Companies are stuck with huge inventories.
The crash in commodity prices is hurting companies as many are carrying huge inventories of raw material, and in some cases, finished goods made with raw material bought at higher prices.
This is especially true for oil refiners. Typically, oil refiners take 8-10 weeks to purchase, processes and sell the products at retail outlets. But crude prices have come down from $147 a barrel to $62 a barrel.
This is hurting pure refiners like Reliance Industries and Essar Oil, who are being forced to sell the petroleum products at cheaper prices, as they export much of their produce.
Falling prices of petrochemical products have also caught many downstream units on the wrong foot. A leading paint-maker conceded that the company stuck with raw material of petrochemical and natural products, whose prices have crashed 30-50 per cent from their peaks. Some anticipated the fall, and took corrective steps.
“We took a conscious call and started reducing production in the last quarter as we anticipated demand to slow down by 10-15 per cent,’’ said OP Lohia, CEO, Indo Rama. Prices of petrochemical intermediates have fallen by 50 per cent.
The aluminum and steel industry have also been hurt by the commodity crash. Steel companies are carrying three times inventory than they usually do.
But where it is hurting companies the most is the inventory-carrying costs of raw materials bought at higher prices, while finished goods prices have fallen sharply. The inventory-carrying cost (interest) is Rs 500 a tonne, estimates a steel maker. Many steel-makers in India, who don’t have their mines, are caught in this trap.
Take chrome ore, from which is derived ferrochrome, a key input for making stainless steel. Orissa Minerals Corporation (OMC), a PSU which mines and sells chrome ore, has reduced prices of the ore by 40 per cent last quarter but finished product (ferrochrome) prices have fallen by 50-60 per cent.
“Ferrochrome prices have fallen further by 10-15 per cent since then. Prices are fixed every quarter and OMC does not have the flexibility to reduce rates. The ferocity with which input prices have fallen is unimaginable. We are stuck with inventory and raw material in the pipeline and that’s what is killing us,’’ said Arvind Parakh, director for strategy and business development, Jindal Stainless.
It’s the same story in aluminium. “October sales were two-thirds than the last few months. We are carrying an inventory of 15-30 days compared to a normal 8-10 days,’’ said Pramod Suri, CEO-aluminium business, Vedanta Aluminium.
But he expects things to look up soon as a lot of smelters will be shut and that will create demand though Vedanta is not cutting production. Last week also saw steel makers and truck makers announcing production cuts as inventory piles up.
The steel industry typically carries an inventory level of one million tonnes of steel or seven days stock. This has now increased to three weeks’ stocks, said Seshagiri Rao, director finance, JSW Steel. Some smaller players are carrying nearly a month’s stock; and this is after liquidating two months’ inventories.
“Right now, there is paranoia. Whenever it dies down, there will be very little material in the system because producers are cutting production,’’ said Ankit Miglani, director (commercial), Uttam Galva Steels.
Some industry experts believe that demand should pick up in December given the shutdowns that have happened. Already, globally scrap prices have started moving up, which is the first sign of recovery in demand. Steel companies have signed long-term contracts for iron ore ($84 a tonne) and coking coal ($305 a tonne) but prices will be revised only next year though spot prices have crashed. New contracts are likely to be signed at $100-$150 a tonne for coking coal and at $50 a tonne or lower for iron ore.
JSW sources 56-60 per cent of its iron ore from the spot market and hence will gain from falling prices.
Jindal Stainless suffered when prices of inputs (nickel and scrap) and stainless steel fell sharply, leaving it with high level of raw material inventories. “We have lower finished goods inventory than normal as we took a shutdown from August but we have a raw material inventory of 25-30 days,’’ said Parakh. “There is an inventory pile up of 35 million tonnes in iron ore across the industry. Typically, it’s around 30 million tonnes,’’ said Ravi Kastia, MD & CEO, Essel Mining & Industries.
