The Steel Economics: Firms’ Perspective

The Steel Economics: Firms’ Perspective

The hot metal is hot both on account of rising prices (Sudhir Shyam, IES Today, 7 July 2008) and rising production expectations. Here an attempt is made to look at the pertinent issues plaguing the steel sector, based on my interaction with plant managers at Bhilai Steel Plant in July 2008. The paper considers the issues of vertical integration, iron ore export policy, input price rationalization, product diversification and technological challenges from the perspective of steel firms, particularly SAIL

Steel Sector in India: The production of steel increased from 1.2 MT in 1950-51 to 53 MT in 2008 but still it is only one tenth of the present Chinese production (Table 1). The last phase starting from the year 2000 onwards (Chart 1) has shown a steep increase in production due to the entry of private players and if that growth momentum is continued, production will be 200 MT by 2020[i]. Iron and steel sector accounted for around 10% of the growth in the manufacturing sector in the last fiscal (Source: Economic Survey 2007-08). However, the per capita consumption is a mere 43 Kg in 2006-07 as against the global average of 197 Kg and China’s average figure of 307 Kg. Worse, the per capita consumption in the rural areas is just 2 Kg compared to 70 Kg in the urban areas. This signifies the scope of expansion India can have. Around 193 MoUs worth Rs.5.14 lakh crores for 240 MT of steel have been signed to cater to this prospective demand.

Strategy of going big: The “steely resolve” to fight back against odd times and ways of 1980’s and 90’s has put the steel firms on a sustained half a decade long growth path since 2000. And with the surging Olympic demand from China and the rest of the world, profit figures of the companies have finally reached acceptable levels. Now the focus is on sustainability for which consolidation and vertical integration are sought after. The vertically integrated companies with sufficient economies of scale are turning out to be the least cost players in the market, for instance Tata Steel with its captive coal mines[ii]. Steel Industry has been violating all perceived laws of nature while being on this consolidation move. Now this is an industry where small fishes eat big fishes. Acquisition of Corus by Tata and Arcellor by Mittal occurred due to this pressing need for consolidation. Tata jumped from 45th position at the global level to the 6th position after the deal. Now Mittal’s production is 3.3 times higher than the second highest producer-Nippon Steel. However, this should alert the regulators to possible monopolistic tendencies in the sector.
Story of Input price increase: Sudhir Shyam, (IES Today, 7 July 2008) had presented the apprehension about steel firms raising prices, taking advantage of rising demand though the claim is based on rising input costs. The selling price was 1.5 times the cost per ton of steel (for SAIL which contributes to around 28% of total production in the country) in 2004. This increased to 1.63 times in 2007-08 (Chart 2). However, this should be viewed against the 20 year long slump in steel market during 1980-2000.
Though there is no dearth of iron ore the prices of iron ore are shooting up. According to IISI, only three firms (CVRD -Vale, Rio Tinto and BHP Billiton) account for 70% of the sea borne trade in iron ore which makes one suspicious of cartelled foul play at the input level though steel firms are at present devoid of cartel arrangements. BHP Billiton is trying to take over Rio Tinto which means, the merged entity will have control over more than 40% of the global iron ore production- same share the oil cartel –OPEC is having at the global level. For strategic reasons the biggest steel producer China is planning to use its Sovereign Wealth Fund to increase its stake in key input suppliers like Rio Tinto. In India, production is mostly based on captive mines hence iron ore price hike has not affected them materially in the short run. The pertinent issue is the rise in the price of imported coke and various ferro alloys which increased on an average by 77% and 33-636% respectively during 2004-08 (Source SAIL). As these resources are to be imported, securing long term supply arrangements is vital to the sustainability of profits.
Export of iron ore: killing the goose laying the golden Egg? China- the biggest producer of steel in the world depends on imported iron ore, allegedly saving its huge reserves for commanding a monopoly position in future. In fact 91.2% of the Indian iron ore exports, which is priced at half the domestic prices, are purchased by China[iii]. Though India is the 4th largest producer of iron ore (China being first), its reserves are meant to last only for 104 years. Is strengthening the bilateral trade with China strong enough a reason to permit this? Or is this a reincarnation of the drain theory? Above all, iron ore comes from those states which are reeling under resource curse, where poverty is at its highest despite being resource rich. Hence a right export-policy and translation of its benefits into high royalty payments to these states is crucial.

The cost of quality improvement is very costly as BIS’s quality standards provide grades whose ranges are large enough to prevent product differentiation. Hence firms do not have enough incentives to improve upon the quality of the apparently homogenous steel products and cash in by charging differential prices. Instead, the sensitivity analysis done at the firm level (Table 2) shows that by changing the coke firing rate or yield rates at mills, firms stand to benefit more. Product diversification is (Table 3) also a preferred option for steel firms. The Bhilai Steel Plant (BSP) of SAIL has a long record of making profit even when other firms of SAIL were running in losses. This is attributed to the diverse product mix (especially production of rail) of BSP. To prevent the hotmetal going back into the hotbed of overproduction and glut, brand loyalty through product differentiation and quality improvement are imperative.
In fact, India’s production of saleable steel is only one fifth of the hot metal it produces. This shows the efficiency gains India has to aim for. Technological progress has eluded the blast furnace and coke oven batteries[iv] which industry experts say, world over is a problem. Sometimes the technology of the user industry itself limits the growth prospects of firms. For instance, BSP has the capability to produce half a km long rails (instead of the present 32m long rail) which reduces the accident rate and cost of repairs and maintenance substantially. But Railway does not have the wagons to transport it.

India steel summit identified 6 important challenges for the steel companies: climate change (industry alone accounts for 5-6% of global CO2 emissions with China alone accounting for 50% of it. In India 15% of the GHG emissions are by the steel companies), raw materials, people (creating a zero accident rate environment alongside better human resource management), capacity investments, growing the market in construction, and the image of steel kept free from that of a dirty hot shop. To reduce CO2 emissions in the light of Kyoto protocol, there is a need to further maximize the recycling of end-of-life steel. With the proposed expansion in steel production, it is of utmost importance that India should not end up as a net buyer of carbon credits.

Role of Government and PSUs: To meet the targeted doubling of capacity, PSUs believe they need fast track decisions from the government, specially on land clearances. The capacity expansion drive when it was first conceived was targeted at an estimated cost of Rs. 26,000 cr, but at present the drive would entail an expenditure of Rs.90,000 cr. However, the debt equity ratio of SAIL is just 0.12 compared to 2-5 for private players like Tata Steel or Jindal. This implies that the PSU can actually go on an expansion drive on its own without creating much future liabilities.

The increase in the share of private players would significantly reduce the governments’ control over price, especially in the inflation scenario that might accompany the high growth trajectory. However, the entry of private players has brought in the much needed technological and efficiency concerns in the industry. The biggest relief is that all stakeholders have started thinking big and is all set to support the globe on our steel frames.

[i] The Joint Plant Committee has initially set a target of 100 MT of steel by 2018
[ii] Arcelor Mittal plans to produce 80 percent of its ore in the next decade, up from 45 percent now, to maximize profits from U.S. steel prices that are at a record-high $1,068 a ton… Bloomberg
[iii] While the net sales realization from exports ranged from Rs 538 per tonne to Rs 1,292 per tonne, domestic price ranged from Rs 1,783 per tonne to Rs 2,546 per tonne. (ET, 17 July 2008, quoting NMDC) Hence NMDC was planning to seek the imposition of ad valorem export duty of 15% matching up with the 65% increase in the international benchmark prices
[iv] Coke oven batteries produces the enriched coke for firing in the blast furnace

(This write up was published on IES today on 29/08/2008)