Fitch Ratings expects that global steel prices will even out in 2008 once cost inflation of raw material is absorbed, according to a new report. Prices increases for steel have been rampant during the first six months of 2008 as companies seek to pass through increased raw material costs. The ability to increase steel pricing is essential to maintain margins for producers who do not control their sources of iron ore, coke, pig iron and scrap.

Contract price increases for iron ore and coke have added approximately $185 per metric ton (mt) to the cost of blast furnace steel without vertical integration. Energy, freight, scrap and labor cost increases can add another $100/mt, far exceeding original expectations.

Growth in global steel demand is expected to run approximately 6%-7% annually over the next 12-18 months, and markets are expected to be fairly balanced. Excess production could drag on pricing and further pressure tight raw material markets, while short supply would be inflationary and may dampen steel demand. Regional variations in pricing and profitability have re-emerged, given high freight rates and protectionism.

Fitch expects further consolidation in the steel space. Steel producers have been acquisitive to diversify geographically, to rationalize production and to gain access to raw materials.

Key 2008 Themes/Events:

-Exposure to consumer end-markets such as automotive and appliance manufacture, markets likely to experience slow growth in industrialized nations, may constrain the ability to pass through cost increases. Exposure to energy-related industries may benefit cost pass-through ability.

-Regulatory efforts to reign in inflation may cut production growth. Tightening credit cuts the ability to finance inventory and support trading activity. Export duties keep local markets well supplied and prices low.

-Fitch believes a BHP Billiton/Rio Tinto plc merger could increase pricing pressure in the seaborne iron ore market. This especially concerns Asian producers: China accounted for 48% of Australian Iron ore production in 2007; Japan accounted for 26%; and Korea accounted for 10%. Japan imports all of its iron and coal needs, China imports about half of its iron needs.

- Production in China has exceeded domestic demand since the end of 2006, weighing on domestic pricing, as well as pricing in Europe and the United States, for some products for certain periods of time. Increased domestic consumption in Russia has cut net exports there, and the Middle East has been a robust market for exports, resulting in fairly balanced markets overall.

Continued excess production drives the raw materials costs up while weighing on pricing. Government measures, in addition to cost pressures, should continue to result in closure of inefficient production capabilities and constrain the growth of China's net exports.