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Global steel 2011 trends 2012 outlook

Competing for growth in the steel sector

Contents
Executive summary A shift to emerging markets Steel sector challenges Growth in market volatility and margin pressure A lack of operational agility A need for business models to evolve How can steelmakers compete for growth? Customer reach Cost competitiveness Operational agility Stakeholder confidence Outlook for 2012 Appendix: Global steel market update 1 3 3 5 7 7 9 11 15 20 23 25 29

Executive summary
Global steel over-capacity becomes the biggest challenge
Despite demand growth witnessed during 2010 and 2011, growth in steelmaking capacity still exceeds steel demand. There is now significant over-capacity in the global steel sector which is putting pressure on operators profitability. This has been exacerbated by the European sovereign debt crisis which reduced confidence in the marketplace in the latter half of 2011 on global economic growth, putting a halt on investments into large-scale infrastructure projects in Europe, and reducing availability of capital for growth. The complexity of the issue is large as growth in steelmaking capacity is expected to continue at pace and political issues are preventing a rationalization of the sector because governments are under pressure to protect jobs and the sector. The timeframe for rationalization will be driven by the political agenda. With over-capacity being the most significant challenge in the sector today, there are further related challenges facing the sector. The Indian steel sector is striving to put on more capacity to capitalize on that growth. In China, however, there is already significant excess steelmaking capacity. Chinese crude steel capacity is expected to amount to 840 million tonnes in 2012, which would be 22% in excess of the expected 688 million tonnes of consumption.2 Growth in market volatility and margin pressure For steelmakers, not only does the performance vary significantly across both emerging and developed markets, but a considerable cause of volatility is the cost of raw materials. The shortage of these supplies in the market has allowed suppliers of iron ore and metallurgical coal to rebuild the pricing mechanisms through the shift from annual to shorter-term price contracts. This has created numerous challenges for steelmakers as they must now deal with volatility in raw material prices, as well as maintain margins with fluctuating demand. Over the past two years, any firmness in steel prices has given iron ore producers an opportunity to increase the prices in the next contract; however the reverse may not be true as steel companies cannot always pass on the rise in iron ore prices to end consumers due to the fragmented market.3 Lack of operational agility The very nature of steelmaking and large amounts of capital investment means that the sector does not find it easy to adjust quickly to changing circumstances. At the time of the global economic crisis of 2008 -09, steel mills were operating at high capacity when demand fell off very suddenly. This caused an unexpected oversupply of steel in the market. There remains a lag between demand fluctuation and production adjustments as there is still structural overcapacity in certain product segments.
2. Chinese steel industry faces significant overcapacity in 2012 CISA, IHS Global Insight daily analysis, 6 January 2012. 3. China steel sector, Macquarie Research, 8 July 2011.

Significant challenges in todays global steel sector


A shift to emerging markets Steel production is shifting from mature to emerging economies. There are fewer domestic growth prospects, as well as increased competitive threats for steel players with an established footprint in Europe and North America. Europe and the United States show a weakness in both GDP and industrial production as GDP is forecast to grow less than 2.0% in both 2011 and 2012, as opposed to an expected 9.0% and 7.5% growth in 2012 for China and India, respectively.1

1. World Economic Outlook: Slowing Growth, Rising Risks, IMF, September 2011.

Understanding the challenges in todays steel market is crucial for the sector in order to explore new opportunities and means of growth.
Mike Elliott Global Mining & Metals Leader, Ernst & Young

Global Steel 2011 trends, 2012 outook

A need for business models to evolve For many decades, the greater margins were derived by the steel mills. The steel mills held both purchasing power over the raw materials supplies and set market prices for steel distributors and customers. In recent years, however, most of the pricing power switched to the suppliers and customers. In response to these changes, steelmakers need to change their business models by introducing greater operating flexibility and becoming more customer-focused in their product mix and more innovative in how they price their products.

is a challenge for the supply chain to attain operational agility. To do so, steelmakers need to focus on improving the flexibility of their supply chains, as well as effectively managing capacity utilization. Stakeholder confidence The economic downturn has increased the perception of risk, and trust has become an issue both internally and externally. During the economic crisis, many risk management systems failed, so now it is more important than ever to regain stakeholder confidence and for companies to put in place new processes to better explain the risks they are facing. Risks to be identified and explained to stakeholders in the steel sector could include political risks, market risks (e.g., price volatility and cyclicality of demand), operational risks and financial risks.

How can steelmakers compete for growth?

To deal with these challenges and attain success in the new economy, we recommend a focus on the following four areas: Customer reach Economic uncertainty combined with poor demand outlook means that steelmakers are looking for new ways to accelerate their earning potential. To maximize potential, some key focus areas include broadening product service offerings, focusing on more profitable segments and prioritizing markets in which to compete. With the rise of the rapid-growth emerging markets, it is still important to focus on existing clients. Cost competitiveness Within the past two years, reducing costs has been a constant focus of management around the world. To keep their companies competitive, steelmakers are adopting a number of different strategies such as vertical integration, passing on the cost pressure, use of steel derivatives, optimization of capital and strategic cost reduction. Operational agility The potential opportunity of a steelmaker is determined by the market it can reach, while its growth is determined by its ability to produce and deploy products or services into the market more effectively than its competitors. The speed at which a steelmaker can respond to changes in the market

A cautious outlook in 2012

The 2012 outlook for steel demand is cautious due to the markets continued financial uncertainty and volatility. The global steel sector is expected to grow, although at a lower rate. Growth will be seen in two different speeds, with emerging economies expected to perform much better than developed countries. The sector is only expected to grow by 2.5% in Europe and around 5.0% in the North America Free Trade Agreement region. Chinese steel production and consumption will continue to outperform the rest of the world. The steel sectors in other emerging countries, such as India, Russia, Brazil and South Korea, will continue to grow, although the uncertain economic outlook may have some effect on these economies. In India, however, demand for steel from the domestic sector is creating a positive outlook as India is expected to perform better than most. Over-capacity will continue to be an issue with increased capacity in the rapidly growing economies coming online. With government rationalization unlikely to occur in the short term, successful steelmakers will need to become more nimble in their approach to changing market conditions. This will occur with improved technologies, lower cost structures, more vertical integration and greater partnering with key customers.

Figure 1: Global steel capacity vs. supply vs. demand


2,000 1,800 1,600 1,400 Million tonnes 1,200 1,000 800 600 400 200 0 Capacity Production Consumption

2003

2004

2005

2006

2007

2008

2009

2010

2011e

Source: ABARE, Worldsteel Association, JPMorgan and Ernst & Young analysis Competing for growth in the steel sector 2

Steel sector challenges


The steel sector is cyclical and its performance tracks the global economy, making the health of the sector a good indicator of a regions economic health. Over the last decade, the sector has grown phenomenally, primarily due to growth in the BRIC (Brazil, Russia, India and China) nations, particularly China. Since 2001, the sector has seen both a major rally and a major downturn, but overall, global steel production grew at a calculated average growth rate (CAGR) of around 6.0%, and consumption increased by CAGR 5.5%. Although the steel industry has been recovering since the global financial crisis, the recent Eurozone sovereign debt crisis has created a lot of uncertainty in the market. This uncertain macroeconomic environment with distressed financial markets and large government budget deficits has led to countries implementing a number of austerity measures. In fact, certain parts of the world have suspended investment in infrastructure and other industries altogether. As a result, steel demand has not rebounded as strongly as predicted and growth in steelmaking capacity still exceeds steel demand. In 2011, steelmaking capacity increased by 80 million tonnes, resulting in an estimated 493 million tonnes of excess capacity.4 This is putting pressure on operators profitability. The complexity of the issue is large as growth in steelmaking capacity is expected to continue at pace and political issues are preventing a rationalization of the sector because governments are under pressure to protect jobs and the sector. The timeframe for rationalization will be driven by the political agenda. With over-capacity being the most significant challenge for steelmakers today, there are further challenges facing the sector. These include: A shift to emerging markets Growth in market volatility and margin pressure A lack of operational agility A need for business models to evolve An understanding of these challenges is essential if the sector is to tap new opportunities and means of growth.

A shift to emerging markets


With production shifting from mature to emerging economies, there are fewer growth prospects and increased competitive threats for steel players with an established footprint in Europe and North America. The shift is evident in the list of top 10 steel producers. In 2001, there were 4 European players in the top 10 steelmakers. In 2010, the only steelmaker in the top 10 with headquarters in Europe was ArcelorMittal.
4. Chronic oversupply hits cyclical headwinds China Steel sector, JPMorgan, 6 August 2011

The steel industry has experienced tremendous growth over the last decade, largely due to Chinas growth.
Peter Markey China Mining & Metals Leader, Ernst & Young

Global Steel 2011 trends, 2012 outook

Figure 2: Top 10 steel producers


Rank
1 2 3 4 5 6 7 8 9 10

2001
Arcelor POSCO Nippon Steel Ispat International Shangai Baosteel Corus ThyssenKrupp Riva NKK Kawasaki

2010
ArcelorMittal Baosteel POSCO Nippon Steel JFE Jiangsu Shagang Tata Steel U.S. Steel Ansteel Gerdau

Source: World Steel Association European steel producers highlighted in yellow.

