Russian and Chinese steel exports threaten India’s steel giants

The world steel industry is facing a major crisis of poor demand growth, low capacity use and falling prices which is unlikely to ease anytime soon, writes Kunal Bose. Steelmakers in Russia, however, have not been singed by the global crisis. The relief for them has come in the form of steep fall in the value of rouble and the push given to US dollar-denominated exports of steel products. Explaining the phenomenon, Chandra Shekhar Verma, chairman of Steel Authority of India Limited, says “Russian producers of steel could be found counting their moolah when their peers in all other countries are in a struggle to keep their heads above water simply because they are paying bills for wages, transportation and logistics in rouble while their export income is in dollar or euros.”

In an identical tone as Verma, ArcelorMittal’s chief financial officer Aditya Mittal says, “Russian steel exports are very competitive, the rouble has depreciated a lot... The Russian economy has fallen into recession, which means lower domestic consumption, which means more tonnes for exports.” Barring exceptionally high-value steels like automotive high strength steel (AHSS), developed to fend off competition from aluminium and other metals, where Russia does not have a presence, it is undercutting rivals like the world’s largest producer ArcelorMittal in flat and long steel products.

The Russian steel industry now has to contend with a few negative developments. First, as ArcelorMittal chairman Lakshmi Mittal says, the global apparent steel consumption growth in 2015 will be in a range of 1.5% to 2%. This will boil down to softening of steel import demand. “All exporting countries, Russia or otherwise, had to contend with ferocity of Chinese steel sales in the world market through 2014 when these rose by 50.5% to 93.78mt (million tonnes). Imports by China restricted to principally very high grades of steel were on the other hand up only 2.5% to 14.43mt,” says Verma. The Chinese export avalanche is continuing in the New Year.

Customs data for January, subject to modifications, show China’s steel exports rising 1.2% month on month to a record 10.3mt, beating market forecasts. What will explain this unprecedented export thrust? Verma provides the answer. “Read prime minister Li Keqiang’s 5th March message to the National People’s Congress suggesting growth of ‘about 7% this year’ on the back of slowest growth in nearly a quarter century of 7.4% in 2014. When he said economic difficulties in the coming days could be even more formidable than in 2014 and downward pressure on the economy was intensifying, the portents for the country’s steel industry could not but be ominous.”

Industry analysis and consultancy group CRU points to a fall in Chinese investment growth in house building to 10.5% last year from 19.8% in 2013. This, for steel, translates into local demand shrinkage for long products. In a demonstration of continued weakness of the manufacturing sector, China’s steel purchasing managers index (PMI) in China hit an 11-month low of 43 in January. Even after giving allowance for the Chinese New Year holiday and routine winter slowdown, demand improvement from now on will remain tepid. Hasn’t Li said the government had anticipated slowdown as attempts were made to build a strong and steady economy? For the first time in 30 years, China experienced a fall in steel consumption in 2014 when exports climbed to a record high.

ArcelorMittal suffering like producers elsewhere due to China’s export surge is expecting the country’s steel demand to grow between 1.5% and 2.5% in 2015 to which Verma agrees, saying,“I shall welcome steel demand improvement there. To the extent more steel is consumed in China, the pressure will expectedly be less on local producers to export.” Verma thinks if China is to realize a growth target of 7% this year, Beijing will have to provide a bigger fiscal support to economic activities over the cut in bank reserve ratio by 0.5 percentage points done earlier. He reminds of Beijing intervening last year by way of loosening monetary policy and giving a shot to public spending to ensure that growth didn’t slip much below official target.

