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Sector & Industry Studies Series Issue I, July 2007 The Steel Industry Worldwide and Regionally: Assessment of Developments and Outlook Economics & Strategy Division www.gic.com.kw

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Sector & Industry Studies SeriesIssue I, July 2007

The Steel Industry Worldwide and Regionally:Assessment of Developments and Outlook

Economics & Strategy Divisionwww.gic.com.kw

This series is intended to provide analyses and viewpoints regarding industries

and economic sectors important to the region. GIC has a recognized record in

direct and project investment in the GCC economies which gives a perspective

on the various industries and economic sectors. We hope that this series provides

interested readers with balanced and well-rounded views on the industries and

sectors under review.

The first study deals with the steel industry in international and regional

contexts. Although GIC is an interested party in this business as investor, it is

the role of the Economics and Strategy Division in the Corporation to provide

an objective and balanced view regarding the prospects of the steel industry.

We hope the readers will find the study informative and useful. As always, we

welcome comments and suggestions.

Soliman M. Demir, Ph. D.

Head of Economics & Strategy

Foreword

Contents

1. Executive Summary……….....................................................…… 7

2. Introduction...................................................................................... 10

3. Steel Products Summary...………....................................…........... 11

4. Global Market Analysis........................................................……... 11

4.1 Supply and Demand................................................................... 11

4.2 Implications for Global Steel Prices……..............................… 17

5. The Current Stance ..………........................................................... 21

5.1 Industry Structure……….........................…........................... 21

5.2 Industry Challenges.……................................................…… 24

6. Cost Structure Analysis......…..................................................……26

7. Regional Steel Market Analysis in the Middle East............................... 30

7.1 Supply and Demand.....………...…….................................… 30

7.2 Key Regional Countries….......................................………… 34

8. Prospects for GCC Countries………………...................………… 35

9. The Steel Industry: Key Concerns……...................................…… 42

Conclusions...........................................................................…………… 44

References.........................................................................................…… 46

7

Executive Summary

1 CIS: Confederation of Independent States (member countries of the previous Soviet Union).

The short-term outlook for the market of steel products appears positive with global demand for

steel continuing to grow. It is estimated that growth in demand for 2006 was 10 percent but is

expected to slow to around 6 percent in 2007. This growth rate exceeds the 5.7 percent annual

growth rate of global steel demand during 2000-05. However, steel consumption growth rates

have differed greatly across regions where North America recorded the highest growth rate of

nearly 15 percent, followed by CIS1 with 13.5 percent, then China by nearly 11 percent. Global

steel production has also experienced marked growth in 2005 and 2006 with 8.8 percent growth

rate in 2006.

Emerging markets such as those of Brazil, Russia, India, and China, the so-called BRICs, were

the key producers. China and India, in particular, were expanding production more prominently

and both accounted for nearly 45 percent of the world’s steel output in 2006. The American

Iron and Steel Institute (AISI) argues that steel companies in these countries, with government

assistance, have planned steel projects that would add 278mt of capacity by 2008 whereas market-

based producers in the NAFTA region are expected to add only 3.3mt of raw steel capacity by

2008. China’s share of the world steel output increased by 33.8 percent in 2006 while Asian

countries as a whole-excluding China- have accounted for 20 percent of world total in 2006. The

Asia region-including China- accounted for 53.8 percent of the world crude steel production in

2006 compared to one-third in 1990.

In 2004, global steel prices increased sharply and rapidly which made the industry more profitable

despite increases of 71.5% in world prices of iron ore in 2005, and higher transportation costs.

This marked increase in iron ore prices, while helping ore producers to enjoy exceptional profits,

placed upward pressure on the cost structure of steel producers.

8

Although global steel prices recovered during the first half of 2006, after declining in 2005, they

remained soft in China and are likely to remain so until China succeeds in its effort to consolidate

steel production in fewer companies.

Over the medium term, the steel industry is likely to face several issues that would affect steel trade

flows. These issues include exchange rate changes, China’s rapid production and consumption

growth, tight supply of raw materials and industry consolidation. A weaker dollar is likely to

raise costs of imports in USD terms and reduce trade in steel products. As China becomes a net

exporter, the 10-20 mt ton p.a. steel producers are likely to be the marginal ones who disappear

while the 30 mt ton plus producers survive as a result of greater market consolidation over the

medium to long term. However, niche producers of high value-added products that are designed

to meet special demand growth in their immediate region, could be the exception to this global

picture.

The driving force behind recent acquisitions in the steel business is to reduce the steel price

volatility implied in the cyclical nature of the steel industry. Incentives for greater consolidation

in the global steel industry became more apparent when Mittal Co., acquired Arcelor to create

the world’s biggest steel company in terms of production and dollar sales. This deal together

with other deals such as Tata-Corus are likely to change the industry’s competitive pattern and

encourage more consolidation which enables companies to enjoy healthy balance sheets and

easier access to capital markets. Consolidation would give steel companies the edge to gain size

and produce higher value-added products with higher margins vis-à-vis the excess supply of

China’s lower-margin products.

9

As for the Middle East, and in particular the GCC countries, steel production was not sufficient

to satisfy the apparent steel demand which grew at 9 percent in 2006 and is expected to see

a similar increase in 2007. As a consequence, GCC countries have become net importers of

finished and semi-finished steel, especially billets, slab, and HR coils. GCC average per capita

consumption is relatively high compared to other regions such as Asia and CIS but lower than

the EU and the US.

Currently, GCC countries are conducting negotiations to sign possible Free Trade Agreements

(FTA) with China and India. Such agreements are likely to induce more imports of finished

steel products to the GCC market from China; hence the ability of the GCC countries to provide

duty protection would disappear following entry into free trade agreements. However, importing

semi-finished products such as billet then rolling it in the GCC region will be more attractive to

GCC businesses than importing finished products.

We conclude the study with an assessment of the prospects for the steel industry in the GCC

region. GCC producers, in order to flourish, would have to become more efficient and flexible

(e.g., consolidate!). In the final analysis the region will be subject to the globalization forces

impacting producers in both developed and developing countries. The effect of globalization

will be more muted in the short to medium term, since the competitive advantage the region

enjoys in energy will reduce the fierce effects of the globalization forces. In the long run,

however, only efficiency, higher productivity, and market flexibility will be the ingredients for

success of regional steel producers.

10

2 The Economist, February 25, 2006, page 67.

2. Introduction

The cycle has shifted gear in the world economy. Growth peaked in 2004 and early 2005 but

now is moderating. Although the slight shift in the growth cycle of the world economy is likely

to reduce demand for hard commodities such as base metals, the global steel markets for most

products continue to be oversupplied. A strong merger trend, however, is leading to a rationing

of production to protect prices. Prices of raw materials such as oil, iron ore, and coil continued

to be high as their supply remained tight. On the other hand, global trade was growing at an

estimated 9 percent in 2006, after sluggish demand in OECD countries caused deceleration in

growth in 2005 to 6.6 percent from 10.7 percent gains in 2004. Emerging Asia and transition

economies of Eastern Europe were the key drivers of global trade and are likely to enjoy the

fastest rates of export growth. China’s economy has grown by around 10 percent p.a. on average

during 2003-06, while India’s economy grew by more than 8 percent p.a. on average during that

period driven mainly by trade growth.

As a result, China has managed to sustain a trade surplus of $177.5bn, which contributed to its

accumulated foreign reserves of $1028.8bn by the end of 2006. India, on the other hand, has

managed to accumulate foreign reserves of $161.8bn though it had a trade deficit of $51.7bn

during that year. The process of integrating these two booming economies into the world

economy in a sustainable way without them facing trade barriers will likely be a challenge.

