The steel industry is poised to benefit from solid demand in the U.S and emerging markets like India. However, concerns linger around the steel industry stock space in the near term. Below, we discuss some of the key reasons and what investors in the steel sector can look forward to in the coming months and years.

Rise in Cheap Imports in the U.S.

Steel imports shot up 38% year over year in 2014. An improving economy along with a stronger dollar has made the U.S. an attractive market for finished steel imports. U.S. steel makers have suffered heavily due to a surge in subsidized steel imports, as reflected in declining orders, idling mills and layoffs across the country.

According to the American Iron and Steel Institute ("AISI") -- an association of North American steel makers -- finished steel imports rose 9% year over year in the first seven months of 2015, based on the Commerce Department’s most recent Steel Import Monitoring and Analysis (“SIMA”) data. Estimated year-to-date market share of finished steel import is 31%, higher than 28% recorded in 2014.

Weakening demand at home amid a flagging economy is forcing China to push up steel exports to attractive overseas markets including the U.S. Low costs of production (leveraging cheap iron ore) in China have enabled the local producers to sell their product at cheaper rates to world markets. The country accounts for roughly half of global steel production.

According to Global Trade Information Services, Chinese steel exports are expected to top 100 million metric tons this year. Fears of accelerated steel exports from the world’s top steel producer in the face of a weaker yuan are haunting the beleaguered American steel industry.

These cheap imports hurt the margins of American steel players like Steel Dynamics Inc. (STLD), U.S. Steel (X), ArcelorMittal (MT), AK Steel Holding Corporation (AKS) and Nucor Corporation (NUE).

U.S. Steel, in particular, suffered a loss in the first half of 2015, affected by a barrage of cheap steel imports. The company, which was once the country’s first billion-dollar corporation, faced a challenging operating environment as high levels of imports led to lower volumes and reduced steel pricing. The company also faced headwinds from the drop in oil prices, as mentioned earlier.

Slowdown in China

Demand in China, that alone accounts for almost half of the total steel consumption, has slowed down due to the country's tepid property market and weaker infrastructure investment. China’s GDP in the first quarter grew at the slowest pace since 2009 and its manufacturing activity also slowed down. The country's year-over-year economic growth was 7% in the second quarter. Analysts have slashed their forecasts for China's growth over the next three years amid increasing pessimism over the health of the world's second largest economy.

The gloomy outlook is the latest setback for China which has had a tumultuous few weeks. The move by the country's central bank to devalue the yuan startled investors and roiled equity markets all over the world. Seeing a feeble impact from efforts to prop up jittery stock markets, Chinese authorities are now reportedly scaling back their market intervention plans.

Excess Capacity: Perennial Problem

The biggest obstacle in the path of persistent growth and profitability of the steel industry is excess capacity. The industry is under relentless pressure caused by years of excess steel-making capacity further aggravated by weak demand and uneven economic growth. To solve this problem, steelmaking capacity needs to be reduced for the industry’s profit margin to reach a sustainable level, and to raise the capacity utilization rate from below 80% levels. The industry remains highly fragmented compared to other global businesses and the restructuring and consolidation needed to eliminate overcapacity is progressing at a slow pace.

Falling Oil Prices

The energy sector, which has been buoyant due to shale discoveries and rising production of crude oil, accounts for 10% of steel consumption in the US. Steel is necessary to make rigs and transport oil. Steel demand from the energy sector is being affected as exploration companies have reduced their capital expenditure budgets in the wake of lower oil prices.

Steel products used by the energy industry are also known as oil country tubular goods (or OCTG). U.S. Steel, being the biggest supplier of these goods in North America, is bearing the brunt of the slump in oil prices.

Low Crude Steel Capacity Utilization

The crude steel capacity utilization ratio remained stubbornly below 80% in 2014 and has stayed there in 2015. The average capacity utilization in 2015 so far is at 71.8% with the graph going downhill. Excess steel capacity has been a perennial problem for the steel industry and steel prices generally move in tandem with capacity utilization rates. To remain competitive, some major steel companies have idled their steel plants in a bid to rationalize operations.

Increasing Use of Aluminum in Auto Industry Poses Threat

Currently, steel is the major raw material for the auto industry, the second largest steel consumer. Major automakers like Ford Motor Co. (F), General Motors Company (GM) and others in specific and the industry as a whole is also becoming increasingly aluminum-intensive, given that metal's recyclability and light-weight properties. The global push to improve fuel efficiency in vehicles is expected to more than double the demand for aluminum in the auto industry by 2025. Hence, in order to remain competitive, the steel companies will have to come up with improved and lighter varieties of steel.

Falling Iron Ore Prices

Iron ore prices continues to plummet due to continued slowdown in China, coupled with a surge in supply. In the next few years, a wave of new supply of iron ore is slated to hit the market as the major producers are going gung ho with their expansion plans to augment production capacity. Brazil and India will also step up their exports. A combination of weak demand and oversupply will continue to pressure iron prices in the near term.

Companies like ArcelorMittal and U.S. Steel fulfill their raw material requirements through their captive iron ore mines. While the steel operations of these two companies will reap the benefits of falling iron prices, the profitability of their iron mining operations are likely to be affected by the same.

Bottom Line

As you can see, there are plenty of reasons to be pessimistic about the steel industry. But what about investing in the space right now -- are there opportunities for short-term investors?

Check out our latest Steel Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.

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