The issue is how much of extra liquidity will flow to traditional industrial sectors making any positive impact on steel after meeting demands of “hi-tech and industrial projects.” One major steel consumption point the housing sector in China is unlikely to see any improvement in outlook till the second half of 2015. According to the country’s National Bureau of Statistics, home sales in 2014 fell by nearly 10% from a year ago, while residential property investment grew by 10.5%. Will the first- and second-tier cities in China lead the recovery in the housing market by the second half of 2015 and smaller cities joining the recovery at some point but not before latter half of next year as some agencies have forecast? Doubts remain. Weak domestic demand resulting in further steel price falls in February in $30 to $60 a tonne range could not but have a domino effect in export and domestic prices in all other markets. Russian FOB (free on board) Black Sea prices for long and flat products are significantly down. But Russian steelmakers like Severstal and OAO Novolipetsk continue to enjoy their best profitability since the commodity boom preceding the global financial crisis of 2008/09, thanks to rouble weakness and dollar- denominated export prices converted in rouble staying much higher than domestic prices. Severstal, with an earnings before interest, tax, depreciation and amortization (EBITDA) of 32% in the fourth quarter of 2014, the highest since 2002, remains an exception in the world steel industry. No wonder, profits being this high, that Severstal and OAO Magnitogorsk share prices have more than doubled in the past 12 months.

What must be said in favour of Russian steelmakers is that, by investing billions in their mills over the past several years, they have made operations cost effective, improved product quality and lived down the Soviet-era stigma of ageing technology, high production costs and environment unfriendliness. Europe’s largest producer, Russia lifted steel output by 2.6% to 70.7mt in 2014. In contrast, China Iron & Steel Association (CISA) has said recently that up to 70% of the industry could not meet the country’s environmental standards. Chinese steel mills will need to spend up to Rmb ($15.96) a tonne in capex to avoid closure and meet new regulations, says Standard Bank.

Hit by punitive economic sanctions by the US and Europe, and with crude prices staying mostly below $60 a barrel, the Russian economy is likely to contract by 4% this year. Remember Russia is a big exporter of oil and gas and export income on this account is steeply down. All this will result in domestic steel demand fall of about 7%, making Russia an even more aggressive steel exporter. Morgan Stanley estimates Russian steel exporting this year is poised to take a leap of 16% to 28.8mt, amounting to 44% of output. Yet another constituent of the former Soviet Union Ukraine is found as aggressive a seller of steel in the world market as Russia and China are.

If anything, Ukraine has suffered a bigger fall in its currency since 2014 start than Russia. In exports, Ukrainian mills have found their viability. But importing countries, especially the ones like India and the EU nursing considerable idle capacity, are realizing to their cost that unrestrained exports by China, Russia and the Ukraine are inflicting incalculable harm to their domestic industries. Imports at a time when economic growth is at the best marginal are keeping domestic steel products prices low while rendering large steelmaking capacity idle. That Chinese steel exports are buffeted by subsidies, hidden as well as not so hidden, find confirmation in anti-dumping suits in the US and EU.

An analyst has raised the issue if “Ukraine and Russia are not becoming a new China in export markets, not in terms of volume, but in terms of their impact on prices.” In a voice of dissentVerma says,“large imports are greatly worrisome for us steelmakers in India. With margins thinning in steel, imports rising by 67.3% on a year on year basis in the first 11 months of 2014/15 to 8.38mt could only be damaging for Indian steel market.” Indiansteelmakershave,therefore,joinedhandstoask New Delhi to exclude the metal from free trade agreements (FTAs) with South Korea and Japan, the two major import sources over the last couple of years.

FTAs with the two Far Eastern countries have provisions to bring down import duties on steel products in phases to nil. The Indian industry wants steel import duty at 25 per cent, irrespective of sources, as it obtains in Brazil. Fear remains as Chinese economy settles down to 7 per cent growth, steelmakers there will come under further pressure to export the metal and India will remain among their principal target markets.

