BOF and EAF Steels: What are the Differences?

What is Steel? Globally, steel can be found in a variety of products and structures – from personal vehicles to the Burj Khalifa: the world’s largest skyscraper. But what is steel, and why is it so important? Steel is an alloy, meaning that it is made by combining iron with another element, usually (but not always) carbon. This alloy can be up to 1,000 times stronger than iron, making steel an extremely useful and sturdy building material (ScienceKids).

Though steel’s roots can be traced back to early human civilizations (Warrian, 11-2), it was not until the 19th century that Sir Henry Bessemer’s new process enabled the inexpensive production of mass produced steel. Once Bessemer’s process hit the market, steel production skyrocketed, setting the stage for continuous innovation in the industry. Today, two distinct processes make up the bulk of worldwide steel production: the Basic Oxygen Furnace process and the Electric Arc Furnace process (MSU).

The Basic Oxygen Furnace The Basic Oxygen Furnace process, or BOF, makes steel using raw material inputs. This process rose directly out of the Bessemer process, and can be traced as the Linz-Donawitz process brought to market in the 1950s (Warrian). Here is a description of the BOF process (MSU):

SteelBOF1 SteelBOF2

The Electric Arc Furnace The Electric Arc Furnace, or EAF, is an even more modern method of steel production. While the common inputs for BOF steelmaking are iron ore and coal,  the EAF furnace operates using scrap steel – steel already produced and ready to be recycled. Nucor, America’s largest steel producer, has made its fortune by popularizing the EAF process at a time when scrap steel making became more effective than the BOF processes of the very integrated firms in the late 20th century (Warrian, 60-2). The diagram below describes the EAF process (A.C.P S.r.l.):

SteelEAF

How do the Two Processes Stack Up? Although the BOF and EAF processes both produce steel as the end product, the varying means to this end between the two processes give each certain economic advantages and disadvantages. The main area of discussion centers around the supply side and the raw materials going into steelmaking. For BOF firms, producing steel requires sourcing a variety of raw materials, namely iron, coal, and limestone (MSU). Due to the necessity of securing these raw materials, early large scale steel firms like U.S. Steel (once the largest in the United States) found it economically viable to vertically integrate its production process backwards into coal and iron mining. Of course, these firms also controlled the necessary railroads, allowing for cheap sourcing of steel inputs (Warrian 27-32).

SteelEAFvsBOFOn the other side, EAF steelmakers have a much simpler input process: EAF furnaces only require scrap steel as the major input. As long as scrap steel remains plentiful in the market, these firms have easy and cheap access to the required raw material. As seen to the right, the supply sides of the BOF and EAF processes are very different (SteelConstruction).

To contextualize these two differing supplies together, raw materials make up 50% of BOF cost and 75% of EAF cost, with the difference between the costs of these inputs determining which is more expensive. However, in the long run, these cost differences even out (WikiInvest) – so what is the primary tradeoff between setting up a BOF mill and an EAF mill? The answer lies in capital costs. For a BOF firm, the average cost per ton of capacity is $1,100, while the cost for an EAF minimill per ton of capacity is only $300. The barrier for entry is thus lower for EAF firms, which can in part explain the rise of such “minimills” over the last half of the 20th century and into the 21st (WikiInvest).

Conclusions With Nucor overtaking U.S. Steel in the American market, it is evident that the industry is facing a period of change. Certainly, the steel industry will be one to watch as the Chinese economy continues to slow down and the industry again becomes mature with numerous players in the EAF game. But despite firms like Nucor’s success, BOF steelmaking still accounts for 71% of total global steel production, with EAF production only accounting for 28% (the last 1% is open-hearth steel production) (WikiInvest). Given BOF’s large market share, will the industry continue to be susceptible to broad changes like that brought upon by vertical integration at the turn of the 19th and 20th centuries and the EAF development in the late 20th? Or, will changes in input prices finally move the industry in one direction (EAF) or the other (BOF)?

Sources:

http://www.wikinvest.com/wiki/Steelmaking

http://www.sciencekids.co.nz/sciencefacts/metals/iron.html

http://geo.msu.edu/extra/geogmich/steel_mill.html

http://www.steelconstruction.info/Recycling_and_reuse

http://www.olifer.com/en/steelmaking.php

Warrian, Peter. A Profile of the Steel Industry: Global Reinvention for a New Economy. New York City: Business Expert Press LLC, 2012.

Gazprom and the Uncertain Future of Russia’s Natural Gas Industry

Natural gas is a very important good in the Russian economy. In 2013 alone, natural gas exports totaled 14% of their total exports—a whopping number only surpassed by crude oil (33%) and petroleum products (21%). Interestingly, the majority of this natural gas is exported to the European market, but Russia has taken steps to increase exports elsewhere, notably through a 2014 deal that will see $400,000,000,000 in natural gas shipped to China over the next 30 years.Russian Exports

And though the natural gas export business plays such a pivotal role in the Russian economy, there is only one player in the game—Gazprom, a firm that has a government sanctioned monopoly on natural gas exports. The reasGazprom's Logoon, according to First Deputy Energy Minister Alexey Texsler: Russian gas should not “compete with itself” in foreign markets, as such competition would only lead to lower prices and decreased export revenue for the motherland.

But the Russian energy industry, and the Russian economy as a whole for that matter, have struggled in recent years. Very low crude oil prices have put a strain on the Russian budget, in turn creating problems in the natural gas sector, where export revenues have fallen 28.5% in the last year.

This graph from NASDAQ shows the fall of oil prices over the last year.

This graph from NASDAQ shows the fall of oil prices over the last year.

Rosneft, Russia’s largest exporter of crude oil, has turned towards natural gas production in the wake of oil restrictions imposed on Russia due to both their conflict with Ukraine and low global prices. To do so, they have pressured the Russian government to end Gazprom’s natural gas monopoly, a move that has reignited questions about Gazprom’s effectiveness and the solubility of the Russian natural gas industry as a whole. That begs the questions: is Gazprom’s monopoly still advantageous for Russia? And, should Russia even continue to export natural gas?

A recent paper by scholar Marina Tsygankova sheds light on some possible answers. For one, Tsygankova’s analysis of the Russian natural gas industry finds that abolishing the Gazprom monopoly would lead to more combined profits for Russian producers in both domestic and foreign markets. However, she also notes that liberation of the Russian natural gas export market would lead to firms divesting in domestic sales to instead flood the European market with their product. This would lead to an increase in domestic price and a corresponding loss in Russian consumer surplus, which she finds outweighs any producer gains realized by eliminating Gazprom’s export monopoly.

Based off of the empirical evidence Tsygankova presents, Russia certainly should not sell more natural gas by ending Gazprom’s export monopoly. Moreover, she notes that given the entrance of shale natural gas into the gas market, the export market for Russia’s natural gas could become even more uncertain should European nations that are so reliant on Russia for energy decide to diversify their gas consumption. Ultimately, the ramifications of continued political pressure by firms like Rosneft and market entrance by shale gas producers could end up dealing a huge blow to both Gazprom and Russia’s financial security, which could destabilize one of the most important players in global politics and international relations.

Sources: US Energy Information Administration (includes export graph), World Affairs, Bloomberg and Energy Economics article

Images: Wikipedia for logo and NASDAQ for prices