China’s growing trade and current account surplus is creating a backlash in the major importing

countries, particularly the US.

The Economist noted that2 the performance of corporations in a given country has been viewed

11

recently as invariant to macroeconomic conditions of that country. The reason is that big firms

in G7 economies are becoming more international, where the share of corporate profits earned

outside the domestic economy is getting higher. Globalization has given firms access to cheap

labor abroad and the tendency to shift more production offshore has helped in keeping domestic

wages relatively stable. It is estimated that the world’s 40 biggest multinational companies

employ, on average, 55 percent of their workforce in foreign countries and earn 59 percent of

their revenues abroad. This trend, as we will see in the study, is helping in internationalizing

production, breaking geographic barriers and is making the steel industry more global than it has

ever been. There are implications for this trend as to how it affects prices, consolidation, regional

development and trade. These implications will become evident in various parts of this study.

3. Steel Products Summary

Table (1):

Low Value-Added High Value-AddedIngots and semis HR/CR narrow strips & silicon sheets Slabs Galvanized coated sheets Billets Welded tubesBlooms Cold drawn wire in coilSections and Rails CR sheets and coilsHot rolled wide strips & platesw Steel tubes, seamless Deformed reinforcing bars Forged bars & cold finished barsOther HR bars & flats HR rod in coil

4. Global Market Analysis

4.1 Supply and Demand

Manufacturing oriented economies are usually more sensitive to business cycles than service

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oriented economies because cyclical changes tend to amplify a given industry acceleration/

deceleration. Obvious changes in demand may lead to significant price changes. Industries like

base metals and raw materials are examples of more volatile and highly cyclical markets i.e., any

supply or demand disturbance could prompt sharp changes in prices. Earnings of firms operating

in such industries tend to be cyclical as well which induces integration among these firms to

reduce the risk of cyclicality. This is apparent in the steel industry where steel companies look

for vertical integration to seize the iron ore they need and secure their supply chain by signing

long-term supply contracts with mining companies as a hedge against price volatility.

A recent study3 notes that, viewed from a historical perspective, the steel and iron ore industries

remain as cyclical and fundamental to countries like China and India in the 21st Century as they

were in the early stages of industrialization in Europe and North America in the 19th Century and

the postwar reconstruction of 1950-70. However, the study contends that the demographic factor

has impacted steel demand substantially when considering China and India, with a population

of over one billion each, embarking upon a rapid program of industrialization and urbanization.

The study expects that demand for steel will grow at a greater magnitude; therefore, the world

appears to have entered into a long cycle of higher demand for steel products than before. There

will be periods of faster growth in demand followed by short periods of slower growth but the

growth in global steel demand is unlikely to reverse back as it did in the early 1990s.

The study argues that since 1970s, the steel industry has undergone nearly five historic cycles,

from peak to trough, driven by technology advancements, globalization, and macroeconomic

structural change. During the most recent cycle, 2000-05, the US steel industry has seen 44

producers file for bankruptcy protection, which represented 20 percent of all steel companies,

3 Metal Bulletin, November 2005, page 53.

13

4 The Economist, May 6, 2006, page 82.

including the second largest producer, Bethlehem Steel. By 2004, the 14 smallest companies

were shut down while the remaining companies were either consolidated or liquidated. Such

market consolidation was motivated by better prospects of realizing profits made jointly with

offshore partners like Mittal and Severstal. At the same time, the industry strived to raise needed

capital to improve efficiency and to meet the rising costs of health care and energy. The US

economy grew by 3.5 percent in 2005, driven mainly by consumer spending, while the Chinese

economy grew by around 10 percent. The US steel imports rose by 36 percent in 2005 to reach 20

mt and the share of manufacturing sector in the real GDP was only 14 percent in 2005. Whereas

investment accounts for nearly half of China’s GDP, exports accounted for almost 40 percent of

GDP, compared to less than 20 and 25 percent for the US and Europe respectively. This contrast

between the US and China has implications for the steel industry.

Real Business Cycle (RBC) models have been revived recently when the world economy

experienced a positive supply shock due to productivity gains from information technology

and the re-emergence of China and India. This supply shock, as The Economist4 argues, has

reduced prices of many goods even though demand was growing and trade was flourishing.

Fluctuations in global steel prices over short periods of time have increased markedly by more

than 80 percent in 2004 while the world economy grew at 5.3 percent in 2004 and 4.9 percent in

2005 and again by 5.4 percent in 2006. The slowdown in 2005 was attributed mainly to slower

growth in the US, Japan, and the EU. While steel prices have recovered during the first half of

2006, after declining through much of 2005, they started to contract during the second half of the

year due to oversupply in China and higher inventories in some other markets.

China grew by 10.7 percent in 2006, and was able to export up to 50 mt of steel during the year,

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5 We do not have hard data on margins in 2005 and 2006 but we estimate a slowing down in 2005 (commensurate with softening of prices during that year) and a slight recovery in 2006.

signaling an excess supply in the global steel market of Chinese steel products. Domestically,

steel overproduction is a threat because excess capacity, especially when it is state financed,

tends to impose deflationary pressure on the domestic general price level. To avoid this, the

Chinese government has focused on consolidating production (supply rationalization) and on

encouraging consumer spending as a driving force for growth. China shall also reduce subsidies

and other export rebates to steel producing companies. It is noteworthy that the recently approved

5-year plan implies a shift in focus from investment to consumption, especially by households.

Chart 1: World Crude Steel Production

Source: www.iisi.org.

Global crude steel production has increased by 8.8 percent in 2006, to reach a total of 1.24bn

tons and is expected to increase by 5.4 percent in 2007 to reach 1.31bn tons. The operating rate,

on average, has increased from 76.1 percent in 2000 to 85.3 percent in 2005 for the world crude

steel, which is equivalent to 33.5 percent increase in production from 2000 to 2005. This rendered

the steel industry more profitable for many years with average operating margin reaching nearly

16 percent in 2004 compared to a modest 7 percent in 20015. Emerging markets such as those of

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6 International Iron and Steel Institute,www.iisi.org.

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Brazil, Russia, India, and China, have played an important role in the steel market and helped

driving up world prices of Iron Ore. China and India were expanding more prominently and both

account for nearly 45 percent of the world’s steel output in 2006. China crude steel production

rose by 20 percent from 349.4mt in 2005 to reach 418.8mt in 2006 while total steel production

capacity reached 462mt which was 10 percent more than production. Total investment in the

iron and steel sector increased by 17 percent from nearly $28.2bn in 2005 to $33bn in 2006. The

growth helped China’s iron and steel sector to achieve profit of $22bn in 2006, an increase of

24 percent over 2005. The Asia region-including China-accounted for 53.8 percent of the world

crude steel production in 2006 compared to one-third in 1990.

Chart 2: World Crude Steel Consumption

Source: www.iisi.org

On the demand side, global steel consumption has increased by nearly 10 percent from 998mt

in 2005 to 1.1bnt in 2006 and IISI6 predicts that global demand would be 5.8 percent higher in

2007 after growing at annual rate of 5.7 percent during 2000-05. China was the driving force

behind that growth in demand followed by Asia Pacific then South America and Eastern Europe.

16

China’s steel consumption has reached 398.1mt in 2006 accounting for 36 percent of global steel

consumption compared to 13.5 percent in 1995. Domestic consumption rose by around 20 percent

a year during 2000-5 compared to a 1.6 percent during 1990s. However, steel consumption per

person in China and India, which is 250kg and 35kg respectively, is relatively low compared to

600kg in Singapore, and 399kg in the EU and the US.

