The electrical supply chain has been seeing a run-up in prices over the past few months that has mixed implications for distributors. It's nice to see the value of your existing inventory increase a little and the margins on higher-priced goods feel better, but telling customers already anxious about costs that prices will rise more than five percent is an unpleasant conversation to have.
Commodity prices have been ratcheting up rapidly and steadily on expectations that the global economy is shifting into growth mode again, but the picture is confoundedly complicated, just on the inscrutable supply and demand side alone. Now there's the possibility that oil prices will further cloud the picture.
Prices for the key raw materials that make up most electrical products — copper, steel, aluminum, zinc and a variety of plastics play the biggest roles — have been increasing since the middle of last year, primarily on expectations of recovery. Now markets are also moving in anticipation of a significant increase in oil prices based on supply constraints related to unrest in the Middle East and northern Africa. The concern is that higher oil prices could plunge a dagger into the markets worldwide just beginning to recover from recession. A disruption of the recovery would most likely cause prices for metals and other materials to recede on faltering demand, but a jump in transportation costs throughout the economy could still raise prices for finished goods.
The price increases seen in the electrical industry have come across the board, varying from three percent for some fittings to 12% to 15% increases for some steel and PVC conduit products, and many manufacturers are tightening up their freight terms as well to account for the increasing cost of transportation and shipping. Distributors generally are telling us they haven't been getting vigorous resistance from customers. Or even if they resist, they can't be terribly surprised.
None of this is exclusive to the electrical industry, of course. Last month's Federal Reserve Beige Book report on economic conditions by region gathered by its 12 member banks said, “Manufacturers in many districts conveyed that they were passing through higher input costs to customers or planned to do so in the near future. Retailers in some districts mentioned they had implemented price increases or were anticipating such action in the next few months.”
The Picture in Fixtures
As a snapshot of the sort of increases seen in most product categories, we can look at lighting fixtures. Lighting manufacturers began announcing the latest round of price increases in late December 2010. By early February 2011, at least a dozen of the major fixture makers had sent letters to their distributors explaining their inability to absorb the constant rise in the prices of steel, copper, aluminum, zinc and other raw materials and component parts.
The announcements found their way onto several distributor websites, where distributors shared them with customers to give them advance notice of the coming increases and to show where those hikes were coming from. The increases were just beginning to take effect in early March.
The majority of the announced increases in fixture prices have been in the 5% to 7% range, and letters delivered to distributors announcing the increases cite the same kinds of reasons. Hubbell Lighting, which announced on Jan. 7 a round of price increases that would take effect March 7, laid out the increases in several core commodities since April 2009 to back up its case:
- Galvanized steel, up 52.5%
- Aluminum (unalloyed), up 64.8%
- Copper, up 110.4%
- Zinc, up 62.9%
- Kraft linerboard (for packaging), up 18.3%
- Diesel fuel, up 47.5%
Some manufacturers offered price protection for certain existing promotional programs or certain product categories. Philips DayBrite, for example, excluded all LED lighting products from its price increases of 5%-7%, which took effect on Feb. 28.
“The escalation in the cost of materials has increased to the point where a price increase is merited early in 2011,” said Acuity Brands' announcement, signed by Geoff Marlow, V.P. of commercial and industrial sales, and Myron Martin, V.P. of pricing and margin management. “Copper is priced at unprecedented levels. Petroleum prices have caused plastic components to increase and transportation costs are surging. Steel and aluminum spot market prices are up and the mills are enforcing future shipments with premiums.”
Keep in mind that all these increases were announced before the rebellion in Libya got underway. The fallout from that crisis — still unresolved as we go to press — already has driven oil prices above $100 per barrel for the first time in more than two years, and a continued loss of Libya's crude from world petroleum markets could push prices even higher. This would have the combined effect of raising input prices further and cooling off the resurgent economy.
Copper Fundamentals Point Up
Copper hit new highs of $4.62 per pound on the New York Commodities Exchange (Comex) on Valentine's Day and $10,190 per metric tonne on the London Metals Exchange (LME) the next day. Based on the fundamental supply and demand picture, many analysts were expecting it to go higher, eyeing the $5 mark. But over the following week it dropped back to four-week lows. Where it goes from here is anything but clear.
Electrical distributors, always keenly aware of the copper price and its impact on the value of their wire inventory, didn't let the drop go unnoticed. One wire manufacturer said in a brief elevator conversation at the NAED conference in San Antonio last month that, predictably, distributors are after him to lower prices on orders they've already placed. Can't hurt to ask.
The market fundamentals of supply and demand appear to support continuing increases in prices through 2011, with an expected deficit in LME warehouses of as much as 440,000 metric tonnes, comparable to the shortfall seen in 2010, said John Gross, a copper industry analyst and publisher of The Copper Journal.
Those fundamentals are based on expectations of recovery in the countries that consume the most copper. “The predominant sentiment is bullish, and when it's bullish the market tends to ignore negative news,” Gross said.
However, sometimes the negative news is big enough that it can't be ignored. The prospect of oil prices rising back to record levels would qualify as big negative news for the still-tender economic recovery — a recovery that hasn't yet reached into the construction market that accounts for almost 50 percent of copper use in the U.S.