Growth in global GDP for 2011 is driven primarily by the BRIC nations. For example, China and India are expected to grow by 9.5% and 7.8% in 2011 and by 9.0% and 7.5% in 2012, respectively.5 The Indian steel sector is striving to put on more capacity to capitalize on that growth. In China, however, there is already significant excess steelmaking capacity. Chinese crude steel capacity is expected to amount to 840 million tonnes in 2012, which would be 22% in excess of the expected 688 million tonnes of consumption.6 In comparison, the European Union and United States have much lower GDP forecasts of less than 2% in both 2011 and 2012. This weakness in both GDP growth and industrial production has accelerated the shift of steel production and consumption to emerging economies. Figure 3: Steel consumption intensity per capita
China
Apparent per capita crude steel consumption growth, average (%) 19711980 19811990 19912000 20012010 5.60 3.71 9.50 13.60 Per capita GDP growth, average (%)

India
Apparent per capita crude steel consumption growth, average (%) 3.74 5.46 2.13 6.24 Per capita GDP growth, average (%)

United States
Apparent per capita crude steel consumption growth, average (%) 1.45 0.73 1.67 2.40 Per capita GDP growth, average (%)

Germany
Apparent per capita crude steel consumption growth, average (%) 0.82 0.34 0.27 1.38 Per capita GDP growth, average (%)

Japan
Apparent per capita crude steel consumption growth, average (%) 3.06 2.04 1.90 0.76 Per capita GDP growth, average (%)

4.46 7.76 9.32 9.88

0.70 3.25 3.52 6.10

2.14 2.29 2.17 0.62

2.62 2.00 0.37 0.99

3.31 4.07 0.93 0.65

Source: Global Insight; World Steel Association

There has been a structural shift in demand of steel products during the last decade. The intensity of demand has shifted in favor of emerging markets. This is mainly due to the fact that GDP growth in these countries is substantially high in comparison to developed nations. Emerging markets, having a higher intensity for steel consumption, command a higher correlation. For example, during the last decade (200110), the steel consumption growth in China was 1.4% in comparison to its GDP growth, whereas the correlation was less than 1.0% for many developed economies. However, it is to be noted that developed countries have not seen much growth in per capita consumption of steel over the last four decades, whereas the intensity of steel consumption has increased continuously in emerging economies such as China and India during the same period.
5. World Economic Outlook: Slowing growth, Rising risks, IMF, September 2011. 6. Chinese steel industry faces significant overcapacity in 2012 CISA, IHS Global Insight daily analysis, 6 January 2012

Competing for growth in the steel sector

Figure 4: Growth of industrial production


16 14 12 Asia -Pacific 10 Growth (%) 8 6 4 2 0 2010 2011e US 2012f Eurozone 2013f 2014f China 2015f Asia-Pacific 2016f US Eurozone China

Emerging economies: growing faster Developed economies: low industrial activity

Source: IHS, Global Insight

This shift in the global steel landscape is evident if we look at steel production and consumption of the world excluding BRIC (see Figure 4). In 2011, the rest of the worlds steel production increased by only 1.9% as compared to 2010, while consumption contracted by 4.3% on the same comparison. Figure 5: Steel production and consumption, 2011 y-o-y Production
World World excluding BRIC Source: BREE, World Steel Association 6.8% 1.9%

Consumption
5.2% 4.3%

Growth in market volatility and margin pressure


While emerging markets are growing, performance varies significantly across them. Similarly, some developed markets are doing better than expected, whereas others are struggling or continuing to decline.

The change from annual to shorter-term price contracts has accelerated the impetus for the steelmakers to increase their involvement in the upstream mining activity to support their margin.
Michel Nestour EMEIA Mining & Metals Transactions Leader, Ernst & Young

Global Steel 2011 trends, 2012 outook

The increased competitive pressure extends across the value chain for labor, input materials and capital. Steelmakers from emerging markets expect competitiveness to increase the most, as companies from developed markets enter, largely through joint ventures, and domestic players intensify their focus. For steelmakers, a major cause of volatility is the cost of raw materials, which has been exacerbated by the change from annual to shorter-term price contracts. Shortages in supply have enabled suppliers of iron ore and metallurgical coal to re-engineer the pricing mechanisms. However, this has created challenges for steel producers. They now have to deal not only with the increased volatility in raw material prices, but also with how to maintain margins with fluctuating demand. This development is significantly affecting the earnings of the steel industry. Figure 6: Volatility of contract prices
350 300 250 US$/tonne 200 150 100 50 0 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 12 12 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Fiscal year Iron ore price (US$/tonne) Coking coal (US$/tonne)
The quarterly contract came into effect from FY11 Q1

Source: CRISIL Research

Competing for growth in the steel sector

During 200911, average iron ore prices increased at a CAGR of 46.7%, and that of coking coal prices grew by 30.2%. The impact of this rise in raw material prices (based on usage per unit of steel production) on a steel players bottom line is phenomenal. Hence, even though the price of hot rolled coil (HRC) steel increased by a CAGR of 23.4% from 2009 to 2011, margins decreased for steel players due to a sharper increase in raw material price. Figure 7: Variation in raw material prices compared to steel prices
Average prices (US$/tonne)
2009 2010 2011 CAGR variation (200911) Ratios per tonne Impact factor* 23.4%

HRC prices
469.0 614.0 714.0 23.4%

Iron ore prices


85.0 153.0 183.0 46.7% 1.6 74.7%

Coking coal prices


170.7 242.7 288.0 30.2% 0.5 15.1%

*Impact factor: impact of the price increase based on usage per unit of steel production. Source: CRISIL Research; Ernst & Young analysis.

Over the past two years, any firmness in steel prices has given iron ore producers an opportunity to increase the prices in the next contract; however the reverse may not be true as steel companies cannot always pass on the rise in iron ore prices to end consumers due to the fragmented market.7

A lack of operational agility


During the global financial crisis of 200809, steelmakers were faced with an operational challenge when demand fell off abruptly. Because many steel mills were operating at high capacity, there was a sudden oversupply of steel on the market. Despite steel companies being fairly quick to adjust their capacity utilization particularly in the United States and Europe there is still structural overcapacity in certain product segments (e.g., steel sections for the construction market). Therefore, the long lag between demand fluctuation and production adjustment remains, largely because the sector is still fairly unconsolidated, particularly compared to iron ore or aluminum companies. In 2010, ArcelorMittal accounted for 7% of global steel production, with the next five largest steelmakers accounting for only 12.9%.8 In China and other nations, there are many small steel mills operating with an annual capacity of less than 1 million tonnes. Many steel mills are seen as national champions and are routinely supported by governments to avoid closure. This has not only led to oversupply in certain product segments but has also decreased the life cycle of products.

A need for business models to evolve


The structure of the steel sector has changed little over the past century other than transitioning from government ownership to private ownership. For many decades, the greater margins were derived by the steel mills that had both purchasing power over the raw material suppliers and set market prices for steel distributors and customers. However, in 2011 most of the pricing power is with the suppliers of raw materials and steel customers. Steelmaking has become a form of raw material processing or beneficiation, not the unique creator of value. In response to these changes, the business model of steelmaking needs to adapt so that supply-constrained raw material price risk is passed directly to steel customers and demand fluctuations of customers are met with more flexible production responses. As discussed, the lack of operational agility has affected the sector and led to the current levels of excess capacity. Steelmakers seeking to transform their business models are introducing greater operating flexibility, increasing ownership of raw material production, and becoming more customer-oriented in their product mix and innovative in how they price their product.

7. China steel sector, Macquarie Research, 8 July 2011. 8. based on Worldsteel Association data, 2011.

Global Steel 2011 trends, 2012 outook

Competing for growth in the steel sector

How can steelmakers compete for growth?


