As Raw Material Prices Are Set To Soar, the Effects of 2020 Will Be Felt Into the New Year
Demand for most raw materials generally fell significantly in the early months of the Coronavirus pandemic, including the demand for steel. The sharp decline in demand caused many steel mills to curb production, which caused capacity utilization to drop to multi-year lows. The early decreases in production, together with the continuing impact of the pandemic on supply chains and economic activity that has rebounded as the country reopened, has resulted in a potent mix of volatility and increasing prices in the steel market.
In April, the benchmark hot-rolled coil steel (“HRC steel”) prices fell below $500 per short ton, and prices remained depressed through July and August (click here to reference HRC steel historical data). Since then, demand in steel-dominated industries, such as automotive, has started to rebound. Recovery in the automotive and construction industries has accelerated, which together comprise a significant portion of domestic steel consumption. As a result, HRC steel prices have been on an upward trajectory since September. Most recently, HRC steel prices surpassed $800 per short ton, and will likely surpass $900 per short ton in the weeks ahead. For context, in July 2018, in the wake of the Trump Administration’s imposition of steel tariffs, HRC steel prices reached $920 per short ton. Simply put, we may be headed toward record level steel prices.
The forecasts are particularly important because steel and other raw material costs constitutes a significant percentage of the cost of many products. As such, volatility and price fluctuations in raw material markets can have a cascading effect across the supply chain. The effects are much more pronounced, however, for upstream suppliers near the origin of raw material, as a large percentage of their product’s cost is tied to the price of that raw material.
As a result, suppliers are well-advised to prepare for additional volatility and are likely to see further price increases. As we have seen in the past, increasing raw material costs, whatever the cause, often results in friction in the supply chain. Suppliers whose contracts do not include indexing for raw material costs often seek to push these higher costs up the supply chain. The problem can be particularly acute for suppliers near the bottom of the chain for whom raw material often makes up a significant portion of their overall costs.
Although an outside event like increased raw material prices may result in higher production costs for downstream suppliers, a company may not be entitled to pass those costs through in the form of increased pricing. Any such request depends on the facts of the situation and the parties’ rights under their particular contract. While some contracts provide for indexing of raw material costs, or other price adjustments under certain circumstances, many more are fixed-price contracts, which generally do not allow for such increases. Depending on the contract term or duration, a party may be able to leverage a soon-to-expire contract, or other commercial issues, in order to obtain current price increases. Similarly, a contract may contain mutual early termination rights. With that said, such language is exceedingly rare, as early termination rights are typically reserved for the buyer, depending on the parties’ relative bargaining power.
Absent such contractual language, many companies turn to declarations of force majeure or commercial impracticability. However, while application of these doctrines may excuse a supplier’s non-performance in some narrow circumstances, the general rule is that higher production costs alone are insufficient grounds to support a claim of force majeure or commercial impracticability.
Companies should remain cognizant of the challenges that lie ahead, particularly in the raw material market. Although there is tremendous reason to be hopeful as we enter the New Year, the effects of 2020 are sure to carry forward into 2021 as these higher cost raw materials are used in production, and likely beyond.