Flat global steel demand and high steel exports apart, what also is keeping metal prices low are iron ore settling around $60 a tonne and metallurgical coal at less than $120 a tonne. Low steel margins prevailing for a long time is not conducive for India to chase a capacity target of 300mt by 2025 against about 105mt now. Not only does the Indian industry need protection from imports, but steelmakers proposing big projects should get allocation of iron ore deposits to create ideal capacity growth condition. Land acquisition for hosting steel mills is becoming increasingly difficult. The answer to untying the knot is in supportive government policy and project promoters having a humane approach to adequately compensating land givers and their rehabilitation. What is not in doubt is that India will be the world’s next major steel consumption growth centre once major infrastructure development projects take off and urbanization takes root. In India, capacity growth must happen both through blast furnace-basic oxygen furnace (BF-BOF) route and electric arc furnaces and induction furnaces.

Therefore, it is essential that sponge iron manufacturers get adequate allocation of gas and coal as feedstock.

Let’s look at some positive indicators for steel as seen by ArcelorMittal. In key markets of the company manufacturing output continues to expand. As of 15 January, its PMI was a comfortable 52.3. The two positives for the US are consumer spending at higher levels supported by low oil prices and investment continuing to grow despite reduction in oil industry investment.

As for the Eurozone, growth was stable in 2014 final quarter. PMI and confidence in the 28-nation EU block have been improving since December. Industrial output is stabilizing in Brazil, though at low levels where any substantial recovery is not expected until 2016. Pitched against these zones is China where economic deceleration continues despite low oil prices supporting consumer spending. Russian outlook remains weak with falls in both investment and steel demand. So the steel market will continue to face destabilization from exports from China, Russia and Ukraine. 


Real’s fall in value turns Brazilian users to cheaper domestic supplies

With demand for consumer goods falling, the steel industry in Brazil is frustrated by the slow start to the long-promised expansion of infrastructure projects designed to take their place, writes Patrick Knight.

It had been hoped that 2015 would see a start made to the long-delayed upgrading and expansion of ports, roads and railways in Brazil, as well as an acceleration of the development of deep sea oil finds. Such projects will require large quantities of steel and so bring new life to an industry facing severe difficulties, as Brazil’s economy slows. But with the economy not now expected to grow at all this year, and with investments being cut back, the industry faces many serious challenges.

The economic slowdown means that consumer spending and borrowing, which had been buoyant for almost a decade and been the main motor for growth, has slowed sharply in the past two years.

Ten years of growth allowed the two leading markets for steel in Brazil, the construction and motor industries, between them responsible for 70% of all the steel used in the country, to grow extremely fast. But contrary what had been planned, the cutback by consumers has not so far been replaced by increased spending on upgrading the country’s creaking infrastructure. Brazil’s poor infrastructure adds greatly to costs of transport, damages the country’s competitiveness and so prejudices exports. This is particularly important at a time when the prices of most commodities has fallen from their peaks, cutting revenues sharply.

The sharp fall in the world price of crude oil and refined products has coincided with the discovery of a massive financial scandal at the country’s state controlled oil company, Petrobras. With its finances in deep trouble, following the collapse of its share price, Petrobras has been forced to cut back, and in some cases, halt exploration and field development work. Large new markets for drilling rigs and production platforms, as well as for the ships needed to carry the oil ashore or for export, had been expected to open up for steel, while a large network of new pipelines to carry gas, now becoming the leading means of generating electricity in Brazil, would require a massive amount of steel.

There has been one positive result for steel from all the financial gloom. This is because the Brazilian currency, the real, which had been overvalued for several years, when interest rates were kept at record levels to attract foreign capital and ease pressure on inflation, has fallen by up to 20% in the past six months.

One result of the collapse in the real is that imported steel, which in recent years had come to form about 15% of the 30mt (million tonnes) used each year in Brazil, has become much more expensive. Some of the steel imported in the past few years, is now being substituted by steel made in Brazil steel by much of industry, and by construction companies, many of which have switched from using reinforced concrete, to steel in recent years. In addition, Brazilian steel has become much more competitive in world markets, so much so that it has been able to take advantage of the increase in demand from leading market the United States, always an important destination for exports, and with which Brazilian companies have close links. The important Arcelor-Mittal company has started up a blast furnace at the Tubarao complex in Espirito Santo state, which had been mothballed for several years. Brazilian steel slabs are used in the US market to make sheet steel, and this trade has begun to fill 

the gap caused by weak demand in other markets, notably members of the EU and elsewhere in Latin America. These countries were previously important importers of Brazilian steel, but many now prefer to buy lower cost steel from China. Following the slowdown of its economy, China now has a 40mt surplus of steel, which is available for export. Brazil has never exported more than 5–6mt of steel in a year, so is not in the same league.

