Steel industry. Forging a new shape

The rise of China is challenging a traditional industry in an unforeseen way

AT THE dawn of the 20th century, steel production was an important measure of a country's might. America, Britain and Germany led steel-making until the 1970s, when Japan and South Korea emerged as the most efficient producers in a world reeling from the first oil shock. These days, knowledge industries such as computer software and engineering are more carefully watched. But shifts in the world steel market still reveal a lot about the forces driving the global economy. And the picture they paint is of relentless globalisation combined with an emerging - and unpredictable - threat to western producers from Asia.

Steel today is dominated by the economic explosion that is China. The country now produces and consumes more than a quarter of world steel output. China's soaring demand lifted the whole industry out of the doldrums in late 2003. At the time, America was imposing import duties to stop meltdown in the mid-west as one American steel company after another toppled into bankruptcy. As China sucked in every available tonne, prices soared. Hot-rolled coil, for instance, the sheet steel for cars and fridges, rose from around $200 a tonne to more than $600. Steel companies saw operating margins rise to a fabulous 30% in some cases, as they made profits of $150-250 per tonne.

This spectacular boom encouraged a succession of mergers that is still underway. The latest twist is a bidding war for Canada's Dofasco between Arcelor, a European multinational that last month launched a hostile takeover, and Germany's ThyssenKrupp which trumped Arcelor with a higher agreed bid, worth euro3.5 billion ($4.1 billion). The wave of consolidation started in 2001, when the top companies in France, Spain and Luxembourg combined to form Arcelor, which became the world's number one. Steel companies had realised they needed to bulk up to get better terms out of suppliers, such as the iron-ore miners.

Arcelor was toppled from its leading position earlier this year when Mittal, the London-based steel empire 88% owned by Lakshmi Mittal and his family, bought America's International Steel Group, itself a recent agglomeration of distressed famous names, such as Bethlehem Steel and LTV. Last month Mittal concluded the purchase of Ukraine's Kryvorizhstal, taking its annual production capacity to over 65m tonnes - well ahead of Arcelor (see table).

Until these deals, steel had largely been a national business, with America's traditional integrated producers serving chiefly the domestic market. The international steel business consisted of export trade, rather than the ownership of assets in several countries. The emergence of Arcelor and Mittal has changed all that, with steel groups that have an increasingly global dimension. Even the formerly insular US Steel, America's biggest domestic producer, now owns plants in eastern Europe that account for a big part of its output.

Both Mr Mittal and Guy Dolle, head of Arcelor, agree that the global industry will come to be dominated by a handful of big groups with production of around 100m tonnes a year. Aditya Mittal, president and chief financial officer of his father's company, told a recent London conference (run by a consultancy, World Steel Dynamics, and Metal Bulletin) that one of the emerging majors would be bound to be Chinese, despite the extreme fragmentation of China's industry at the moment.

In 1994 China's steelmaking capacity was only 11% of the world total, now it accounts for roughly 25%. The country's production has tripled since 2000 and consumption has more than doubled - every monthly twitch of demand sends ripples through markets round the world. Last autumn, and again in the spring, China was briefly a net exporter of steel. Coil steel prices slumped from $600 per tonne in March to $440 in early summer. Though prices recovered somewhat during the autumn, the abrupt decline showed China's influence over all markets.

The worry on every steelman's mind is that as the growth in demand for steel slows from its recent hectic rates, the huge increase in Chinese production capacity will be diverted to turning out steel for export. Over-capacity in the domestic market has already driven China's internal steel prices for the benchmark sheet steel down to $300 a tonne, well below the levels in other markets such as America. Exports would seem to offer a tempting way out of this problem.

China's total exports have already leapt 185% in the first half this year, propelling it from eighth position in the league of exporters to third, behind only Japan and Russia - although the volume of exports has declined since the summer. China's production capacity is growing rapidly. It is investing at a rate of $35 billion a year, and has plans for at least four huge new coastal steel plants. Peter Marcus, a steel-industry veteran and managing partner of World Steel Dynamics in New York, says that by 2010 China will have capacity for steel products some 63m tonnes ahead of forecast domestic demand.

Given this prospect, it is little wonder that the same western steelmakers that have done so well out of rising Chinese demand are now quaking at the prospect of fleetloads of Chinese metal steaming straight into their markets.

Made in China

But the Chinese threat to western steelmakers may not be all it is cracked up to be. China has little iron ore, and even that is of poor quality compared with Asia's other emerging steel giant, India. So it has to buy expensive imports from Australia and Brazil, which will make Chinese steel less competitive.

High energy prices and weak infrastructure for moving steel are further handicaps. And the Chinese steel industry is also fragmented, despite government plans for consolidation. Mr Mittal Jnr, whose firm already has a minority stake in one Chinese producer and is seeking to snap up other opportunities once consolidation starts, reckons that Chinese producers are far from being truly competitive, with a lot of poor-quality output unfit for many markets.

Mr Marcus points out other reasons why there may be no flood of Chinese exports. The government is wary of causing yet more trade friction in a world awash with Chinese manufactured goods. It has already started to reduce export tax credits for steel, and could even impose duties and quotas. Mr Marcus thinks the government would rather China's railways and ports were busy with other, higher-added-value exports.

There is an historical parallel. Japan's steel exports stopped being a big bogey to Europeans and Americans when the Japanese started in the 1960s to bend steel into boxes called cars and ships. Although few expect China's car industry to make much of an impact internationally for another decade, there are straws in the wind. Exports to Europe and America have started, and trade with small markets in South-East Asia and the Middle East allowed China this year, for the first time, to export more vehicles than it imported. Western fears about China's steel exports may fairly soon give way to another, deeper anxiety.

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