To curb the imbalance between supply and demand, Asian countries have taken steps to cut

their production of steel. In China, some7 propose that domestic steel makers need to cut their

production by 5 percent to avoid falling prices and the consequent widespread losses that many

companies would incur. The government intends to consolidate the domestic steel industry

around six large steel makers producing higher value-added products. These companies would

be encouraged to restructure or even take over small-scale producers that tend to have outdated

equipments, poor infrastructure, and higher operating costs. The motive is to screen initially

the 66 biggest iron and steel producers out of nearly more than 800 steel enterprises. These big

companies have earned combined profits of $13bn in 2006 compared to $9.5bn in 2005 with

annual increase of 36.8 percent while the steel sector’s total profits have increased from $15.7bn

in 2005 to $22bn in 2006. However, the proposed 5 percent output reduction is likely to cause

bankruptcy among the small-sized steel makers, of which 14 have already reported losses. Also

market share of China’s ten biggest steel makers fell slightly from 34 percent of 349mt in 2005

to 33 percent of 418.8mt in 2006 though their combined production increased from 117.5mt in

2005 to 138.4mt in 2006. This indicates that the consolidation is becoming more urgent.

The government may exert strict control on new project approvals and stop any major capacity

expansion as well. To help rationalize the supply side, the Chinese regulators have devised a

7 The Chinese Association for Iron and steel.

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8 www.seaisi.org, South and East Asia Iron and Steel Institute, February 2007.

five-year plan to ease the current excess and slow the demand for iron ore. By 2007, the plan

will reduce 55mt of steel making capacity focusing on outdated blast furnaces producing pig

iron. By 2010, the plan is expected to shift production capacity of nearly 100mt of iron ore, pig

iron, and raw cast iron to producing crude steel. Also the plan emphasizes improving technology,

capital investment and environment protection measures. This move encouraged more product

differentiation and highlighted the need to replace the abundant lower value-added products in

the Chinese market by higher value-added products, which are in short supply in view of the

growing demand for such products. These products include cold-rolled steel plates, cold-rolled

silicon steel sheets, zinc-plated steel plates and steel pipes used in automobiles and appliances.

The plan to cut steel production may signal downward pressure on surging international iron ore

prices as China’s demand for iron ore slows. China became a net steel exporter of 30.4mt by

the end of 2006, and this excess supply of steel from China in global markets is likely to affect

steel prices. However, the magnitude of price fall will depend on how far steel producers are

responsive to the production cut plan. In 2006, China exported 40mt of finished steel products

and over 9.2mt of semi-finished products. Its import of both finished and semi-finished products

were 17.5mt and 1.3mt respectively. China’s steel exports are likely to fall by 10mt or more than

20 percent in 2007 as a result of government policies and a growing trend towards protectionism,

according to China Iron & Steel Association (CISA) officials8.

4.2 Implications for Global Steel Prices

Cost pressures on the steel sector would persist as iron ore contract prices, normally less than the

spot price, have increased markedly by 71.5 percent in 2005, which helped mining groups enjoy

18

extraordinary profits. As a result, much of these profits have been assigned for investment in

expanding old mines and developing new ones. If prices continue to increase, the Chinese steel

companies will suffer losses and would have to cut iron ore procurement. However, increasing

supply of iron ore from traditional suppliers such as India, Australia, Brazil, and also the Ukraine

may offset this upward trend in prices. Indeed, when the global market cycle slows, there is a

possibility of a glut.

China’s iron ore imports have increased by 18.7 percent from 275mt in 2005 to 326.3mt in 2006.

While China accounted for 40 percent of 687.5mt worth of global iron ore trade volume in 2005,

it is expected to account for 51 percent of 895mt worth of global iron ore trade volume by 2010

according to Iron and Steel Statistics Bureau9.

Steel supply has been reduced recently in the US and the EU by 5.8 and 3.6 respectively. This

reduction, however, is likely to be offset by higher supply from China, especially to markets

such as NAFTA and the EU. In 2006, the US was the top steel importer with 40.4mt, followed by

EU25 with 38mt. China was the top steel exporter with 49.2mt, followed by Japan with 34.2 mt,

and Russia with 31mt. After declining in 2005, global steel prices recovered during the first half

of 2006, although they remained soft in China and are likely to remain so unless China succeeds

in its effort to consolidate supply in its domestic steel market through tight fiscal measures and

the elimination of export rebates. Government spending is crucial because export rebates and

subsidies, in China and the OECD, are distorting the market for steel prices.

9 www.issbb.co.uk, March 2007.

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Chart 3: Steel Price Forecast

(USS/Ton)

Source: www.eiu.com

In the EU and the US, average prices were falling because lower prices of imports from Asian

markets were inducing relative prices of steel to level off. The escalation in costs of raw materials

and in steel prices in 2004 led to a surge in inventory building in early 2005 in the EU and the

US to hedge against future price increases. But the supply of steel, mainly hot rolled sheets,

has increased markedly from China during 2005 and 2006 and prices have declined afterwards.

Such prices are likely to move upward as demand increases and supply is rationed. However for

cold rolled, supply remained tight as it fell short of demand during 2002 - 2006.

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Chart 4: Iron Ore Contract Prices(US$ Cents/dry metric ton unit)

Source: CVRD, Wall Street Journal, US Steel and other steel producers.

Chart 5 : Flat-Rolled Products Transaction Prices

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Source: Peter Morici “Manufacturing and Steel Prices” paper presented at the National Press Club, Washington, D.C. on 15 February 2005.

The chart shows that steel and iron ore prices in dollars per ton, have been very volatile, especially

in 2004. Price volatility in general has been common in the world market but global steel prices,

in particular, have risen at a greater magnitude. In particular, the higher costs of health care and

21

pension obligations in the US have constituted cost-push factors in the price increase. In the

most recent edition of The Economist Intelligence Unit, Global Outlook (May 2007), the EIU

forecasts steel prices as follows (US$ per ton):

2007: $574, 2008: $435, 2009: $425, 2010: $500 and 2011: $515.

5. The Current Stance

5.1 Industry Structure

Global steel industry is fragmented and only 20-25 percent of global steel production is

concentrated in a few large steel companies. For example, in the EU a few large firms have

a combined market share of 75 percent whereas the remaining 25 percent of market share is

scattered across many small producers. World regions, however, differ with respect to their

degree of fragmentation.

The steel industry is undergoing a period of structural change, through mergers and acquisitions,

to consolidate mining and steel assets into a small number of holding companies. The incentive

came as big steel companies managed to sustain good profits and enjoy relatively healthier balance

sheets boosted by higher steel prices in the last few years. Other drivers of global consolidation

include: easier access to international capital markets and the reduction in barriers that existed

on cross-border transactions.

22

Chart 6: Biggest Steel Producers in 2004 vs. 2006

Source: www.worldsteel.org.