The fall in the value of the real, which is expected to remain low for a considerable time, was not only because of the weakness of the Brazilian economy, but also because of the sharp falls in the price of numerous commodities. These include iron ore, soya beans and meal, Brazil’s top two export earners, as well as pulp, leather, cotton, tobacco, wood and a range of others. The lower prices and weaker demand resulted in Brazil’s exports earning less than the country’s imports cost in 2014, the first time this has happened for more than a decade.When the real was strong, imported goods were often cheaper than the manufactured goods made in Brazil. This brought some benefits, notably that inflation was held down as cheaper imported goods replaced high cost ones made in Brazil. But the strong real also greatly harmed Brazil’s own industry and, with it, demand for steel. One result of the increase in imports in recent years, has been that the contribution manufactured goods formed of the gross national product, fell from the more than 30% of GDP 20 years ago, to little more than 10% of GDP last year. The strong real not only caused severe harm to the steel industry, as less Brazilian-made steel was used compared with a decade previously, and goods containing steel made abroad replaced Brazilian-made goods. Goods imported each year contain about 30mt of steel, displacing much which was previously made in Brazil.

Because the cost of imports has now increased sharply, the replacement by imports of goods made in Brazil, referred to as ‘de-industrialization’ — a process which had earlier affected numerous countries in Europe — has started to go into reverse. With imports so much more costly, many manufacturers, notably in the key construction and motor industries, as well as makers of consumer durables, are now switching back to buying Brazilian-made components and steel. The Brazilian steel companies claim to have invested about $20 billion dollars in modernizing in the past few years, so Brazilian steel is better placed to compete on quality as well as price.

For decades, most of the buildings and other structures built in Brazil, were made of reinforced concrete, and Brazil became one of the world’s leading users of this material. But steel has gradually gained ground in recent years and now forms 15% of all new buildings. Steel has many advantages over reinforced concrete. Steel frame buildings can be erected far faster than those made of cement. They weigh less, so their foundations are less substantial and because so many components are pre- fabricated, considerably less labour, as well as time, is needed to construct a steel building than one made of reinforced concrete. This means that the cost of a steel structure is often only a little more, or sometimes less than one made of concrete.

For the past ten years, Brazil has been governed by politicians from the ‘Workers Party’ which, as its name suggests, has tended to favour the less well off who had fallen behind in previous times when inflation was extremely high. Basic wages, notably the ‘minimum wage’ paid to the great majority of workers in the public sector and the lower paid in the private sector as well, 

have been raised by substantially more than inflation every year. At the same time, various social programmes and pensions were widened and extended. As a result, an estimated 30 million Brazilians, almost 15% of the country’s total 200 million population, have seen their purchasing power rise by enough to allow them to be considered as belonging to the middle class. Millions have been able to buy a wide range of consumer goods, such as cars and white goods, previously out of reach.

At the same time, partly because of the stabilization of the Brazilian currency, partly resulting from the strong economic growth in most of the rest of the world, inflation fell. The stabilization of the economy allowed credit to be made available to millions more people that before. The amount lent by banks for the purchase of a house or flat, for home improvements and for large consumer durables such as

cars and white goods, grew by an average of about 20% a year. This allowed these key industries to grow far faster than the economy as a whole, pushing up demand for steel. But this phase has now come to rather an abrupt end, and with a high proportion of consumers deep in debt, the model is unlikely to be resumed for some time.

Aware of the changed situation,
the government decided to switch
spending away from consumption as
the main motor for growth, towards
spending on infrastructure. But problems associated with obtaining finance, and getting planning permission in what continues to be a very bureaucratic country, has meant making a start on many project announced with a fanfare by politicians, continues to be delayed.

