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The Hottest Thing in Natural Gas: Steel?

New drilling technology has opened up huge energy deposits across North America and created an abundance of natural gas resources. That has sent natural gas prices downwards toward 10-year lows, transforming a variety of industries. From chemical manufacturers to utilities, low natural gas prices have spurred growth with end users cashing in on the fuel’s cheapness.

Here’s another industry you can add to that growing list of winners from the natural gas and fracking revolution: steel.

The sector continues to benefit from rising demand for tubular steel products used in pipelines, drilling equipment and rigs. At the same time, steel producers are enjoying the low price for natural gas by using it — much to coal’s chagrin — at new direct-reduced iron (DRI) plants. That’s providing big cost savings and expanded margins.

For investors, the opportunities in the steel sector are just getting started and could be a great play on America’s road to energy independence.

Gas-Fired Rebound

Hydraulic fracturing of shale rock formations such as North Dakota’s Bakken and the Northeast’s Marcellus has quickly boosted natural gas supplies and sent prices plunging by as much as half over the last two years. In April, futures reached a decade low of $1.91 per million Btus. That has helped a variety of domestic industries mount impressive comebacks after years of declines versus foreign rivals.

That includes U.S. steelmakers, which have struggled to stay profitable amid weak domestic demand, depressed product prices and competition from China. Global steel output has grown by roughly 14% since 2008, but U.S. production actually shrank by 3.4%.

Now, though, rising natural gas supplies and plunging prices may finally give U.S.-based steel producers an edge.

To take advantage of cheap natural gas as a feedstock, many producers are now turning to DRI plants and other advanced technologies. DRI technology has existed for around 25 years, but with high natural gas prices persisting for much of that time, the technique wasn’t economical.

That’s all changed, and at least five U.S. plants are under construction or in the planning stages that would use gas instead of coal to “cook” iron ore.

DRI lets producers make steel for roughly $324 a ton. That’s a savings of about $82 a ton versus using a traditional blast furnace, or between 10% and 20% per ton. The global average  is about $600 to $700 per ton, with Russian steelmakers coming in at the bottom. Analysts estimate that even if natural gas were to double to around $8, steelmaking via DRI will continue to enjoy a cost advantage over coal. That could make way for increased U.S. steel exports.

Domestic producers have another ace up their sleeves. In an almost ironic twist of fate, among their biggest customers lately are natural gas producers and pipeline operators. Industry stalwart U.S. Steel (NYSE:X) has seen its orders for tubular steel products surge over the last few years as North American shale drilling has exploded. The firm has even unveiled a joint venture plan to build a new DRI plant right in the heart of Permian Basin to produce pipes for exploration and production industry.

Betting on Steel’s Return

With the industry poised to capture some hefty growth at the hands of low natural gas prices, investors may want to consider adding the beleaguered sector to a portfolio. Buying the broad Market Vectors Steel ETF (NYSE:SLX) could be enough capture some of the sector’s rebound because many of its holdings, including a few foreign firms, have caught DRI fever.

However, a better and more profitable play could be minimill superstar Nucor (NYSE:NUE).

The second-largest U.S. steelmaker has pushed forward plans to benefit from cheap natural gas by building a new DRI facility in Louisiana that will start in mid-2013. Gas for the plant will be fed through a $3 billion deal with Canadian energy company EnCana (NYSE:ECA), helping Nucor secure low-cost gas for the next two decades. Analysts expect Nucor to open a second EnCana-fed DRI plant within the next year.

Aside from the cost savings, Nucor benefits from being a minimill. These operators melt recycled steel or pig iron in electric arc furnaces to create new finished steel products. On the other hand, U.S. Steel cooks iron ore and coking coal in blast furnaces, an old-fashioned technique that limits how much natural gas it can substitute for coal.

Nucor could be the hottest thing in the steel industry going forward.

As of this writing, Aaron Levitt didn’t own any securities mentioned here.

Article printed from InvestorPlace Media,

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