A recent example of global consolidation is the acquisition of Arcelor by Mittal for $32.2bn

which aims at increasing market share of the merged entity across continents by achieving

economies of scale. The merger of Mittal Steel of India, the biggest with total production of

more than 60mt, and Arcelor of Europe, the second biggest company with total production close

to 50mt, accelerated the move towards global consolidation that began earlier. Mittal took over

International Steel Group (ISG) of the US in 2004 and has taken control of Krivorozstahl of

Ukraine. In Europe, the merger of Arbed, Acerelia, and Usinor formed Arcelor, which later

boosted its Latin American interests by acquiring Dofasco as well. Mittal has shown interest

in buying minority stakes in Chinese companies and recently bought 37 percent of a steel pipe

maker in China. Nippon Steel and Posco, Asia’s two biggest steel makers, agreed on a five-year

tie-up in 2000, which was extended in 2005. Tata, an Indian steel company, has recently acquired

the UK’s Corus Group for $12.2bn to create the world’s sixth largest steel producer10. US Steel,

the largest integrated steel producer in the US, initiated talks in 2006 to acquire AK Steel,

the third largest US based steel maker. The merger would create a steel producer with global

production capacity approaching 30mtpy, placing it among the top ten largest in the world. In

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23

May 2007, Arcelor Mittal showed interest in the AK Steel company and may offer about $4.5bn

for the company according to the Financial Times website11. However, such overseas possible

acquisition would be subject to US regulatory review and there is a tendency for US authorities

to resist foreign takeovers, especially in sensitive sectors.

The above chart12 shows that the biggest producers are located in Asian countries, mainly India,

China, Japan, and Korea. Their combined production of 287mt accounted for nearly 23 percent

of global steel production in 2006. The world’s five biggest steel makers produced 19 percent of

global output in 2006 up from 14 percent in 2000. Mittal-Arcelor is the biggest steel producer

in the world with more than 100mtpy as well as global operations with subsidiaries and plants

across four continents. However, the expansion of the Chinese market continued to be a major

driving force behind the steel business, as the number of Chinese companies listed in the top

fifty-five steel companies worldwide has reached fifteen. The top fifteen steel producers in the

world have a combined production of 435mt of crude steel, accounting for 35 percent of world

steel production in 2006, which stood at nearly 1.24bnt. The biggest 7 crude steel producers have

combined total sales of $186.4bn out of nearly $500bn that the global sector generated in 2005.

These companies benefit from relatively cheap labor and are located in growing steel markets as

well as close to mines of raw materials. Recent steel merger activities are driven mainly by the

desire of steel companies to strengthen their negotiating power with suppliers of raw materials

( i.e., iron ore) Mittal, for example, has large capital stock in areas where iron ore mines exist

in Australia, Brazil, Ukraine, and Russia. It has purchased mines worldwide that have so far

satisfied 82 percent of its iron needs. The company intends to be self sufficient in iron by

creating its own mining in Liberia, Bosnia, Mexico, and Kazakhstan, or through acquisition of

11 www.bloomberg.com.12 The Economist, February 4, 2006.

24

Ukrainian mines. Its mines in Liberia will produce 10mtpy, while mines in Bosnia, Mexico, and

Kazakhstan will produce each 2.5mtpy by 2007. Mittal also acquired mines in Ukraine with

capacity to produce 11mtpy by 2009.

The merger between Mittal and Arcelor does not represent a threat to market competition since

Mittal-Arcelor has aggregate steel production of around 100mtpy, representing 10 percent

market share. However, one would expect that 10-20mt producers are likely to be the marginal

producers to disappear as a result of market consolidation. The attempt of Canadian subsidiary

of Mittal Steel Company to acquire Canadian Stelco was an attempt to penetrate the NAFTA

market in late 2005. Russia’s biggest steel maker, Evraz agreed to buy Oregon Steel Mills, a US

company, for $2.3bn in order to boost its crude steel processing capabilities in North America

and Europe for making higher value products such as rail tracks and oil pipes13. Major Chinese

steel makers Shougang Group and Tangshan Iron& Steel have agreed to coordinate their raw

material purchases and steel sales, in what could be another step towards an eventual merger

that would create one of world’s largest producers. Mittal and Posco are each planning to build

multi-billion dollar steel plants in eastern India. Also a Russian steel company is considering

an Indian partner to build a 10 mty steel plant in the Indian state of Orissa to capitalize on the

potential availability of iron ore. All these examples reinforce the trend towards consolidation

in the steel business.

5.2 Industry Challenges

There are many factors that affect the current outlook for global steel growth and prices. These

factors can be either exogenous or endogenous, depending on whether one can control them or

13 www.bloomberg.com, November 20, 2006.

25

not. For example, tax differentials and trade barriers as exogenous factors have contributed to

the rising costs of the global steel industry and caused reduction in competitiveness. In the USA,

direct taxes are placed on capital and labor whereas in Europe indirect taxes such as VAT are

common. According to the WTO rules, the rebate of direct taxes on exports are not permitted,

whereas the same rules do permit rebate of indirect taxes on consumption. This means that the

U.S. steel companies would be worse off compared to their counterparts in Europe. Russia and

Ukraine impose tax on their Ferrous Scrap while India and USA follow Anti-Dumping measures

in an attempt to combat the huge increase in their steel imports. China maintains tax rebates on

certain products as part of its policy for export quotas. Overvalued dollar exchange rates in 2005

coupled with higher costs of health care have helped to reduce the competitiveness of the US

steel industry. Endogenous factors such as firm size, product differentiation and innovation also

represent challenges to the steel industry.

Maintaining an undervalued currency of major steel exporters such as China, Brazil, South Korea,

and Japan vs. US Dollar have promoted their exports and forced US producers to cut production.

In January 1993, China devalued the Yuan from 5.7 to 8.7 per dollar and kept the Yuan pegged

at nearly 8.3 per dollar until it revalued the Yuan again in July 2005 by only 2 percent. The effect

on the Chinese economy of the earlier devaluation of the Yuan resulted in encouraging FDI and

boosted investments in China. Whereas the minor 2 percent revaluation of the Yuan in 2005 has

done nothing to cool the investment boom or reduce FDI inflows.

The Entry / Exit Barriers are crucial since major steel markets such as the US and the EU usually

impose import tariffs and quotas as barriers to their markets, especially when they view the Yuan

as drastically undervalued against the dollar and the Euro. Moreover, they have the tendency to

resist foreign acquisition of domestic firms. On the otherhand, countries like Australia, Brazil,

26

and Ukraine have enjoyed easier regulation, abundant raw materials, and cheaper cost of labor,

therefore, US and EU steel companies have acquired factories and invested in these countries.

This helps in providing US and EU companies with raw materials from the ore and mining

interests they own outside their boundaries.

6. Cost Structure Analysis

Cost structure is relevant when it can be identified with different types of costs a given steel

company is likely to incur. These costs include raw material, energy, transportations, operating

costs, transaction costs, and social costs implied by the cost of negative externalities14. The

analysis should include exchange rate variability and terms of trade since steel is a tradable

commodity and the industry is cyclical. The extent to which natural resources, like gas and oil

are abundant and the seasonality of its use are relevant in analyzing the cost structure as well.

For example prices of natural gas in cold climate countries tend to be higher in winter than in

summer as the increase in demand for heating purposes reduces the amount available for the

metal industry. Seeking alternative fuel supplies such as coal, diesel, or oil and the environmental

concerns inherent in the use of these other sources of energy also matter.

The global steel industry has a relatively homogeneous cost structure across steel companies i.e.,

each company faces declining marginal costs and rising fixed costs. Also, the highest portion of

a given steel company’s cost structure is raw material costs, followed by energy, transportation,

then labor costs. The industry enjoys relatively free entry (no real entry barriers), but higher

cost of exit. The free entry condition is likely to make profit margins thinner due to the high

probability of new entrants. In the late 1980s, some of the US steel companies were forced to

14 Negative externalities imply costs that are imposed by society and its laws and regulations (e.g., imposed health, insurance and environmental costs, social pensions, national security,…etc.).