Success in the new economy will depend on whether steelmakers can respond to these challenges. We suggest a focus on the following four areas:
Customer reach The markets and segments that a steelmaker can reach effectively determine the size of the opportunity it faces. A steelmaker focused on its domestic market may have a lower potential opportunity than one that is operating across many borders. However, it is possible to make the most of domestic market opportunity by introducing production flexibility to adapt the existing product range to customer preference and diversify into new customer segments. An assessment of the current product range in conjunction with market demand may also lead to a decision to rationalize the product range. As we reported in our 2011 Steel Report: India next landmark on the global steel landscape, India represents the new growth frontier for global steelmakers. A number of those companies have entered into Indian joint ventures or greenfield developments in India. Cost competitiveness The profit of a steelmaker is determined by whether it can sell its products sufficiently above cost to deliver a satisfactory level of return for its needs and those of its stakeholders. Cost management needs to be embedded sustainably across the supply chain on a long-term basis. Operational agility The growth of a steelmaker is determined by how effectively it can meet the needs of its chosen markets and, increasingly, by how quickly it can respond to the opportunities that emerge in a changing market. Similarly, in a volatile economic environment the ability to use optimal flexibility to reduce or shut down production is an asset. Stakeholder confidence The value of a steelmaker is determined by the confidence of the investment community in the companys ability to manage the risks in its market to deliver its forecast level of return. This depends on confidence in risk management, regulatory compliance and the delivery of sufficient transparency through the firms reporting system. To enable this, steelmakers need to identify and explain risks in their sector, including political risk, market risk (e.g., price volatility and cyclical demand), operational risks and financial risks. The considerable tension between these goals requires a steelmaker to strategically choose where it focuses its attention. Players can still choose to compete by being the cheapest, the most innovative in its products or the best (perception-wise). The implications of these choices are significant and extend throughout a steelmakers operation and organization. But focus should not obscure the critical linkages between each of these areas: The markets a steel company chooses to compete in determines not only its scale of the opportunity, but also the risk, regulatory and reporting landscape in which it operates and the challenges for its supply chain. These markets will be more varied than before. The growth rate achieved reflects a steel companys success in meeting the needs of the market it seeks to serve. Flexibility and speed will be critical factors, but these need to be delivered at a price that wins in the market and drives an appropriate profit for stakeholders. Cost-competitiveness plays a critical role in determining which markets and segments a steel company can serve profitably. It drives the pricing decision upon which market success will depend, but it also determines the investments that can be funded to achieve agility. The effectiveness with which a steel company reports both its opportunities and performance builds its financial reputation and, in turn, both its value and ability to fund future plans.

Global Steel 2011 trends, 2012 outook

While focus remains important, returning to growth profitably requires steelmakers to consider their performance on all four dimensions of this framework. All of these goals depend on a steel companys ability to attract, deploy and retain the talent it needs to deliver its strategy. Figure 8: Competing for growth framework
Broadening product offering Prioritizing markets to compete in

Focusing on more profitable segments

Customer reach

Speed in adjusting capacity utilization

Accelerating speed of response

Vertically integrating Using derivatives

Creating a flexible supply chain

Operational agility

High performers have...

Cost competitiveness

Implementing strategic cost reduction Passing on costs to consumers

Optimizing capital

Identifying and explaining risks Enhancing reporting

Stakeholder confidence

Re-engaging with internal talent Complying with regulatory activity (parallel importing)

Competing for growth in the steel sector

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Customer reach
Growth is a reflection of how effectively steelmakers can meet the demands of a market. The scale of opportunity is therefore determined by the size of the market where the company operates. Uncertain economic circumstances combined with a poor demand outlook, particularly in developed markets, means that steelmakers are seeking new ways to accelerate their earning potential. Some of the key focus areas when seeking to maximize potential include: Broadening product offerings a focus on niche, higher-margin steel products to maximize service to current clients and gain new clients Focusing on more profitable segments growth or decline of downstream sectors Prioritizing markets to compete in the rise of emerging markets While new markets are important, it is still important to focus on existing customers first before moving into them. Better yet is a combined focus on these three areas.

1. Broadening product offerings

High-performing steelmakers firmly have their current customers as their main focus. A broad range of tactics are necessary to increase sales, including innovating new products, increasing marketing, opening new distribution channels and creating marketentry approaches that can reach new markets more effectively. Many steelmakers in developed markets have recognized that innovating new products is central to their competitive strategy. In particular, European and American steelmakers are increasingly taking a customer-centric approach, selling products that deliver higher margins instead of those that are volume-driven. Figure 9: New products
Companies
JFE Steel

New products
JFE Steel has developed high-end electronic resistance welded (ERW) pipes to be sold under the MightySeam brand name. These pipes are expected to have much higher weld toughness than conventional ERW pipes, even at temperatures below 50 Celsius. The company plans to make 10,000 tonnes of pipe in 2011. USS-POSCO Industries (UPI), a joint venture between U.S. Steel and POSCO, is introducing advanced highstrength steel (AHSS) for automotive and other applications. The product is intended for the automotive markets in the United States and Mexico. JSW Steel aims to increase its European market share with its high-value coated steel. The company is expected to commission a new line to manufacture coated coil specifically for the appliances industry. Tata Steel will market a new ultra-high-strength automotive steel under the ZnX brand, after the European Patent Office revoked a contested patent. The revoked patent pertained to the hot forming of zinc-coated boron steel.

POSCO and U.S. Steel JSW Steel Tata Steel

Source: Factiva

Steel companies can only generate a sustainable competitive advantage over their competitorssteel, metals and other basic materials (concrete, glass, plastics)when their product and process innovations will enable their customers customers to improve their energy and material effectiveness beyond good ecological citizenship.
Pierre Mangers Strategic Direction, Metals and Cleantech Advisory Leader, Ernst & Young Luxembourg

11

Global Steel 2011 trends, 2012 outook

Such niche steel products are often value-added solutions that can create new revenue streams for a steelmaker. Currently these products could be higher-value, coated, flat-rolled sheet, fire- resistant steel, high-strength steel or lightweight steel products rather than commodity-grade, hot-rolled sheet products. Specialized automotive steels also have had higher demand and hence higher margins. These value-added products generally bring more revenue and profit per unit. And a higher-value product mix boosts profits in good times, when strong demand pushes up volume and profit on each unit of production. During downturns, a higher-end product mix may be less price-sensitive, which can help to cushion the impact of volume declines. More broadly, a diversified product mix helps to insulate the steelmaker from cyclical downturns in individual markets.9 These products must be truly differentiated to ensure that they actually resonate with clients requirements. The product differentiation needs to be aimed at sufficiently large segments and demand structures. The amount of capital to change the production line to produce new products also has to be considered, and new steel mills are increasingly being planned with this flexibility in mind. But steelmakers also have to contend with the possibility of substitution for example, large-diameter steel pipes compete against reinforced pre-stressed concrete pipes, cast iron pipes, various types of plastic pipe and fiberglass-reinforced plastic pipes. In fact, steelmakers have had a lot of competition from aluminum in the automotive industry. However, they took this challenge head on with large-scale education programs to differentiate their products along with increased innovation in lighter types of steel. Currently steel continues to dominate, with about 87 million tonnes of steel used annually in the worldwide production of automobiles world-wide annually, compared with about 12.5 million tonnes of aluminum.10

Steelmakers are seeking to increase the value of production and raise margins by continuing to tap into growth in the automotive industry. The outlook for the automotive sector is positive, with 8% growth forecast in 2012.11 China is emerging as the largest market for automobiles, and the outlook is also good in India. Chinas automotive market is expected to grow from 14.6 million to 22.2 million vehicles from 2010 to 2016, and the Indian car market is set to grow from just under 2 million units in 2010 to 3 million units by 2015. In these two markets alone, the potential for auto grade steel is considerable.12 The changing dynamics of the auto industry mean that steelmakers are able to work with automakers to come up with solutions to issues such as the reduction of carbon emissions and the threat of alternative materials.13 Their collaboration has resulted in the creation of specialist steel that is lighter to ensure energy efficiency in cars. Overall, the automotive market clearly represents one of the best opportunities for steel companies to differentiate their products and services from the competition and move along the value chain. There is also strong demand from the mining sector from the capital goods sector, and demand for pipe, tube and rigs used in oil and gas exploration is increasing.14 In addition, in emerging markets the need for infrastructure is still great this underlies much of the growth in steel demand in these countries. In China alone, there are plans this decade to increase rail by 54%, the road network by 85% and airports by 47% through to 2020. And in developed countries, any stimulus funds will likely be directed to roads, bridges and other infrastructure elements.15 The construction sector has not been as resilient as the automotive market, particularly in developed countries. This is often the first sector to be put on hold in a recession. In addition, steel executives or companies do not have the same collaborative relationship with the construction sector as they do with the automotive sector. The global construction market outlook is generally flat in 2012, particularly in Western Europe. Credit-tightening restrictions have also slowed construction in China. Construction spending in the United States is forecast to recover modestly in 2012 and even more so by 2013.16

2. Focusing on more profitable segments

Segmentation is at the heart of local marketing: identifying differences that can form the basis for a sharper proposition. The cheapest route to market is through an existing relationship. High-performers have been investing more time and resources in their attempts to both secure and strengthen their position with current customers. Similarly, there is a focus on developing new distribution routes to serve the existing client base and enhanced marketing activities to capitalize on the current opportunity. Industrial metals companies are highly dependent on the fortunes of cyclical consumer industries. The outlook for these sectors will determine how steel companies can maximize their opportunities to create additional value.

9. Industry surveys Metals: industrial, Standard & Poors, 4 August 2011. 10. Aluminum tests its mettle against steel in drive for lighter cars, Wall Street Journal, 16 March 2011.

11. Global commercial vehicle production: Third quarter 2011, LMC Automotive, 2011. 12. Industry forecast India Q4 2011, Business Monitor International, 31 October 2011. 13. Leadership in the automotive steel market: investor day presentation, ArcelorMittal, 23 September 2011. 14. European Capital Goods: Q3 wrap up: weaker outlook statements, results mild positive, JP Morgan Cazenove, 14 November 2011. 15. China iron ore 2011, Rio Tinto, 22 March 2011. 16. Building & Construction: Clear upside; unclear timing, Morgan Stanley, 10 November 2011.

