S. D. Naik

While the steel industry is no doubt passing through good times right now, there is fear that with many players rushing in to create new capacities, there may be overcapacity by 2010. However, Indian companies are in a much better position to weather the temporary mismatch in demand and supply and price declines today because their debt-equity ratios and interest rates are much lower. Yet, steel producers need to guard against the likely bottlenecks and prepare themselves for new challenges, says S. D. Naik.

Steel producers are going in for major capacity expansion but they need to guard against the problems that could arise from likely over-capacity some years down the line.

THE steel industry is now having a dream run, thanks to the booming global demand, propelled by China, and a significant pick-up in domestic demand. In fact, the surge in domestic and global demand for the metal has continued uninterrupted for three consecutive years since 2002 and the outlook remains positive for the medium term.

The steel scenario has undergone a dramatic transformation over the last three years with rising prices the world over, following a strong revival in demand. Not long ago, this industry was virtually in the dumps because of severe demand recession lasting five long years till 2001 and rock-bottom prices. Consequently, most producers in India and abroad incurred heavy losses and quite a few downed shutters.

The new generation steel companies in India, which had borrowed heavily to fund their new projects in the wake of high consumption growth in the boom years (1994-96), found it extremely difficult to service their debt as they incurred heavy cash losses. Many had to pledge over 50 per cent of their equity to financial institutions in lieu of the loans or for further rescheduling of loan repayments.

That was also the period when steel producers were forced to make concerted efforts at restructuring, technology upgradation and downsizing of workforce to reducing their production and operational costs. Consequently, when the global and domestic demand for steel started picking up since 2002 and the international prices of the commodity staged a smart recovery, the industry reaped well-deserved benefits.

Until two years ago, financial institutions in India were a worried lot because of their huge exposure to the steel industry, which had turned sick, and the RBI had had to create a Corporate Debt Restructuring (CDR) Cell to bail out the ailing industry.

But thanks to a significant improvement in profit margins on the back of rising steel prices, companies such as Essar Steel and Jindal Vijaynagar Steel have improved their debt-equity ratios by repaying the loans to the financial institutions. SAIL, which was not a CDR company, is virtually debt-free now, as is Tata Steel.

Thanks to the strong demand in international markets, exports of finished steel from India rose from 2.7 million tonnes in 2001-02 to 4.5 million tonnes in 2002-03 and further to 5.3 million tonnes in 2003-04. According to estimates, exports in 2004-05 were over five million tonnes. There was also a surge in domestic demand for steel because of the rising offtake from sectors such as automobiles, consumer durables, infrastructure and engineering.

The domestic consumption of finished steel rose to 30.4 million tonnes in 2003-04, more than double the 14.84 million tonnes achieved in 1991-92. With GDP expected to grow at a higher rate of 7-8 per cent per annum in the coming years and the increased emphasis on infrastructure development, domestic steel consumption is slated to grow at over 8 per cent per annum.

According to experts, the potential for growth in domestic demand for steel is enormous as the per capita consumption of the metal in India is only around 30 kg, far lower than the world average of 140 kg and the developed world's figure of over 400 kg.

According to Steel Ministry estimates, India's per capita consumption of steel is expected to increase to 55-60 kg by 2010 and over 100 kg by 2020.

Not surprisingly, therefore, a number of steel producers have already lined up ambitious expansion plans in the short and medium term. A few companies have also planned greenfield investments.

The companies that have announced their investment plans are: SAIL (8 million tonnes), Tata Steel (9.5 mt), RINL (7 mt), Essar (1.5 mt), JVSL/JISCO (3.0 mt), JSPL (1 mt), Ispat (1.7 mt), Nilachal Ispat (1 mt), Uttam (0.5 mt), and Bhushan (0.3 mt). This adds up to 33.5 mt, nearly equal to the existing capacity of about 36 million tonnes.

In addition, the Orissa Government and the South Korean Steel major Posco signed a Memorandum of Understanding (MoU) on June 22 committing $12 billion to set up a 12-million-tonne steel plant at Paradeep. The project, to be completed in two phases, comprises two modules of three million tonnes capacity per annum. The first module is scheduled for completion by June 2010 and the second by 2016. This is the biggest single FDI in India so far.

