OREN KAPLAN: Amsa is collapsing the SA steel industry with unsustainable prices

Trade adviser Donald MacKay in a recent article identifies the key challenge facing players in the steel industry (“Who actually gets government support in the steel sector?”, May 6). He asks,: “Is there a way for all of them to survive?” And answers quite simply, and correctly: “No.”  

He attempts to illustrate why this is the case by focusing on one product segment — wire rod. It is worth expanding on his chosen example to understand why he is right about the challenge, but fundamentally wrong about the cause. A short indulgence in the details of this submarket is instructive for the overall debate.

First, this debate has pitted ArcelorMittal SA (Amsa) against the “mini mills”, the scrap-consuming steelmakers. The mini-mill label should be refined into two further subcategories: mini mills and micro mills. Mini mills use electric arc furnaces to melt scrap and require an output of 400,000 tonnes or more per annum to be efficient. Micro mills use induction furnaces and require a smaller annual output of perhaps 100,000 tonnes per annum. Amsa’s blast furnaces require at least 1-million tonnes per annum to be efficient.

Notably, mini mills are capable of making a wide range of steel qualities, while micro mills are severely constrained by the nature of their process. For the purposes of the wire rod example, it is important to note that it is only the mini mills that make wire rod. This means when it comes to wire rod, Amsa competes only with producers Cape Gate and Scaw Metals. Amsa does not compete with the Industrial Development Corporation-sponsored micro mills in this area.

MacKay accurately notes Amsa’s pricing behaviour after its bailout. It has crashed prices, but only in the long product market. Its flat product prices remain untouched. But it is not true, as MacKay claims, that Amsa had no choice but to collapse pricing because of the mini mills’ “subsidised” cost structure.

Before Amsa’s price decrease domestic wire rod prices were trading appropriately above import parity pricing (about R12,000).

Currently, Scaw Metals is producing its wire rod from nonscrap sources and therefore its pricing ability has nothing to do with price preferential system (PPS)/scrap exports. So, before Amsa’s state bailout our market share was not being maintained by virtue of a distorted cost of scrap. We were competitive on an international basis.

The size of the entire wire rod market in SA is about 650,000 tonnes per annum. Cape Gate and the part-owners of Scaw Metals, the Barnes Group, have their own downstream wire rod-consuming businesses amounting to about 330,000 tonnes per annum, or a 50% market share. This market share has not been aided by government subsidies. Vertical integration has simply been a sound strategy.

Of the remaining 320,000 tonnes available in the SA “open market”, Amsa can perhaps succeed in capturing 200,000 tonnes per annum. This illustrates the real problem. Newcastle needs to roll at least 1-million tonnes of all long products (bars, rods and medium sections) to be viable, and wire rod is required to fill part of this capacity. At best it can contribute 20%.

This situation is also true for all other long product markets, such as bars and medium sections. There is about 465,000 tonnes of demand for bars. Assuming an even playing field, Amsa would be doing well to capture a third of that, or 140,000 tonnes a year, adding just 14% to its minimum required load.

Amsa simply has no home for its product. By shocking the market with two closure announcements it has lost even more credibility and its customers have in part turned to Cape Gate and Scaw Metals for security of supply. We have the capacity to fulfil that demand. 

The reason Amsa used government funds to lower wire rod prices is therefore not due to scrap regulations. It needed to buy back market. But there is no market to buy back. Instead, due to its bailout, the entire market has collapsed to unsustainable prices.

It is therefore true that reducing the PPS and the export tax poses an existential threat to scrap-consuming mills. That’s because by irrationally maintaining inefficient capacity, prices drop to unsustainably low levels. That’s why I have called government’s approach to capacity-saving a game of whack-a-mole. Saving Amsa’s capacity (imagined to require adjustments to PPS, scrap tax, and so on) simply puts other capacity at risk of closure.

The question is which capacity should go. There is simply insufficient demand in SA to justify Amsa’s 1-million tonne per annum Newcastle mill. There is no market for the amount of output they require to be efficient. For this reason — insufficient volumes to run a blast furnace at capacity — Amsa has the least efficient mill in the market.

This is, of course, not a cause for celebration, but rather a deeply unfortunate economic reality that has a regrettable effect on employment and the social fabric of certain towns. But the mini mills firmly believe that with correct decisions a vibrant and environmentally compliant steel industry can still thrive in SA.

• Kaplan chairs Cape Gate.