Competing for growth in the steel sector

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Another sector that remains flat is global manufacturing. Production slowed in the Eurozone and the United Kingdom and stagnated in the United States. However, growth in China, Japan, India and Russia offset some of this contraction.

3. Prioritizing markets to compete in

Rapidly emerging markets are a source of growth for steelmakers, either as a market into which to expand (if possible) or to sell steel products. Securing a strong base in these countries will be critical for investors seeking growth beyond them. When adjusted for variations in purchasing power parity, the ascent of emerging markets is impressive. The International Monetary Fund (IMF) forecasts that the total GDP of emerging markets could overtake that of the developed economies as early as 2014. The forecasts suggest that investors will continue to invest in emerging markets for some time to come. By 2020, the BRIC countries are expected to account for nearly 50% of all global GDP growth.17 This growth in emerging markets is matched by their need for steel. These markets continue to be large consumers of steel, and much of the growth predicted by the World Steel Association in 2011 (6.5%) and 2012 (5.4%) will be from these markets. The sheer size of emerging markets and their relative economic growth mean they are sources of growth for steel companies. WorldSteel estimates 70% of world growth in steel over the next few years will come from emerging markets, with China and India accounting for 40% of that growth.18 By 2012, steel use in the developed world is forecast to be 15% below the 2007 level, but in the emerging and developing economies, it will be 44% above. In 2012, emerging and developing economies are forecast to account for 73% of world steel demand, in contrast to 61% in 2007. Figure 10: Emerging markets versus developed countries growth outlook
1,600 1,400 1,200 Million tonnes 1,000 800 600 400 200 0 372.7 2010 392.9 2011e 403 5 0 341.5 361.4 389 598.1 643.2 681.6 30 China 25 20 % growth 15 10 Emerging economies (excl. China) Developed economies % growth developed economies % growth emerging economies (excl. China) % growth China

2012f

Source: World Steel Association


17. World Economic Outlook: Slowing Growth, Rising Risks, IMF, September 2011. 18. October 2011 Worldsteel short range outlook, World Steel Association, 12 October 2011.

Steel demand is robust in emerging markets. This is a good opportunity for emerging market players to capture this growing demand and global majors to retain growth.
Anjani K Agrawal Indian Mining & Metals Leader, Ernst & Young

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Global Steel 2011 trends, 2012 outook

While there is growth in emerging markets and many will want to capitalize on this growth not all players should expand across borders. Players should carefully consider both possible risks and available resources. In addition, there is the consideration that steelmaking is largely regional, so growth is generally captured by the local regional player. In fact, countries have or are increasing trade controls to protect their domestic steelmakers, which have long been domestic champions of manufacturers and an important employer. Many of the larger players are targeting the growth of these markets. Steelmakers like ArcelorMittal and POSCO are persevering in their efforts to invest in greenfield steel mills in India. POSCO recently obtained permission to set up a steel mill in the Indian state of Orissa. There are, however, delays in acquiring land and more recently in obtaining approval to use non-Indian labor.19 Japanese steelmakers, unable to expand further in their domestic market, have formed joint ventures with Indian steelmakers to enter the countrys automotive steel market. JFE Steel, Japans second largest steelmaker, signed a collaborative pact with JSW Steel. This enables JSW to produce automotive steel products through the technological assistance of JFE. Japanese Kobe Steel is also planning to sign a joint venture agreement with Steel Authority of India to build a 500,000 tonnes mill in West Bengal to manufacture special-grade steel. Total investment in the project will be US$400m.20 The profile of steel demand in emerging countries is shifting from long products associated with infrastructure and construction to flat products used in the automotive and white goods sectors. China and India have both been increasing their flat steel production to keep pace with the demand for consumer goods from a rising middle class. The usage profile for both countries is now 50/50 long and flat steel. However, the lower margins associated with producing flat steel in China, combined with increased regulation of steel capacity, have slowed the pace of flat steel production growth. In India, nearly all of the 10 million tonnes of capacity added in FY11 has been flat steel production. India imported close to 5.5 million tonnes of flat steel in 2010. While some of these imports are specialty products, many of them can now be replaced with domestic production.21 Emerging markets are indeed the source of increased steel demand, but not all steelmakers are in a position to take advantage of them. In addition, their stakeholders may not be prepared to take on the risk of investing in these markets. Key questions for management
Knowing your buyers How detailed, complete, current and accurate is your customer information? When did you last review your segmentation? How has the changed economy affected your customers? Identifying your products or services Which are your most profitable products? Where are they on their product lifecycle? What are the key trends in your market? What processes are applied to identify and prioritize new ideas? What role does your customer play in your innovation strategy? Understanding your market opportunities Which markets offer the greatest mid-term opportunity for you? How will you reach or enter them? What is different about those markets? Why will you win?

Creating your value proposition How powerful is your brand? What reasons other than price can influence your buyers decision?

19. Indian steel ministry update on POSCO steel plant progress, Steel Guru, 10 December 2011, via Factiva. 20. Indias SAIL looking to finalize JV with Kobe Steel in a month, Asia in Focus, 7 December 2011. 21. Indian steel, Nomura via ThomsonOne, 22 June 2011.

Competing for growth in the steel sector

14

Cost competitiveness
Becoming more cost-competitive in production, as well as sales distribution and service, are two of the top five factors that companies expect to be most critical over the next two years.22 For the past two years, reducing cost has been a constant focus of management around the world and has dominated thinking in this area.

Cost-saving considerations for steelmakers


Ability to quickly adopt new technology: access to capital and technical knowledge are required to promptly and effectively invest in new capital equipment that saves costs, improves productivity or enhances product quality. Having links with suppliers or vertically integrating raw materials into the supply chain: steelmakers need to ensure they have links with major miners or are vertically integrating the source of raw materials into their supply chain to ensure consistent access to raw materials during periods of high demand when firms are competing for supply. Economies of scale: operating on a large scale allows cost savings such as bulk purchasing discounts. Large operations tend to have more ready access to capital for expansion and investment in laborsaving technology, although larger steelmaking operations will lack operational agility. Marketing of differentiated products: product sales into several major demand industries help to insulate producers against slumps in any one industry. Establishment of export markets: the ability to export assists in attaining the large throughput required for economies of scale and provides a buffer against downturns in domestic demand.

Steelmakers are adopting a number of strategies to keep their companies cost-competitive: Vertical integration moving upstream Passing on the cost to customers Use of derivatives Optimization of capital Strategic cost reduction

Vertical integration

Cost competitiveness starts with pricing more specifically, seeking to maintain as much control of the pricing decision as possible. For steelmakers, this has been the hardest part to control. Raw material prices have surged and in some cases, when raw materials have to be imported, they can account for up to 70% of the overall costs of goods.23 Figure 11: Raw material and steel prices*

Source: CRISIL Research *Raw material prices include iron ore 63% fines and coking coal prices.
22. Competing for growth, Ernst & Young, 2011. 23. Korea Steel Sector, Credit Suisse, 14 October 2011, via ISI Emerging Markets.

15

Global Steel 2011 trends, 2012 outook

Steelmakers with a strategy of owning the mines that feed their mills are far more competitive. The mills that have relied on miners to provide their feedstock are now focused on acquiring or are considering acquiring mines or stakes in mines to secure raw materials at a more competitive price. In the first nine months of 2011, there were six completed deals with a combined value of US$833m in which steelmakers acquired coal or iron mining capabilities. The largest deal in this period was the acquisition of Baffinland Iron Ore Mines by ArcelorMittal and Nunavut Iron Ore Acquisition Company for US$514m. There also are some significant deals in the pipeline. Magnitogorsk Iron and Steel Works OJSC (MMK), the Russia-listed steel manufacturer, has agreed to acquire all the outstanding shares of Flinders Mines, an Australia-listed iron ore and minerals miner, for US$502m. OneSteel has agreed to acquire Southern Iron Ore from WPG Resources for US$360m.24 Figure 12: Iron ore and coal acquisitions by steelmakers in 2011
Type Date effective/ unconditional
03/25/2011 02/01/2011 05/11/2011 03/23/2011 03/21/2011 03/17/2011

Target name

Target country
Canada South Korea Brazil Brazil Indonesia Netherlands

Target commodity
Iron ore Coal Iron ore Iron ore Coal Coal

Acquiror name

Acquiror country/ nation


Luxembourg South Korea Russia China India South Korea

% of shares acquired
94.75 100.00 25.00 27.06 100.00 90.00

Value (US$m)
514 205 49 30 24 11

Cross-border Domestic Cross-border Cross-border Cross-border Cross-border

Baffinland Iron Mines Corp SK Energy-Coal Mining Bus SPG Mineracao Ltda Adriana Resources Inc Sarwa Sembada Karya Bumi PT Novoko B V

ArcelorMittal, Nunavut Iron Acquisition Co SK Networks Co Ltd Severstal WISCO Intl Resources Dvlp Monnet Ispat & Energy Ltd SK Networks Co Ltd

