic front too, NMDC iron ore prices have also increased by 12% YTD, in line with international prices.

Lower Margins and Force Majeure:

As Domestic steel mills are dependent on imported coking coal, a sharp rise in its prices has resulted in a sharp drop in gross margins. During 2021 steel mills were able to maintain gross margins around INR 31/Kg (i.e HRC Selling price- raw material cost for Coking coal, iron ore & scrap). But now the margins have fallen sharply to INR 11/Kg (down 62% from 2021 levels). Coking coal contributes around 70% of the total raw material cost for steel production.

?This is forcing several steel mills to invoke the force majeure clause and renegotiate short- and long-term contracts. Few steel mills are looking to negotiate with customers for price rise, without impacting production. But non-integrated steel mills, which are not in a position to pass on the additional cost, may opt for production cuts. Integrated steel mills, which have the option for exports to Europe, where prices are higher & realization higher, will be in a better position to pass on the additional cost.

Overall lower production by Non-Integrated steel mills along with higher exports to Europe will keep domestic availability tight for Steel products and consequently, prices are expected to remain higher. HRC Prices are currently trading around INR 74.5/Kg (up 16% YTD). In order to maintain the Avg margins Steel mills have to increase prices by another INR 10/Kg but it has to be seen whether the market is in a position to absorb such high prices.

Identifying, measuring, and managing such price risks explains the need for a knowledge-based framework that can address changing market dynamics' impact on prices, future price path, the magnitude of risk, and hedging policy enabling efficient decision making.??

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