27

exit through liquidation of assets after suffering severe financial problems. The demand curve

for steel is relatively flat i.e., no single firm can dictate market prices, for example, by reducing

production to raise prices. As global demand showed signs of weakness during that period

(1980s), the industry cut output yet prices were not very responsive and continued sliding. The

world crude steel production has been growing at nearly 7 percent annually since 2002, and as

a result, the world iron ore trade excluding the spot market sale has grown by 9.1 percent from

550mt in 2004 to 600mt in 2005 and is expected to reach 895mt by 2010, with a growth of 49.2

percent for the period.

The spot market price of iron ore is higher with a premium of nearly $20 over the contract price

which is negotiated annually. Benchmark iron ore prices increased by 19.1 percent in 2006 and

is predicted to grow moderately by 9.5 percent in 2007 to reach 83.4 US Cents/dry metric ton

unit. These modest rises, after the marked jump of 71.6 percent in 2005, were due to falling

freight rates, high spot market prices, and the appreciation of domestic currencies against the

US dollar. A weaker dollar tends to raise costs in dollar terms and improves US exports but

is likely to push up the cost of importing iron ore denominated in dollars. The historic rise in

2005 was justified by strong demand from China while iron ore supply remained tight. This rise

may have acted to encourage companies to increase efficiency and labor productivity as well

as to increase incentives among steel producers to acquire mining companies to control input

costs. An example was a bid by Mittal Steel and Tata Group for South African based company

(Highveld) that has huge reserves of iron ore. Highveld mines its own ore and uses electricity

rather than costly coking coal to process the iron ore and also makes hot metal in Electric Arc

Furnace (EAF) rather than Blast Furnace.

28

In Russia, the biggest iron ore producer, with 45 percent market share, produces 39mt of iron

ore and 6.3mt of crude steel. There is a growing tendency for steel companies to look for other

possible substitutes and trade iron ore for billets, slabs and pig iron. Also, there is an incentive

for companies to use conversion contracts of iron ore to pig iron and negotiate contract prices

as a way to handle rising input costs. Soaring demand from China in 2005 prompted miners

and energy producers such as BHP Billiton to spend $29.4bn expanding and building mines. On

June 20, 2006, China’s biggest buyer of iron ore, Baosteel Group, agreed to a 19 percent price

increase for iron ore following extended negotiations with the world’s three biggest mining

companies, BHP Billiton, Rio Tinto and CVRD. As a consequence, share prices of both BHP

Billiton and Rio Tinto gained 3.1 and 2.5 percent respectively following the agreement on June

21, 200615. On December 22, 2006, Baosteel agreed to another 9.5 percent price increase for iron

ore following negotiations with CVRD, the largest iron ore producer in the world which controls

nearly two thirds of the global iron ore trade.

Consolidation and privatization of government owned companies are likely to make the industry

less inclined to be oversupplied with low value-added products to maintain output quotas. This

will reduce steel price volatility and increase long-term profitability. Product differentiation

towards higher value-added products will improve a company’s ability to survive. Steel makers

outside Asia, where many plants are hindered by relatively high fixed costs as well as labor

charges, are becoming more optimistic about their chances of survival. The reason is a partial shift

towards higher value-added products, and in this respect, Mittal priced Arcelor’s steel mills in

France, Spain, and Belgium for their technological sophistication, which explains the high price

offered by Mittal to acquire Arcelor. One may also surmize that chances for niche producers in

the GCC region, specializing in high value added products (e.g., USCO), are better if they focus

15 www.xinhua.com, June 21, 2006.

29

16 www.bloomberg.com.17 ROE: return on average equity.

on meeting regional demand for such products, utilizing their competitive advantage in lower

shipping costs, lower energy costs and relatively lower labor costs.

In this regard, the US steel industry has a positive outlook implied by a price earnings ratio of

7.0 which is below market valuations of around 15 for the S&P 500 index. As their shares have

gained momentum, US steel companies have initiated talks about the prospect for merger and

acquisition as seen in the US Steel Corp talks to buy AK Steel Corporation. While S&P 500 has

gained 6 percent for the year till May 2007, a comparable index of steel producers has increased

by 39.1 percent during the same period16. Stock yields of Nucor and the US Steel Corp have

increased, on annualized basis, by 21.1 and 52 percent respectively for YTD till May 16, 2007.

This came as a result of higher prices and rising demand in non-residential construction which

in turn enabled both companies to reach a record ROE17 of 38.6 and 36.6 percent respectively.

In the long run, the industry is expected to benefit from synergy effects stemming from further

consolidation, a lower cost structure, and a continuation of the decline in the US Dollar.

The above analysis of the cost structure of the steel industry shows that the highest portions of

a given steel company’s cost structure are raw material costs, energy costs, and transportation

costs. The steel industry has a positive fundamental outlook, which indicates an upward trend

in share prices. Selling prices for metals have more than doubled since 2002 and share prices

in the sector have nearly quadrupled over the same period. Yet raw material and energy costs

have continued to rise for steel producers worldwide. The three biggest mining companies have

greater negotiating power over the price of their iron ore. This along with higher energy and

transportation costs, has led to the squeezing of profit margins for steel companies. A shift in

30

global demand would impact steel prices given the cyclical nature of the industry. In countries

that have pegged exchange rate regimes to the US dollar, such as the GCC countries, where

interest and exchange rates are tied to the US rates, prices of tradable goods would import global

disturbances to domestic markets.

7. Regional Steel Market Analysis in the Middle East (ME)18

7.1 Supply and Demand

Crude steel production in the Middle East is projected to increase markedly by nearly 70 percent

from 15.4mt in 2006 to 26.1mt in 2010. Metal Bulletin Research (MBR), December 2006 issue,

states that capacity expansion will reside mainly in Egypt, Saudi Arabia, and UAE. Egypt will

have added capacity expansion of nearly 2mt, Saudi Arabia 5mt, and UAE 1.5mt by 2010. Also,

finished steel products capacity will increase by 46.7 percent from 22.9mt in 2006 to 33.6mt

in 2010. Main capacity increases include UAE by 3.1mt, Egypt by 2.5mt and Saudi Arabia by

1.9mt. For raw steel production, MBR argues that it is expected to reach 51.5mt and 62.9mt in

2007 and 2010 respectively. However, the bulletin contends that such steel production was not

sufficient to satisfy the apparent steel demand growing at 9 percent in 2006 and a similar rate in

2007. This in turn has led the ME to become a net importer of semi-finished steel, mainly billet,

slab, and HR coils in which billet and slab are intermediate materials used to produce long and

flat products. The large increase in consumption of semis and flat products has been partly met

by imports, which have risen from 6.4mt in 1997 to around 25mt in 2005 and is expected to

reach 30mt in 2007.

18 Middle East refers to: Bahrain, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Oman, Palestinian Authority, Qatar, Saudi Arabia, Sudan, Syria, Turkey, UAE and Yemen. MENA refers to all the above in addition to: Algeria, Libya, Morrocco and Tunisia.

31

Demand in the region is dominated by long products, most of which are used in construction.

Long product output such as rebar will be the dominant form of steel production, although its

share of output will be declining. Rebar output grew from 14.1mt in 1997 to 21.6mt in 2004

and is expected to reach 28.9mt in 2010. Although the Middle East has been one of the world’s

active regions for steel plant suppliers in recent years, its steel plants are mostly starting from a

lower steel-making base especially in flat products. Total flat products production has increased

from 9.9mt in 1997 to 18 mt in 2004 driven mainly by Turkey and Iran and to a lesser extent

Saudi Arabia and Egypt. In the Middle East, most current investments are driven by growth in

domestic demand emanating from a strong construction boom. Steel demand in the region is

expected to increase from 70mt in 2007 to around 90mt in 2010. GCC steel demand will be in

the range of 20-30 mt during the same period.