Source: Thomson Financial

However, there is significant competition for mining resources. For example, there was an estimated US$30b in coal deals in 2011, up significantly from US$17.9b in 2010. This activity was driven primarily by major coal mining companies looking to boost production capacity to meet increasing demand from China and India. Larger power utilities and some steel companies, often with government backing, are integrating into raw materials to manage volatility and long-term security of supply. The acquisition of a mining division also creates additional risks and challenges for a steel company, including: Substantial capital investment is required to set up a mine. New iron ore and coal mine sites are increasingly in riskier locations that also require significant infrastructure investment, such as Liberia. Steelmakers need to compete with miners for skilled labor. Changes are needed to IT and management dashboards to correctly measure the performance of the mining division versus the performance of the steel division. It needs to be determined if the mining division should be exclusive to the steelmaker or allowed to sell to the external market and at what transfer pricing. In addition to purchasing mines, some companies are locking in a portion of their long-term raw materials supply to reduce their exposure to escalating input costs. For example, AK Steel has acquired all of the stock of Solar Fuel Co. Inc. for US$36m. Solar Fuel owns or leases estimated reserves of more than 20 million tonnes of low-volatile metallurgical coal in Somerset County, Pennsylvania. AK Steel also has taken steps to secure its access to iron ore by forming a joint venture with Nashwauk, Minnesotabased producer Magnetation Inc.25

24. Mergermarket. 25. AK makes key deals to secure raw materials, American Metal Market, 7 October 2011

Competing for growth in the steel sector

16

Steelmakers also have to consider how they can maximize the value of their mining operations. A simple way is to use the thirdparty sales of coal and iron ore from integrated mines to create a financial hedge. ArcelorMittal is creating a separate mining business as a means to integrate upstream with appropriate value. This addition creates a strong business able to undertake premium mining acquisitions. Materials from mines that could be sold outside the group are now transferred internally at market prices. Production from captive mines (limited by logistics or quality) continues to be transferred at cost-plus to the steel facilities.26 Gerdau has also announced that it will finalize its sales strategy for its surplus iron ore by the end of 2011. Possible options include partnerships with miners or trading companies, as well as an initial public offering (IPO).27

Use of derivatives

The depth of the derivatives market for both steel and its raw materials is increasing as prices move away from longterm contracts and closer to the spot market. The closer prices are to the spot market, the greater the need for price risk management. Steel futures contracts are a means through which companies are able to hedge their price risk by buying or selling a volume of product for delivery on a fixed future date at a price agreed now. Many steel mills already hedge currencies and energy sources, while others just hedge some or all of their raw materials purchases.28 There are a growing number of exchanges, banks and brokers now offering services for iron ore derivatives. Some examples of exchanges offering over-the-counter (OTC) iron ore swaps include the Singapore exchange and the London clearing house LCH Clearnet. The Singapore exchange currently clears about 85% of globally traded iron ore swaps. The volume traded on the Singapore exchange has been steadily increasing 6.9 million tonnes were traded in 2009 when it was launched. In the first eight months of 2011, almost 22 million tonnes of iron ore swaps were cleared.29 However, some steelmakers remain reluctant to use derivatives to hedge steelmaking raw materials. Steelmakers have also been averse to getting involved in the market, with Baosteel warning delegates at the 2011 CISA iron ore conference in Qingdao that they should be cautious about using such a contract.30 Overall, steelmakers have also been hesitant to hedge steel prices, largely because they would rather keep the price of steel within their control. There is a fear that steel futures will attract speculators and cause greater price volatility. Pure market theory would suggest that speculators provide a useful role in moving markets to true equilibrium. However, even without the influence of speculators, the steel price has become more volatile. HRC prices reached nearly US$900 per tonne in March 2011 and have since declined to around US$700 or lower, per tonne.

Passing on the cost to customers

The ability to pass on the cost pressure of raw materials is important in optimizing margins. Not all steelmakers will be able to invest in mining operations or secure some form of selfsufficiency in raw materials. However, all steelmakers will seek to pass on the pressure of high raw material costs. The ability to do so will depend on the bargaining power of a steelmaker versus that of its customers. The prominence of regional or national steel companies means that there may be a lack of connectivity in the steel industry. The customer groups often have stronger bargaining power, and combined with lackluster demand and excess steelmaking capacity, it may be very difficult for the steel industry to negotiate price increases. As a result, not all steel companies have renegotiated their sales contracts to match the shorter-term contracts now offered by raw material suppliers. In India, however, many Indian steel players have successfully renegotiated their contracts to quarterly with their automotive customers and even monthly with customers in the construction segment.

26. Building a world class mining business, ArcelorMittal, 23 September 2011. 27. Strategy for surplus iron ore will be settled this year, Gerdau says, Metal Bulletin News Alert Service via Factiva, 8 August 2011.

28. Futures guide, Steel Business Briefing, www.steelbb.com/steelfutures, accessed 28 November 2011. 29. LME Week Factbox Who is doing what in iron ore swaps, physical, Reuters News, 3 October 2011. 30. The options for iron ore: swaps, futures and physical, American Metal Market, 1 October 2011.

The current trend among steel companies has been to reduce costs by entering into joint ventures. This way the cost is shared between the parties, creating economies of scale, as are technological advances that usually reduce the cost base.
Sangwook Cho Partner, Mining & Metals, Korea, Ernst & Young

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Global Steel 2011 trends, 2012 outook

Steel production is a capital-intensive business. Investments such as vertically integrating mines, building new plants, maintaining old plants and pursuing potential acquisitions will need to be funded. In the current economic conditions, the rising cost of finance is squeezing small and medium steel market players, particularly in Europe.31 In 2010, steelmakers raised US$87.5b in 282 issues, accounting for the highest share of global proceeds of the commodity groups. Debt financing accounted for 94% of capital raised in the steel sector, with 100 loans worth US$57.1b and an additional 86 bond issues worth US$25.2b. In the first nine months of 2011 this trend continues, with steel companies raising US$23b in 60 issues.32 The largest single deal in the first nine months of 2011 was a follow-on issue by Gerdau that raised US$3.1b. Gerdau is using the proceeds to fund its investment program and strengthen its capital structure. Figure 13: Proceeds and number of issues by steelmakers by asset class in the first nine months of 2011
January-September 2011
IPOs* Follow-ons* Convertibles Bonds Loans Total * Domestic and inbound Source: Thomson Financial

Optimization of capital

Strategic cost reduction


A successful strategic cost reduction program is based on six tightly integrated elements:35 Strategic clarity the strategy of the organization and the capabilities and resources required to execute it are clearly understood Leadership alignment and commitment the leadership is visibly committed to achieving a single definition of success Focus on maximum value management maintains focus on achieving the maximum possible savings Operational performance benchmarked leading practices and breakthrough thinking are used to drive cost reductions Execution discipline an integrated benefits management system is used to promote disciplined execution of initiatives and identify and remedy low-performing initiatives Embedding cost optimization behaviours cost savings are sustainable in the long term by embedding cost optimization behaviors within the culture

Proceeds (US$m)
355 6,928 438 17,918 23,028 48,667

Number of issues
4 26

42 60 134

2. Le ad ers hip ali gn me nt an dc om mi tm en t

1. Strategic clarity

um xim ma on us Foc 3.

4. Operational performance 5. Execution discipline

Once funds are obtained, the extent of investment may also be subject to a number of potential problems or uncertainties. These include the changes in economic conditions, delays in completion or delivery, cost overruns, and defects in design or construction of a steel mill. Companies can minimize spend on a particular operation by either reducing equity through a joint venture or using a bilateral agreement with another company to share equipment and therefore achieve economies of scale. This can help to share risk and operating and capital requirements for a particular operation. In India, for example, Nippon Steel is in talks with Tata Steel to expand their Indian partnership. The companies have already agreed to form a high-end automotive steel joint venture in India and are now considering a blast furnace unit at an initial investment of around US$2b to US$3b.33 In China, ArcelorMittal is co-investing in the Chinese auto steel sector through two joint ventures with Hunan Valin.34

6. Embed cost optimization behaviors

lue va

31. Rising costs of finance to squeeze small and medium steel market players Eurometal, Reuters, 21 October 2011. 32. Data sourced from Thomson Financial Group. 33. Nippon Steel, Indias Tata Steel/ Conclude joint-venture contract for automotive cold rolled sheet, Japan Metal Daily, 11 January 2011. 34. ArcelorMittal China webpage, ArcelorMittal, http://www.arcelormittal.com/china/index_ en.asp, accessed 21 October 2011.