Rather than replacing the motor and civil construction industries this year, as had been planned, the increase in spending on infrastructure now looks more likely to only start making an impact in 2016.

Attracted by the fast growth in car sales, numerous vehicle manufacturers from countries such as China, South Korea, and Japan, as well as from Europe, have built new assembly plants in Brazil. Companies were attracted by the fact that although vehicle sales have boomed in recent years, the number of cars per head of population still lags well behind that in more developed countries. If all goes well, many millions more cars will be needed each year for some time yet. Whether there is space for all the numerous vehicle assemblers now present in Brazil remains to be seen. Several firms are making small, or no profits. On the other hand, prospects for exporting vehicles, which had fallen sharply during the period the real was so strong, are increasing again.

The threat of climate change, something made very obvious in the past year by a long and very severe drought which has reduced water levels in lakes used both to power hydroelectric power stations, and to provide water for populations in Brazil’s still fast-growing cities to critical levels, is a new worry in Brazil. The lack of water, both for generating electricity and for use by industry, not least the steel industry, has forced some companies to halt, or slow production. The Brazilian government has now been forced to take the threat of damaging climate change seriously. Measures aimed to reduce fuel consumption and emissions of CO2, are obliging manufacturers to reduce the weight of vehicles, either by using lighter steel, or switching to using aluminium.

Until recently, most of the 11 large companies which own most of Brazil’s 29 steel mills, which between them have capacity to make 48mt of steel each year, preferred to buy much of the iron ore they need each year from the massive Vale company. Vale now extracts more than 300mt of ore each year from its mines in Minas Gerais and Para states. But anxious to take advantage of the sharp rise in the world price of ore caused mainly by strong demand from China, but with its own output not rising as fast as demand, a few years ago,Vale decided to give priority to exporting, neglecting local mills. Most steel companies reacted by investing in developing their own often large deposits of ore and in some cases moving to compete with Vale in export markets as well.

The ore price has fallen by up to 40% in the past few months, while Vale’s production is on course to rise sharply in a year’s time when a new mine at the Carajas complex starts producing what will eventually be up to 100mt of extra ore; the company might prefer to sell more in Brazil. But most of the private companies are unlikely to switch back to buying their ore from the giant, although many have shelved expansion plans at their own mines following the collapse in the price of ore, or ceased exporting. In the past couple of years, companies such as CSN and Arcelor Mittal, had earned as much from exporting ore as they did from their exports of steel, maintaining profits in this fashion. But this state of affairs has now come to an end.

Brazil’s steel companies claim to have spent the equivalent of $20 billion on upgrading mills, and increasing the quality of the steel they make in the past few years, as well as taking measures to reduce the still fast rising cost of labour. Mills say they can make steel as cheaply as any company in the world. But they are handicapped by high overheads, the high cost of obtaining capital, and by the high cost of transport. Although the steel companies have a share in several of Brazil’s railway companies, no less than 75% of the steel made and sold in Brazil is taken, often very long distances, by road This should gradually change over time, particularly when the new railways come into service.

Until 20 years ago, the CSN company operated a plant which made rails. But as more lines were abandoned as were built, and while most existing lines were not even upgraded, this plant was de-activated. In theory, thousands of kilometres of new rail track are to be laid in the next few years, and much of the existing 30,000km of track will also need replacing. But despite this, no company has yet taken the decision to build a new rail- making plant. This seems to indicate that the steel companies at least, are not yet convinced that the new tracks will be completed according to plan. With the completing of numerous part built lines long delayed, there is no reason to question their judgement. But because of the lack of rail making capacity, Brazil now spends hundreds of millions of dollars on importing rails each year, most from China, from where 70% of the steel imported by Brazil each year now comes. In some parts of the north east of the country, it costs less to import steel from China, than it does to bring it up by road from Brazilian mills, most of which are located in the south east and south of the country.