GCC countries especially Kuwait, UAE, Saudi Arabia and to a lesser extent Oman and Bahrain

are net importers of products such as ingots and semis, steel tubes, seamless, hot rolled rod in

coil, cold drawn wire in coil, welded tubes, and cast iron pipes. However, net imports are likely

to fall back to 5.4mt by 2010 with the expected increase in domestic production.

In flat products, Egypt will remain a net exporter while the net import requirements of Saudi

Arabia will remain around 1mt. However, the growing consumption from the UAE, Iraq, and

other smaller states in ME will cause overall imports to rise. In billet, the higher demand in the

UAE, Syria and, Sudan will offset falling demand from Saudi Arabia.

Most production in the region is from Direct Reduction Iron (DRI) which forms an important

component of ME expansion, utilizing natural gas which is plentiful. Production of DRI had

32

increased from 8.3mt in 1997 to 13.7mt in 2004 and is likely to reach 28.6mt in 2010, boosted by

major projects in Saudi Arabia, Iran, Qatar, Oman, Bahrain and the UAE. However, the increase

in DRI will require importing more pellets, scrap, and iron ore for direct reduction plants.

Table (2): Consumption of Iron ores, Pellets, and Scrap in the production of DRI in the

Middle East (1995-2005) in million tons

1995 2000 2005Iron Ores 4.3 4.2 7.7Pellets 8.0 9.6 14.7Scrap 0.54 1.0 4.25

Iron ore oxide pellets are reduced via a hydrocarbon gas, usually methane, to produce DRI which

then may be converted into steel using an Electric Arc Furnace (EAF)19. Pure DRI is the feed for

around 60 percent of steel produced in MENA, with around 25 percent from scrap and 15 percent

from blast furnace production. DRI output was estimated at around 10mt in 2006, according to

HSBC report, and is expected to increase to 19.3mt by 2010 which will require more imports of

both iron ore and scrap in the region.

Arab Countries have DRI / EAF plants with total capacity of 8.75mt. Qatar and Saudi Arabia

have started their production in 1978 and 1983 respectively with production capacity at 0.72mt

and 3.65mt each, then Egypt with 2.92mt in 1986 and Libya with 1.46mt in 1990. Middle East

iron ore imports have increased from 14.6mt in 1997 to 22.2mt in 2004 and are expected to

reach 42.5mt by 2010, even with Iran planning to double its own iron ore production capacity

to 25mtpy by 2010. Outside Iran, iron ore is only mined in Turkey and Egypt, and total output

is 18.6mt. ME iron ore, however, is a low grade iron ore relative to Australian or Brazilian ore.

The UAE, Saudi Arabia, Oman, Qatar, and Egypt take most of their imports in the form of pellet.

Such imports reached 13mt in 2004 and are likely to reach 25mt in 2010. Bahrain imports iron

19 HSBC report on SABIC, April 2007.

33

20 www.oxfordbusinessgroup.com, March 2007.

ore fines as an input for the pellet plant, which are then re-exported. Pellet in Bahrain is produced

by Gulf Industrial Investment Co. (GIIC) which is a subsidiary of Gulf Investment Corporation

(GIC). Other countries that produce iron ore since 1979 include Mauritania, Algeria, and to a

lesser extent Saudi Arabia which started producing in 1997 with 2.9mt capacity.

Scrap generation in the ME is relatively low and stood at around 5mtpy over 1997-2000, but has

since increased to 8mtpy due to rising steel prices, production, and consumption over the 2001-

04 period. Scrap consumption in the ME was less than 12mtpy until 2000, excluding Turkey, and

the region was a net exporter until 2004. Volumes of exports from Iraq, Israel, Kuwait, Lebanon,

Sudan, Syria, the UAE and Yemen offset imports into Egypt, Jordan, and Qatar. As new capacity

materializes, the region, excluding Turkey, will become a net importer of over 1mtpy due to

rising demand from Egypt, Iran, and Saudi Arabia. Turkey is the biggest single importer of scrap

in the world.

The region is likely to become a net exporter of Hot Briquetted Iron (HBI) and Libya has been

a regular supplier of HBI to Spain and Italy. Meanwhile Qasco in Qatar is a regular buyer of

Venezuelan HBI to maintain its steel production but soon will become a net exporter once its

new 1.5mtpy DRI plant starts operating in 2007. In Oman, Al-Ghaith plant of Hamil Steel

which is due to start in 2007 will also be a small net exporter of HBI. The Sohar Industrial Port

(SIP) Company, based in Oman, has signed a MoU with CVRD in November 2006, to conduct a

feasibility study into setting up an iron ore pelletising plant worth $1bn20. The proposal involves

constructing a facility with an initial capacity to produce 7.5mt of pellets for DR annually with

the potential to expand output to 22mt if the project is implemented. Production is supposed to

34

21 MBM, December 2005, www.metalbulletin.com. 22 MEED, Vol. 51 No. 10 , 9-15 March 2007.

start in 2010. Shadeed Iron and Steel of Oman has also announced, in February 2007, a $4bn

joint venture project with India’s Jindal Saw Int’l, to produce up to 1mt of seamless tubing. The

plant is being constructed in Sohar Industrial Port and is to start production in the second half

of 2008.

7.2 Key Regional Countries

Iran, Turkey, Saudi Arabia, and Egypt are the major steel producers in the region. Iran and

Turkey are the key drivers followed by Egypt and Saudi Arabia. During 1999-2004, Iran, the

region’s biggest steel producer and consumer, was a significant net importer of billet and flat

products. But from 2005 onwards, it became a supplier of long products, followed by slab, and

its net import requirements for billet and flat-rolled products are diminishing. This is due to the

fact that its crude steel output is expected to rise from the current 7.3mt to 14.7mt in the next

3 years. Investments in Iran’s steel sector are increasing markedly and as a result, raw steel

production is expected21 to rise, on average, from 10mt in 2005 to 18.5mt in 2010, at a growth

rate of 13 percent annually. Nisco, the government steel company is planning to add 5.6mntpy

of new capacity through building seven new plants each with a capacity of 800,000ty. This new

capacity will be in steel mills, melt shops, billet and slab casting22.

In Turkey, billet exports are likely to decline when Isdemir shift from long to flat-rolled production.

The company’s net addition to HR coil supply along with other CR capacity will significantly

reduce Turkish net flat-rolled import requirements. Arcelor-Mittal will acquire 20 percent stake

35

23 Erdemir has acquired another Turkish steel company (Isdemir) in 2002. Turkey’s military pension fund (OYAK) had purchased 49.29% of Erdemir shares on February 27, 2007. Thus Arcelor-Mittal and OYAK both own an overwhelming majority in Erdemir, the largest Turkish steel company.

in Erdemir23, to develop its position in the growing Turkish and regional steel markets. This

will increase the company’s influence in Eastern Europe and the Middle East and provide a

base for exports to East Asia. However, steel production in Turkey is vulnerable to cold weather

that hinders shipping lanes between the Black Sea and the Mediterranean during some winter

months.