35. Margin protection: cutting costs not corners, Ernst & Young, 2009.

Competing for growth in the steel sector

18

There are various ways in which steelmakers can make cost improvements: Analysis of company cost trends versus major peers Implementation of leading-practice procurement Evaluation of the supply chain to ensure optimal efficiency Divesting high-cost operations Improving productivity Implementing sufficient program management Analyzing the opportunities for cost and benefits Ensuring the ongoing monitoring of benefits realization through a performance management system Sustaining cost reduction efforts Steelmakers that have successfully undertaken performance improvement and cost-reduction initiatives will benefit in the following ways: Reduced or rebalanced operational, infrastructure and management costs Improved balance between security and cost of controls Decreased revenue leakage Clearly identified and prioritized improvements within the supply chain Improved IT performance, from strategic alignment to day-to-day operations Better return on program investments Process transformation A cost-effective tax function that covers tax risks while focusing on optimizing tax liabilities and related cash flows Key questions for management
Informing your pricing Do you understand your true comparative position? Do you understand what drives your customers value assessment? How are your sales teams supported? Sustaining cost reduction Is cost reduction an ongoing strategic priority? Do you have a process to measure and monitor progress? Do you benchmark internally or externally? Optimizing your use of capital How will you fund your growth plans? How does your cost of capital compare with your competition? What options exist to reduce it? How do you control capital allocation? Optimizing working capital Do you have a process to monitor working capital? Do you measure the impact of changes on working capital? Are you measuring working capital as an issue across your entire supply chain?

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Global Steel 2011 trends, 2012 outook

Operational agility
While a companys potential opportunity is determined by the market it can reach, its growth is determined by its actual ability to produce and deploy products into that market more effectively than its competitors. How closely is management paying attention to the market, and how quickly can an organization respond to changes in the market? This is a challenge for the supply chain to attain operational agility. Steelmakers have had to seek ways in which they can improve their ability to deliver effectively in a fast-changing market, ranging from: Adjusting capacity utilization to respond to changing market conditions Enhancing the flexibility of their supply chain to respond to smaller but profitable opportunities Refocusing on innovation Therefore, steel companies will have to consider the trade-off between reducing costs and decreasing utilization to respond quickly to an upturn versus finding ways to balance optimal inventory levels without significantly increasing networking capital.

Adjusting capacity utilization to respond to changing market conditions

To adapt to a volatile environment, steel companies need to pair a dynamic outlook with flexibility in production. In developed countries, steelmakers have been disciplined in adjusting their capacity utilization to match market conditions. With the impact of the Eurozone debt crisis, several major European players are producing at reduced capacity utilization or have mothballed their less efficient operations across the region. This was done to adjust their production levels to the demand prevailing in the market. But this is easier said than done, as a temporary shutdown still requires care and attention; the decision to fully mothball a plant is even more serious, as it is very costly and time-consuming to restart a blast furnace. Logistical problems also may arise, such as the availability of raw material, staff on temporary shifts and how the production plan fits with the sales plan. In addition, the implications of capacity adjustment on cost base as well as working capital management and lead time delivery need to be considered. Figure 14: Production cutbacks by major European producers
Company
ArcelorMittal (AM)

Action AM to shutdown EAF facility in Sestao Spain during November and December 2011. The company is implementing US$1b asset optimization plans to shut down high-cost facilities and increase utilization at its lower-cost locations. AM Poland is running at 80% capacity utilization. AM has temporarily shut down an EAF facility and two rolling mills in Luxembourg. A German blast furnace was shut down by the company due to weak local demand.

SSAB Tata Steel Europe

The company has lowered capacity utilization to 80% in the wake of weak demand. The company stopped its tinning line in Wales for one week to adjust production to demand. The company has shut down one blast furnace at its Scunthorpe steel work in the United Kingdom. The company is operating at 80% to 85% capacity utilization.

Source: Factiva

In addition to carefully managing capacity utilization to match demand, plant optimization to adjust volume and save variable costs can be an alternative to a temporary or full shutdown of a steel plant. In some instances it may be necessary to divest loss-making assets. In early 2011 Tata Steel divested Teesside Cast Products in the United Kingdom to Thai company Sahaviriya Steel Industries (SSI). Tata Steel initially mothballed the plant in 2010, and most of its steelmaking operations were reduced. SSI plans to produce slabs that will be exported to Thailand.36

36. Thai takeover saves Teesside steelworks, Financial Times, 24 February 2011.

Competing for growth in the steel sector

20

Enhancing supply chain flexibility

While most steelmakers have adopted the principles of lean manufacturing, Kanban or just-in-time production, there is still room to focus on improving the flexibility of their supply chains. Steel players need to evolve into dynamic entities that are ready to respond to volatile raw material prices or uncertain demand for their products. In order to be flexible, companies have to carefully revisit the complete production value chain, even when the process conflicts with production concepts such as economies of scale. However, companies should cover the entire gamut of operations across the supply chain from procuring raw materials to flexibly managing production capacity to successfully catering to the new and dynamic economic environment. A single change in one part of the production value chain can have repercussions across the value chain. These can often be external events; for example, new regulations for minimum coal pricing in Indonesia will affect costs, supply chains, and the financial models of some steel players across the tax jurisdictions in which they operate. Steelmaker supply chains can also be affected by external events; for example, the fraud conducted by a few iron ore miners in Bellary region of India led to complete ban on iron ore mining and exports from India significantly affecting steel producers in India and iron ore prices globally. The supply chain can also be used as an enabler of margin enhancement in mature markets and as an enabler of growth in emerging markets (see Figure 14). For each of these dimensions (either enhancement or growth), there are primary challenges that need to be addressed: When looking at enhancing margins in developed markets, steelmakers should consider: Creating cost competitiveness Optimizing global spend Improving operational agility and responsiveness When looking at how to grow in an emerging market, steelmakers should consider: Establishing effective supply chain operating models and infrastructures Enabling new revenue sources Managing complexity and risk Figure 15: Supply chain With slow revenue growth in mature markets, the supply chain must create sustainable cost savings to support margins and to help pay for growth elsewhere.
Visibility and governance over total spend must be managed at the global level across the extended supply chain. Limited sales growth, increasing input costs, pricing pressures and lack of margin growth are challenging companies to operate differentiated cost-effective supply chains by market channel. Growth efforts must be protected against risks in emerging market countries, from poor supplier performance, financial instability, tax implications, quality issues, asset theft and fraud. The supply chain must partner effectively with the commercial side of the business to create an engine that enables growth in new markets.
Optimizing global spend Improving operational agility and responsi veness Managing environme ntal and sustainabili ty expectations

To be competitive, supply chains need to be more customer-centric and configured to balance the conflicting need of faster market response while reducing cost and cash flow.

Reconfiguring supply chain to create cost competitiveness Managing operational, tax and regula tory risk

Improved results

Increasing environmental and sustainability regulations will have a profound effect on supply chain network configuration. Companies need to turn this to their advantage.

Enabling new revenue sources

Establishing effective supply chain model and infrastructure

With companies seeking hyper-growth within emerging markets, ensuring an effective supply chain operating model within the constraints of poor infrastructure will be key.

The supply chain must enhance its core competency to become a strategic business enablement vehicle to drive top-line growth.
21 Global Steel 2011 trends, 2012 outook

Key questions for management


Accelerating your processes How well do you know your customer and monitor changes in demand? How fast are you compared to your competition? How do you identify and eliminate inefficiencies? How do you evaluate the players in your supply chain? How well do you use your management information systems and data? How well-integrated in your IT systems are your suppliers and customers? Enhancing supply chain flexibility Have you considered taking sales and operations planning beyond the supply chain to become demand-driven and financially oriented? How will this fit with your existing manufacturing footprint? What is the role of IT in optimizing your operational flexibility? To what extent was your supply chain able to respond to the last change in demand from your customers? How flexible is your supply chain from supplier choice through manufacturer to customer? Can you out-execute your competitor to drive change through the organization? Re-engineering your business model How much effort do you spend on your continuous improvement processes, especially in the business support functions? Are your service functions aligned? Are your business units flexible enough to add or reduce functions on demand? Do you have the in-house capability to assess the organizations business model effectively?

Improving innovation management How does your innovation process work? How are your stakeholders involved in this process? Are there new and specific implications for innovation and innovation management? Who is in charge, and are they dedicated to leading this process? Do they have the support of the management? Have you designated funds to develop new products and services?

Competing for growth in the steel sector

22

Stakeholder confidence
Trust has been a major victim of the downturn both externally and internally and the perception of risk has increased. Consequently, the area of stakeholder management has been one of the biggest areas of change in how companies compete. Whether through choice or external demand, businesses are moving from a compliance mind-set to managing their stakeholders more proactively.

Carbon taxes According to the International Energy Agency, the iron and steel industry accounts for approximately 4% to 5% of total world CO2 emissions.37 Therefore, the imposition of carbon taxes is an important issue in the sector and can have a significant impact on steelmaker margins. Two examples of recent developments in carbon schemes that affect steelmakers are in Europe and Australia: The targets set under the emissions trading scheme for 20132020 for the EU have been challenged by the European steel industry body, EUROFER, at the European Court of Justice. The body argues that the EUs increasingly stringent, and in this case potentially unachievable, carbon rules will drive steelmakers to set up in countries in emerging markets where there are no emissions caps and trade rules. Australia recently passed the Clean Energy Bill which will become law from 1 July, 2012. At that time, polluting industries will pay US$23 per tonne of carbon emissions. The Government has introduced a Steel Transformation Plan (STP) that would make a fund of US$300m available over four years to the major steelmakers to help with pay carbon costs. Introduction of resource taxes on raw materials The introduction of resource taxes will have an effect on the cost of raw material inputs. For example, Australia, as a major exporter of both iron ore and coking coal, will be introducing a Mineral Resource Rent Tax (MRRT) on iron and coal operations from 1 July, 2012 at a rate of 30% (22.5% after the extraction allowance). Land acquisition in India Both Indian and foreign steel majors are planning many greenfield and brownfield capacity extension projects, but their execution and implementation can be difficult. For example, the greenfield projects to be set up by ArcelorMittal and POSCO have still not broken ground five years after the steel plant was proposed. The major stumbling blocks relate to land acquisition, mining leases, forest clearances, and relief and rehabilitation (R&R) policies.