Buoyed by their improved financial strength and competitive edge, some of the domestic steel majors are also looking for overseas acquisitions. Last year, Tata Steel acquired the Singapore-based NatSteel for $486.4 million (Rs 1,313 crore). NatSteel has a capacity to produce about two million tonnes per annum of rebars, wire rods, pre-stressed concrete wires and strands.

This acquisition not only gives Tata Steel a manufacturing foothold in countries such as Singapore, Malaysia, Thailand, Vietnam and the Philippines, but geographical access to the Asian region.

This year, Essar Steel bought out Stemcor of the UK from two companies — Hy-Grade Pellets Ltd (HGPL) and Steel Corporation of Gujarat Ltd (SCGL) — for $450 million (around Rs 1,950 crore).

The acquisition will make Essar Steel a fully integrated steel producer with end-to-end control over raw materials, processes, technology and finished products.

Recently, Tata Steel decided to invest $700 million in Iran over the next five years to set up two joint ventures with the Iranian Mines and Mining Industries Development and Renovation Organisation (Immidro). The first will be for a 1.5 million tonne per annum steel plant to make slabs and a unit of similar capacity for making billets. The second venture will be for a three million tonne per annum capacity export-oriented unit that will come up in two phases of 1.5 million tonnes per annum each.

Since Iran has abundant supplies of gas, a cheap fuel for making steel, Tata Steel will reap substantial cost advantage. Moreover, it proposes to use billets from Iran at its NatSteel facilities and replace electric arc furnaces that use much expensive scrap. The company has also signed a pact with Immidro to explore iron ore mines in Iran.

Even as the steel industry is passing through good times, some analysts have expressed apprehension that with so many players rushing in to create new capacities, there may be overcapacity by 2010 and if the commodity cycle takes an unfavourable turn, producers may find themselves in a difficult situation, as happened five-six years back.

China is already augmenting its production capacities and could become a net exporter of steel by next year from being a major importer. Russia and Ukraine are also raising their output.

Already, benchmark prices of the commodity in the international markets have declined by over 20 per cent this year from their all-time high last year, according to Metal Bulletin data. However, there is no need for panic.

According to market operators, hardening prices last year had led to somewhat nervous inventory building by major consumers, particularly the automobile and white goods manufacturers. However, profit warnings by major groups in Europe and the US have led to rapid liquidation of inventories at consumer end.

Mr Lakshmi Mittal, the owner of world's largest steel group, is among those who believe that steel's long-term prospects remain bright, notwithstanding recent glitches. In any case, the Indian companies are in a much better position to weather the temporary mismatch in demand and supply and price declines today because their debt-equity ratios and interest rates in the market are much lower now.

Moreover, companies have learnt from their mistakes and are planning their new projects in two or three phases so that they have the flexibility to alter their investment plans.

At the same time, Indian steel producers need to guard against likely bottlenecks and prepare themselves for new challenges. For instance, with the Steel Ministry targeting an output of 100 million tonnes by 2020, there is an urgent need to develop assured raw material sources such as iron ore and coal. Also, adequate infrastructure such as power, ports, road and rail transport is a pre-requisite for the Indian industry to remain competitive in a fast globalising economy.

For the past year, domestic steel producers have had to contend with the rapidly escalating costs of raw materials such as coke, iron ore and scrap. But for the equally buoyant steel prices, the industry would have found itself in a difficult situation. It is, therefore, time steel producers got their raw material linkages in place. Wherever possible, they should also try to acquire coalfields abroad for their captive use.

Tata Steel, which has its own iron ore and coal mines, is acquiring a coal block in Australia by the year-end since it is going for a massive expansion of capacity over the next decade. Others would do well to emulate its example since backward integration will give it greater control over costs in the supply chain apart from reducing uncertainty relating to raw material supplies.

Another problem in India is the prevalence of too many small players in this industry with uneconomic scales of operation and little scope for backward integration. Such units should seriously explore the possibilities of going in for mergers and consolidation. Otherwise they will find it difficult to survive in times of price decline.

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