Egypt will remain a net exporter of flat products while Saudi Arabia’s net imports are likely

to fall as the Saudi Iron and Steel Company (Hadeed), allocates 5mtpy of its planned 17mtpy

expansion in its steel making operations to flat product output by 2020. The main players in the

steel business in ME are Hadeed Company in Saudi Arabia, Qasco in Qatar, NISCO in Iran,

Erdemir (through Isdemir) in Turkey, and Al Ezz Steel in Egypt.

8. Prospects for GCC Countries

Currently GCC countries are negotiating to sign possible Free Trade Agreements (FTA) with

China and India. Such agreements are likely to have a great impact by inducing more imports

of finished steel products to the GCC market, mainly from China; hence the ability of the GCC

countries to provide duty protection would not be possible following the signing of free trade

agreements. However, the introduction of a tariff incentive on imports of semi-finished products

such as billet then rolling it in the GCC region may appear to be profitable compared to importing

finished products. In July 2006, GCC government officials have concluded the third round of

negotiations with China while the GCC, as a bloc, signed a bilateral framework agreement for

36

economic cooperation with India in August 2004 to initiate FTA negotiations.

The steel market is highly fragmented in the Middle East with 51 out of 62 producers having

production capacity of less than one million ton a year. In the GCC region, the market is even more

fragmented with 14 out of 15 companies having production capacity of less than one million ton

each. Saudi Iron & Steel Co. (Hadeed) is the only company that has production capacity of more

than one million ton. In 2005, the number of plants producing basic iron and steel reached 45

in the GCC region with total investment worth $2.8bn whereas the number of plants producing

metal products manufactured from iron and steel reached some 1,725 with total investment

worth $6.5bn24. Although iron and steel production is accelerating in the region, there exists an

imbalance between long and flat-rolled products. GCC countries, especially Saudi Arabia, are

planning to increase the production of flat-rolled products over the medium term. The overall

effect of these investments will be to reduce the region’s need for imports, especially semis and

flat products. For example, Hadeed by the end of 2007 will have 60 percent of its output in long

products while the remaining 40 percent in flat products. The import of iron and steel products in

the GCC region has doubled from around 7.1mt in 2001 to 14.3mt in 2005 as a result of surging

demand for basic iron and steel products. The demand is expected to increase from 15mt in 2005

to around 19.7mt in 2008 and this is encouraging domestic investments in the steel industry.

24 www.zawya.com, April 14, 2007

37

Chart 7: Steel long Products Capacities & Consumption in GCC Countries in 2004

0

1000

2000

3000

4000

5000

6000

Bahrain Kuwait KSA Oman Qatar UAE

Thousand Ton Capacity Production Consumption

Source: www.mesteel.com.

Chart 8: Major GCC Producers, Capacity in Thousand TPY (2004)

0

500

1000

1500

2000

2500

Hadeed Ittefaq QASCO CAPITAL Ymmamah Emirates U.Steel Sohar Wafoor Unirol & Yanbue I&S Factory

Source: www.mesteel.com.

Saudi Arabia is a pioneer in this respect with many steel investments done by the government

owned Hadeed with a total production capacity of 5mtpy by the end of 2006. Hadeed is planning

38

to increase production capacity to produce 10mtpy and 17mtpy by the end of 2010 and 2020

respectively. While the majority will be long products with facility to produce more than 3.2mt

per year, the company intends to allocate around 5mtpy to flat products output. It is also building

the world’s largest DRI plant, a 1.76mtpy Midrex unit, which is expected to start in 2007. This

project will increase the company’s flat-steel products from 0.8mtpy to 2mtpy; moreover, the

company is expanding its hot bar rolling mill capacity, slab and coil yard as well as setting a new

plant for the production of steel reinforcing bars and wire rods jointly with the Italian plant maker

Danieli. In the GCC region, demand for DR iron ore pellets is expected to increase from 5mt

in 2006 to 24mt in 2012. This encouraged Hadeed to acquire 14.8 percent of Australia’s Sphere

Investment, while Qasco (in Qatar) acquired 9 percent in the same company. The Australian

company is developing the Guelb el Aouj DR iron ore pellet project in Mauritania where it owns

a 50 percent stake. The project is expected to produce 7mtpy of DR pellet for 30 years, when its

operations start around 2010, utilizing the high quality Guelb el Aouj magnetite deposit25.

MBR indicates that Al Tuwairqi Group is planning to be a 5mtpy producer by 2010 and has

recently acquired a meltshop in the UK to ensure regular supply of different grades of billet to its

plant, increasing production capacity to 1mt a year. It also has plans to relocate a former Corus

DRI plant and plans to set up a $100m steel billet plant in Pakistan to produce 1mt of steel billet

a year. Zamil Steel Company has a joint venture with Japan’s Mitsu Co. worth $8mn to operate

in Vietnam. Other companies, such as Yammamah and Yanbue and Unirol of Bahrain have not

yet utilized their long products capacities. Saudi Arabia’s sales of long and flat products have

been for both the domestic market and for export. Qasco, of Qatar, is building a 1.5mtpy DRI

plant which is expected to start in 2007. Hamil Iron & Steel (or Shadeed), of Oman, has ordered

a 1.5mtpy DRI plant and associated billet-producing mill.

25 www.mineweb.co.za, March 2007.

39

In the UAE, the General Holding Co., signed an MOU in January 2006 with Danieli for the

construction of its phase one expansion, which will include a 1.6mtpy DRI plant, a 1.4mtpy billet

line, a 1.2mtpy bar rolling, meltshop and wire rod mill. This MOU reflects the desire of Abu

Dhabi authorities to move towards flat products as part of a second phase of increasing product

mix at its Emirates Iron and Steel Factory (EISF). This transforms EISF from a 600,000tpy

rebar producer into the biggest integrated steelworks in the UAE. Total production is expected

to be around 2mt of rebar or wire rod, therefore exceeding the 1.8mtpy original design capacity.

This expansion aims at meeting the increasing demand for steel products in the UAE and other

GCC states. The second phase of the expansion will double production capacities of DRI plants,

billet line, and long product lines to reach 4mt. In the long run, this steel expansion in the UAE

helps in diversifying the economy and would support other industrial sectors, including offshore

platforms, welded steel pipes and automotive components. EISF is considered for privatization

by the government as well26.

In Bahrain, a 90,000 tpy CR stainless steel mill in the Hidd industrial area is underway by GIC,

which initiated the project and holds 30 percent of the equity in Bahrain’s United Stainless

Steel Co. (USCO). The company will be the first stainless steel production facility in the Gulf

region with production target of 90,000 tpy of stainless steel in sheets, narrow strips and coils.

GIC intends to build a 6mntpy iron ore pellets plant in Bahrain adjacent to its existing 4mntpy

palletizing plant. The new company, Foulath, with an investment cost of $350-400m is due

to start production in 2008. There are new factories and expansion plans under way in the

GCC Countries for various CR products. These include: Alghourir in Dubai, Saudi Industrial

Development Company (SIDC) in addition to the existing ones of Hadeed and Unicoil.

26 www.metalbulletin.com, this draws on information contained in pages 18-24 of the December 2005 issue.

40

Middle East steel consumption has grown by 31.1 percent from 34.7mt in 2005 to 45.5mt in

2006 and is expected to reach 73.3mt by 2010. GCC countries are considered among the largest

consumers of iron and steel products with per capita consumption estimated at 378kg while

world per capita consumption is barely 182kg.

Chart 9: Average Annual Growth Rates of Finished Steel Consumption

-10

-5

0

5

10

15

20

Bahrain Kuwait Oman Qatar KSA UAE

%1997-2004 2004-2010

Source: www.metalbulletin.com, December 2005.