Identify and explain risk

Following the financial crisis, the perception of risk has increased. Stakeholder confidence starts with risk and, more explicitly, the processes that a company puts in place to identify and explain the risks that it faces. Internally, management needs robust systems of risk mitigation and management, but many analysts will also heavily emphasize the clarity of risk explanation in forming their views on investment. Leading steelmakers are doing significantly more to identify, explain and address the risk that they see in their market. The development of a long-term strategy goes a long way to ensuring that the business acts in the interests of all stakeholders, investors, customers, employees and market participants. It also allows the identification of risks associated with the strategy. Some risks facing steelmakers may include political risk, market risk (e.g., price volatility and cyclical demand), operational risks and financial risks.

Regulatory activity

It is necessary to anticipate the regulatory changes, both as a defense and a source of opportunity. Management also needs to spend time communicating with the key stakeholders. Dialogue with investors and regulators to help them understand the steel companys market, strategy and performance seems to be rewarded. Some regulatory activities that affect steelmakers include: Carbon taxes Introduction of resource taxes on raw materials Regulation on land acquisition in India Trade tariffs

37. Steels contribution to a low carbon future, World Steel Association, 1 November 2011.

The competition for capital is tough; the competition for confidence may be tougher.
Francis Small Partner, Transaction Advisory Services, Ernst & Young United Kingdom

23

Global Steel 2011 trends, 2012 outook

While such challenges are common to large projects in several parts of the world, India has the following specific issues: Land required for large projects comes into conflict with Indias social set-up almost 70% of its land is covered by agriculture and forests, further accentuating the lower land-to-land population Certain inadequacies in the land acquisition regulations (e.g., definition of public purpose, compensation benchmarking, coverage of displaced persons) Divergence between state and central legislation and procedures The Government is seeking to work out solutions in keeping with its inclusive growth agenda and is already addressing some of these complex issues. The sector is also consciously moving to obtain a social license to operate by supporting community development and would be well-advised to address longer-term sustainability issues. Trade tariffs parallel importing Trade tariffs and quotas applicable in certain countries need to be considered when evaluating both risks and opportunities. The imposition of trade tariffs by governments to protect domestic steelmakers may affect where a steelmaker chooses to sell its products. In addition, in some regions like the European Union, quotas are imposed on imports from countries that are not members of the World Trade Organization (WTO). For example, current quotas for Kazakhstan amount to 0.2 million tonnes a year and 3.2 million tonnes for Russia. These quotas would lapse when these countries join the World Trade Organization.

Enhance reporting

Steelmakers are seeking to improve the transparency and frequency of corporate communication on their performance with stakeholders. High performance in this area seems to result from identifying risk and practicing risk management, adding nonfinancial performance measures and significantly increasing coverage of environmental and corporate social reporting issues. A significant number of global steelmakers issue sustainability reports on a regular basis.

Re-engage with internal stakeholders

The re-engagement with internal stakeholders most critically the talent of the company will benefit overall performance. The Ernst & Young Competing for Growth Survey showed that while high- performing companies face significantly higher labor cost inflation, this is largely because they are focused on attracting and retaining key talent. High-performing companies reacted differently to the downturn than their competitors. Cutting headcount was not a top response, and alternatives were actively explored. Consequently, these companies have seen less disengagement from their workforces and have less distance to recover. Today they are rewarded by facing the challenge of growth with the talent to attain it. During the financial crisis, many steelmakers used innovative ways of keeping their employees onboard. In Europe, steel producers introduced reduced working hours as a means to cut costs and avoid laying off staff. US Steel in Slovakia introduced a four-day working week. Employees were given Fridays off but received 60% of their normal wages for that day. The plant also changed its scheduling and is producing the same amount of steel with fewer workers.38 Key questions for management
Risk Have your risk profile and appetite changed? Are controls optimal for the current business environment? How confident are key stakeholders on risk management effectiveness? How are decisions being communicated? Reporting How does your reporting compare to your peers how transparent do you appear? Are reporting changes fully understood and evaluated? Are you involved in influencing the outcome of consultation processes, either directly or indirectly? Re-engagement How do you measure the engagement of your workforce? How does your workforce morale compare with your competitors? How loyal is your key talent? Regulation Are the implications of regulatory change being monitored, and is their impact on the business model being considered? Will they affect operational agility and cost base? Is the regulatory framework in new markets properly understood?

38. US Steel Kosice cuts work week, maintains current output, Steel Business Briefing, 27 January 2009.

Competing for growth in the steel sector

24

Outlook for 2012


The outlook for 2012 remains cautious. Despite a good start to 2011, the global economy entered an uneven and uncertain territory in the second half of the year. Global industrial activity has weakened, and confidence has fallen on account of financial turbulence in the Eurozone, weak private demand in the United States, and events in Japan and the Middle East.39 Emerging markets are also affected by the current economic slowdown, particularly when reliant on export income from developed markets. Inflation is an issue in many emerging markets, and governments are lifting interest rates. According to Global Insight, global real GDP is expected to grow by 3.0% in 2012, compared to 4.2% in 2010.40 In 2012, the global steel industry is expected to grow, albeit at a lower rate. Global steel production is expected to grow at a CAGR of 2.6% by 2015; however, the growth is expected to be at around 6.7% in 2012.41 Steel demand will vary depending on the outlook for different regions and countries. Steel demand in developed regions such as the North America and Europe is forecast to be lower, but stronger economic growth in China, India, Brazil, Russia and South Korea indicate the likelihood of stronger steel demand from these regions. Figure 16: Outlook for steel production and consumption to 2015

Source: Bureau of Resources and Energy (previously ABARE), Ernst & Young analysis, December 2011
39. World Economic Outlook: Slowing Growth, Rising Risks, IMF, September 2011. 40. Global executive summary the global recovery at a dangerous juncture, Global Insight, October 2011. 41. Resources and energy quarterly, Bureau of Resources and Energy Economics, December 2011.

With an uncertain economic outlook, finding a framework that can aid steelmakers in dealing with volatility, manage risk and increase overall cost competitiveness is increasingly important.
Angie Beifus Senior Mining & Metals Analyst, Ernst & Young

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Global Steel 2011 trends, 2012 outook

Steel consumption in both Europe and the United States will be affected by the weak economic environment in the region. A reduction in government spending and decreased investment into infrastructure will lead to growth in 2012 of about only 1.0% in the European Union and 1.8% in the United States.42 This low growth is largely due to decreased economic activity and lower investment in these regions. As a result, the steel sector is forecast to grow by only 2.5% in Europe and around 5.0% in the North American Free Trade Agreement region. Figure 17: Developed markets growth in steel consumption compared to economic outlook

Developed markets Europe and the United States

Source: Short-range outlook, World Steel Association; World Economic Outlook, IMF, September 2011

China

Chinas economic policies to contain inflation have led to a cooling in the countrys industrial production. As a result, GDP growth, an indicator of steel consumption fell to 8.2%43 in Q3 2011 after growing by around 10.3% during 2010. The World Steel Association estimates that apparent steel consumption in China is expected to grow by 6.0% in 2012, down from growth of 7.5% during 2011. Continued growth in steel consumption is expected to be supported by programs to expand infrastructure and social housing construction.44

India

As we reported in our 2011 Steel Report, India next landmark on the global steel landscape, India represents the new growth frontier for global steelmakers. The Indian economy is better insulated from the global economy than other Asian countries because it does not rely heavily on exports to the developed market. However, in the globalized environment, no economy is completely decoupled from the world economy. In addition, GDP growth in 2010 and 2011 was hampered by the 13 consecutive interest rate hikes aimed at curbing inflation. In an effort to curb inflation, policy- makers and regulators have adopted policies that slow down the real economic activity in the economy. However, economic fundamentals high savings and investment rates, demography, and a rapidly growing middle class remain strong in India, which will ensure a relatively stable economic performance for the country. The following table summarizes various forecasts for GDP growth, which of late, have been lowered.

42. World Economic Outlook: Slowing Growth, Rising Risks, IMF, September 2011. 43. Data insight, Global Insight, accessed 12 December 2011. 44. Resources and energy quarterly, Bureau of Resources and Energy Economics, December 2011.