Developments in the Middle East and northern Africa in the first few months of the year have raised new doubts about the prospects for that recovery. The unrest that began with the overthrow of governments in Tunisia and Egypt didn't cause oil investors any heartburn until it spread to Libya, a major oil exporter and OPEC member. The prospect of a disruption to oil supplies there as Col. Gaddafi clings violently to power pushed oil futures for April delivery past $100 per barrel to levels not seen since mid-2008.
The unstable situation in the Middle East opens the possibility of a significant run-up in oil prices over the longer term, which would have a devastating effect on economic growth throughout the industrialized world and reduce demand for copper.
Not that volatile copper prices are anything new under the sun. In 2008, copper prices hit a new high in July at just over $4/lb, then dropped to $1.25 in just two months as the global recession began to bite. No one then expected the price to come back as quickly as it has, Gross says.
Along the way, the relationship between metals inventories and price has become decoupled, in part because investors use commodities such as copper to offset risks in fluctuating stock prices and currency values. This decoupling “will last as long as it lasts,” says Gross.
The introduction of new exchange-traded funds (ETFs), which are essentially tradable investment vehicles that hold assets in commodities such as copper, adds to the volatility of futures prices by allowing investors to play commodities markets without having to trade in the actual commodity.
China's recent moves to raise its core lending rates and shift its economy to one based less on exports and more on domestic consumption have tempered the demand outlook for the world's largest consumer of copper, but there are indications that this shift may already have been factored into copper pricing. When China raised rates in October, the price of copper fell 10 percent the next day, but subsequent increases in December and February had little discernable impact on the price of copper, Gross says.
All the electrical industry can really do is plan for continued volatility, meaning having strategies for dealing with scenarios where the price of copper is unusually high or low, says Gross. “There is little point in trying to outguess the market, it can't be done consistently,” he says.
Surging Steel Prices Confound the Experts
Many of the same global and market trends that affect copper pricing shape steel prices. Like the red metal, steel prices are also surging. But generally speaking, steel usually offers a more stable pricing environment than cantankerous copper. Like any basic building material, pricing is directly tied into demand, and as in the copper market, China plays a huge role in the market because it's the world's biggest importer and producer of steel.
But you usually don't see as many wild swings in pricing as you do with steel — at least until the current run-up in pricing, where prices for some types of steel have risen 50 percent or more. The Hubbell Lighting pricing data mentioned earlier said prices for stainless steel increased 53 percent since April 2009.
At least one construction analyst was expecting a much less volatile steel market for 2011. In a presentation posted on www.youtube.com last September, John Anton, Global Insight's lead analyst for the steel market said he expected the 2011 steel market to be smoother, more controlled and less volatile than 2010. Anton, who has been tracking steel prices for Global Insight for 10 years and is widely respected as one of the most knowledgeable sources on steel pricing in the United States, said in that presentation, “If you are buying steel for 2011, your budget should be slightly higher, probably five percent to 10 percent higher. What you will see is prices lower at the beginning of the year and gradually going higher. 2010 started low and rose rapidly to some of the highest steel prices ever, although not as high as 2008.”
More recently, according to a report posted on www.metalcenternews.com, Anton said at a January meeting of the Association of Steel Distributors, that he doesn't expect the rapid run-up in prices to last because although economy is improving there isn't enough demand for steel at these prices.
Other analysts expect price increases to stick — and to keep on climbing. An article posted at the Financial Times' website (www.ft.com), included 2011 steel price projections from 11 steel industry executives and industry analysts. Their combined forecast for 2011 steel price increases averaged out to +32%. One analyst, Rod Beddows, chief executive of Hatch Corporate Finance, a business consultant and M&A advisory firm specializing in the metals industry, said he expects a 66 percent increase by year-end because of the increases in raw material costs and a desire by steel producers to push up their profit margins shredded by the 2008-2009 recession.
Interest in steel pricing pops up in some unexpected places, particularly prices for No. 1 Heavy Melting steel scrap. Even former Federal Reserve Chairman Alan Greenspan followed the price of this type of scrap steel and factored it into his economic forecasts because he, like other economists, believes that when scrap prices are rising, it's a dependable indicator that the economy is growing. According to the U.S. Geological Survey Department (USGS), Reston, Va., scrap prices fluctuated widely between about $290 and $367 per ton in 2010 (a 26.6% swing). The Scrap Bulletin (www.scrappricebulletin.com), which provides the USGS with this and other pricing data, said at press-time that regional prices in Chicago for No. 1 Heavy Melting steel scrap were in the $428-$429 range. However a posting on the website cautioned that this increase over 2010 may be due in part to the horrendous weather conditions the Midwest had to endure in early 2011. The Scrap Bulletin posting went on to say scrap prices saw an even bigger spike of more than $100 in 1Q 2010 because of bad weather before declining mid-year.
According to a recent USGS report, global demand for steel scrap is fueling this price increase. “North America has been experiencing a shortage of iron and steel scrap, owing to increased export demand, primarily from China, Turkey and Canada,” said the report. “Even significantly increased prices for scrap have not led to an increase in scrap availability, because almost all old scrap had been collected from farms, ranches and other sources, and recession-hit consumers have been keeping and repairing old appliances rather than disposing of them. Also, manufacturers were decreasing production, thus producing little new scrap for the scrap market.”