WSD has a theory it calls "Oversupply Equilibrium." The assumption is that when oversupply is moderate to substantial, the world hot-rolled band price, ex-works, has a tendency to decline to:
- The operating cost of the median-cost non-Chinese mill.
- The marginal cost of the median-cost Chinese mill. In this case, the price may remain at marginal cost for a relative long time, which would normally not be expected, because Chinese steel production is so "sticky" on the downside.
A pricing "death spiral" on the world market - i.e., when the price falls to the marginal cost of the median-cost mill - is not a long-lived event (i.e., it's a short age) because it forces some of the mills in the third cost quadrant, and many in the fourth cost quadrant, to cut back output. In general, death spirals are susceptible to occurring when the price of the hot-rolled band is elevated and buyers' inventories are so high that, once the buyers fear the price may decline, there's a marketplace "chill" - i.e., a dearth of orders - that can persist for two months or more. As a consequence, the price plummets until it hits an unsustainable low that's rarely in place more than six weeks, if that.
In the accompanying exhibit, we plot the marginal cost of the median-cost Chinese mill against its ex-works export price realization after taking into account: a) the cost to ship the steel to the port of export and load it on the boat, plus other costs; and b) pay an 8% value added tax on the steel assuming it contains some boron (which means that, at least for the present, it doesn't pay 17% because there's a 9% value-added-tax credit). The price is assumed to be equal to our assessment of the world export price for hot-rolled band less $10 per tonne - which, as of September 2014, is about $430 per tonne ex-works (and about $490 per tonne, FOB the port of export).
As of September 2014, the Chinese export price is highly depressed in the eyes of many people in the marketplace; yet, it's still about $27 per tonne above the marginal cost of the median-cost steel mill (with that premium portrayed in the right hand bar in the exhibit).
The median-cost Chinese mills' cost, of course, has fallen sharply the last six months due to the lower prices for steelmakers' raw materials.
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