Total per capita consumption of finished steel in the ME in 2004 was 146k. For Arab countries,

the UAE has the highest per capita consumption with 801kg while Sudan the lowest with just

12kg per capita. This reflects the wide divergence among economies within the region. It is

expected that by 2010, the population of the ME will grow to an estimated 412m, and per

capita consumption will rise to 182kg. Per capita consumption of crude steel (378kg) for GCC

countries, on average, is relatively high compared to other regions such as Asia (138kg), CIS

(123) and the global average but lower than Europe (399kg).

41

Chart 10: GCC Average Per Capita Steel Consumption, kg

0

50

100

150

200

250

300

350

400

1980 1985 1990 1995 2000 2005

Source: www.mesteel.com.

Source: www.mesteel.com.

Chart 11: GCC Steel Consumption, t/yr

0

2

4

6

8

10

12

1980 1985 1990 1995 2000 2005

42

9. The Steel Industry: Key Concerns

1. The Steel industry remains highly fragmented at the global and regional levels where the

ten largest steel companies account for nearly 30 percent of total steel production. The

trend, however, is towards consolidation and integration: in China, the top ten are expected

to produce nearly half of China’s steel by 2010 and two-thirds by 2020. The number of

steel companies in China that has production capacity of more than 1mtpy is only eight

at the present. The Chinese government is trying to consolidate steel production in fewer

companies for efficiency and better resource allocation.

2. Steel companies are likely to face oligopoly situation in the market for raw materials,

such as iron ore, scrap, and coking coal, where sellers are few. This oligopoly forced steel

companies to accept annual increases in their contract prices with raw material suppliers.

Also freight costs are high due to the nature of steel as heavy weight commodity as well as

size compared to other commodities. The increase in fuel prices is contributing to higher

transportation costs.

3. The exchange rate of the dollar is a concern and a weaker dollar implies higher cost of

imports in USD to the US, and countries with currencies linked to USD such as Asian and

GCC currencies.

4. Uncertainty regarding China’s rapid demand and supply growth. In 2006 production

exceeded demand by more that 6 percent. China, as a result, became a net exporter of

30.4mt which is equivalent to a steel trade surplus of $7.3bn. If the trend continues, China

will become a major exporter affecting domestic production in higher cost countries such

43

as Europe and even the GCC.

5. Government subsidies such as tax breaks, cash injection or export rebates to steel producers

in most BRICs27 give them the incentive to build excess capacity. This induces lower market

prices and cheap imports to market-based regions such as NAFTA and the GCC. This

trend has given rise to protectionist tendencies as manifested in the recent US Congress

moves regarding imposition of tariffs on Chinese imports. This same trend, also, will pose

a challenge to domestic steel producers in the GCC.

27 BRICs : Brazil, Russia, India and China.

44

Conclusions:

1. Global steel prices increased markedly in 2004, which turned the steel industry more

profitable despite related increases in raw materials, energy and transportation costs.

However, prices fell slightly in 2005 then recovered in 2006 and are likely to move upward

as demand surges and China rations its supply. Global production capacity is expected

to increase from 1240mtpy in 2006 to over 1307mtpy in 2007 according to World Steel

Outlook28. Global steel supply, mainly HR products, has increased markedly from China

whereas supply of CR remained tight and fell short of demand during 2002-2006. Hence,

prices of CR and long products are likely to increase more than those of HR products.

2. Steel is a cyclical business, which means that a fundamental shift in global demand and

supply resulting from the world economic cycle will have impact on prices. However,

greater consolidation is likely to reduce the implied cyclical volatility and this is the main

reason behind the recent acquisitions in the steel business (Examples are: Arcelor-Mittal,

Tata-Corus, and possibly the US steel with AK steel of the USA).

3. More focus on increasing the production of primary cast products such as slabs, blooms

and billets. Pellets as the raw material for the primary steel products is produced through

Direct Reduced Iron (DRI) and Electric Arc Furnace (EAF) processes. Pellets are crucial

to the growth of the GCC steel industry and the shortage in supply creates a limit on

how much the GCC steel industry can grow without having assured raw material supply

chains.

28 www.worldsteel.org, February 2007.

45

When looking ahead there are potential risks that face the GCC region. The first risk arises

from consolidation which will likely put pressure on small regional producers to survive as

independent producers. Consolidation would make such small producers less powerful with

respect to negotiating raw material contracts. Also, it makes them more vulnerable to demand

changes and volatilities. The second risk stems from huge capacity additions in China, which

induces attack on margins of domestic producers in regional markets by low cost Chinese

producers. Large capacity increases in the GCC region will also put preasure on local producers

when the cycle turns downward and demand slows. Finally, different products will have different

market parameters and as we mentioned earlier, niche regional producers of high value products

have good short to medium term prospects.

As we mentioned on page 11 of this study, the steel industry is subject to the globalization

trend that affects world trade, production and prices. The GCC region has some advantages in

the steel industry that will continue - in the short to medium term - to ameliorate the impact of

globalization on its steel industry. The profitability of the GCC producers, however, will depend

on their ability to be flexible, market-oriented and efficient. It also will depend on how long an

economic boom the region will enjoy in the coming years.

46

References

1. HSBC report on SABIC, April 2007.

2. www.mineweb.co.za, March 2007.

3. www.issbb.co.uk, March 2007.

4. www.seaisi.org, South and East Asia Iron and Steel Institute, February 2007.

5. CVRD, Wall Street Journal, US Steel and other steel producers, 2007.

6. MEED Vol. 51 No. 10 , 9-15 March 2007.

7. www.oxfordbusinessgroup.com, March 2007.

8. www.ft.com, March, April 2006.

9. Global Business News, www.webbolt.ecnext.com, 2006.

10. The Economist, different issues, 2006-2007.

11. Metal Bulletin, Different Issues, www.metalbulletin.com, 2005, 2006.

12. China’s steel consumption, www.chinadaily.com, 2006.

13. www.english.people.com, “Regulators to make cuts in Steel Industry”, January 2006.

14. Global outlook, www.eiu.com, The Economist Intelligence Unit, February 2006.

15. www.taipeitimes.com, 9 June, 2006.

16. www.xinhua.com, 21 June, 2006.

17. www.steelhome.com, Macqurie Research, October 2005.

18. International Iron and Steel Institute, www.iisi.com, 2005.

19. Middle East and Steel Statistics, www.mesteel.com.

20. www.reuter.com.

21. www.bloomberg.com.

22. www.zawya.com.

47

23. The Japan Iron and Steel Federation, www.jisf.or.jp.

24. Steel Manufacturers Association, Inc, Congressional Steel Caucus, March, November

2005, www.steelnet.org.

25. International Stainless Steel Forum, www.issf.org, May 2005.

26. Oxford Economic Forecasting, OECD, World Bank, IMF (several publications and

website material).

27. NAFTA Pulse, North American Steel Trade Committee, May 2005.

28. US Census Bureau, www.census.gov, January 2006.

29. Challenges for Steel in 2006, www.worldsteel.org.

30. World Steel Review, www.issb.org, 2005.

31. Peter Morici “Manufacturing and Steel Prices” paper presented by Professor Morici at

the National Press Club, Washington, D.C. on 15 February 2005.

32. www.integer-research.com.

Contact Details: Sharq, Jaber Al Mubarak Steet, KuwaitP.O. Box 3402, Safat 13035, Kuwait

Email: [email protected], Tel: +(965) 222-5000, Fax: +(965) 222-5010