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GDP growth (% y-o-y) (forecast)


2010 2011 2012

EIU
8.8% 7.9% 7.8%

Global insight
8.8% 7.5% 7.7%

IMF*
10.1% 7.8% 7.5%

Source: Economist Intelligence Unit, via Thomson (*EIU numbers are for the financial years 201011, 201112 and 201213, respectively)

The slower economic cycle is expected to have a bearing on steel production and consumption as well. Despite the weak cues from the global economy, India is expected to perform better due to the domestic consumption of steel both for building infrastructure as well as demand for consumer durables from a growing middle class. Crude steel capacity is also expected to increase in the next two to three years as large expansion projects are commissioned.
Steel growth (% y-o-y) (forecast)
FY11* FY12F FY13F

Production
7.9% 15.3% 13.4%

Consumption
9.9% 9.0% 10.0%

Source: Indian Steel: geared to ride in turbulence, Nomura, 22 June 2011, via Thomson One *FY= Financial year in India, i.e., FY11 is April 2010- March 2011

However, the Indian steel sector needs to address its own opportunities and challenges, some of which are unique to the country. While issues around social licences to operate and growing resource nationalism are visible in most developing economies (and many developed countries as well), their impact on the growth of the Indian steel sector is more profound at current times. These include land acquisition issues and complicated regulatory procedures. Inadequate infrastructure, while a current challenge, also provides a significant market opportunity. Indias iron ore resources and surplus iron ore production are significant strengths that have not been fully leveraged by the steel industry. This strategic advantage, coupled with expected demand growth, makes it an attractive investment destination for global majors. However, success has eluded most of them, with little progress on the implementation of most greenfield plants. Despite this, India continues to be on the radar for most global players for retaining growth.

South Korea

The steel industry in South Korea is expected to experience competition among domestic steelmakers. The largest steel producer in the country, POSCO, is moving forward with its domestic and global expansion plans, and domestic output in the country is expected to grow to 74.1 million tonnes in 2012, a 4.0% year-on-year increase. On the other hand, nominal consumption in the country may remain flat at 57 million tonnes, indicating a fall in imports and a further rise in steel exports, leading to pressure on steel products. Korean steelmakers, who import almost 100% of their raw material requirements, will benefit from falling raw material prices, but domestic competition, coupled with global uncertainty, may cap any margin improvement.

Brazil

Currently, Brazilian steel producers are under pressure as they are not able to raise prices due to strong demand for cheaper steel produced from countries like China and Turkey. The Brazilian currency has risen about 90% from 2009, which has increased imports in the country, forcing local producers to slash prices to retain market share. The short-term future for the Brazilian steel industry appears challenging, as a tighter credit cycle will slow down the manufacturing industry and further increase the supplyside pressure on steel manufacturers in the region. Moreover, steel mills in Brazil export a significant portion of their production to Europe, where the markets are weakening. A slowdown in domestic steel consumption, higher raw material prices, increased imports from China and Turkey, and fewer exports to Europe could lead to a challenging year for the Brazilian steel industry in 2012.

Russia

In Russia, the steel industry is grappling with high inflation, tight credit cycles and high interest rates. The gap between production and domestic consumption is growing and is expected to be more than 33 million tonnes in 2011. In light of slower GDP growth expected in the region during 2012, the Russian steel industry may feel the heat of oversupply and steel product pricing. Despite the economic slowdown, major steel players in Russia are going ahead with their expansion plans, which will boost production in the country to around 85 million tonnes by 2013. However, apparent steel consumption may only rise to 43 million tonnes by that time, indicating that the Russian steel industry may face a massive oversupply in the very near future.

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Global Steel 2011 trends, 2012 outook

Combatting over-capacity

Over-capacity will continue to be an issue with increased capacity in the rapidly growing economies coming online. With government rationalization unlikely to occur in the short term, successful steelmakers will need to become more nimble in their approach to changing market conditions. This will occur with improved technologies, lower cost structures, more vertical integration and greater partnering with key customers. Factors like demand location, labor costs, cost of carbon and cost of energy will all be strategic drivers of where steelmaking capacity will be in the future a bid to maintain viable margins. Figure 18: Global steel capacity vs. supply vs. demand
2,000 1,800 1,600 1,400 Million tonnes 1,200 1,000 800 600 400 200 0 Capacity Production Consumption

2003

2004

2005

2006

2007

2008

2009

2010

2011e

Source: ABARE, Worldsteel Association, JPMorgan and Ernst & Young analysis

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Appendix: Global steel market update


A story of two halves and two markets
The global steel industry witnessed steady growth during 2010 and 2011. This growth has been driven by increased demand from key steel end-user industries including infrastructure, construction and automotive, especially in the emerging markets. 2011 began with a positive outlook as fears of a double-dip recession declined. However, in the second half of 2011, the global economy entered an uneven and uncertain territory. According to the International Monetary Fund (IMF), global industrial activity has weakened and confidence has fallen on account of financial turbulence in the Eurozone, weak private demand in the United States, and events in Japan and the Middle East. The focus is on emerging economies, especially in markets that can withstand the effect on output of weaker foreign demand. Through the end of 2011, emerging markets are estimated to grow at 6.5%, in contrast with the 2.5% growth expected in developed economies.

Change in global economic outlook in 2011


January 2011 World GDP growth
Two speed recovery; subdued growth in advanced economies and increased activity in emerging economies Private demand is replacing public demand

September 2011 World GDP growth


Slower than expected recovery in advanced economies

Economic recovery is uncertain

Financial environment continues to improve albeit slowly Source: World Economic Outlook, IMF, January, April and September 2011

Fiscal and financial uncertainty in the developed economies, pronounced after August 2011

Global crude steel consumption trends

Despite the stimulus packages announced, steel consumption in developed markets, such as European countries and the United States, has not recovered to pre-crisis levels, and the majority of the improvement in crude steel consumption comes from emerging markets. The growth in 2011 can be segregated in two halves. In the first half of 2011, global steel consumption grew relatively faster, underpinned by infrastructure construction and manufacturing activity. In the second half of 2011, steel consumption is estimated to be lower than in the first half due to moderate economic growth in China, the United States and Europe. In 2012, according to the World Steel Association, global steel consumption is estimated to increase at approximately 5.0% to reach 1.4 billion tones, after increasing at around 6.0% in 2011.

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Global Steel 2011 trends, 2012 outook

Global crude steel consumption

2010

Recovery in steel demand due to fiscal stimulus and restocking

2011

Economic uncertainty in Europe and the United States; steel demand expected to increase by 6%

2012
Source: World Steel Association (World Steel), Ernst & Young analysis, 2011; (*f: forecasted and *e: estimated)

Majority of growth in steel demand to occur in China and India

Developed versus emerging countries apparent steel usage

The emerging markets have underpinned growth in steel usage, with crude steel consumption in China, India and Brazil growing considerably. In 2011, Chinas consumption is expected to grow by 4.7% y-o-y and has increased by a CAGR of 4.9% since 2009. India and Brazil have also enjoyed substantial consumption increases since 2009. Steel consumption in India and Brazil is estimated to increase at a CAGR of 10.9% and 23.4%, respectively, between 2009 and 2011. There is some debate between steel market analysts regarding the extent of demand growth from China. Some foresee slower growth as the Chinese Government tries to moderate its overheating economy. Others think it is just as likely that the Chinese Government will keep its 8% GDP growth target in the medium term, which will mean that both investment in infrastructure projects and private spending will continue.

Source: World Steel Association (World Steel), 2011

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Recovery in global steel production driven by growth in China and India

In 2011, world steel production is estimated to increase by 7.0% y-o-y, underpinned by growth in China and India, to reach around 1.5 billion tonnes. However, the growth of Organisation for Economic Co-operation and Development economies is expected to be stagnant or modest at best. Global steel production is expected to grow by another 7.0% in 2012. In early 2011, there were major concerns that the rapid growth of Chinas steel production was putting pressure on international steel markets due to the impact of demand on key raw material inputs. Steel prices rallied in the first half of 2011 due to raw material cost escalation. The cost-push rally is because cost prices have been rising faster than the steel prices, thus squeezing the margins of steel players. Chinese crude steel production in the first half of 2011 increased about 10% to reach 353 million tonnes and was expected to continue to increase at a moderate pace in the second half of 2011 in response to slower consumption growth in the country. Growth in Chinese steel production has changed the country from a net importer of steel to a net exporter of steel. The various provincial governments in China view investment in steel as way to promote growth in GDP, employment and tax revenues. Additional capacity has been supported by both international and domestic demand. The Indian steel sector has grown significantly during the last decade, registering strong demand in the last five years. Indian crude steel production in the first half of 2011 increased about 4.0% y-o-y to 35 million tonnes. Overall, the y-o-y production growth in 2011 is expected to increase at a healthy rate of 7.0%. The country is expected to produce about 72 million tonnes of crude steel in 2011. The growth is expected to increase further as new steelmaking capacity is added by various steel producers to meet the growing demand. Other emerging economies, such as South Korea and Taiwan, are installing newer steel capacities, which will result in decreased dependence on imported steel to meet the domestic steel consumption in these respective countries. These markets are suited to withstand the current economic scenario because their economies are less dependent on foreign demand.

Global crude steel production trends

Source: BREE September quarter 2011, World Steel Association (World Steel), Ernst & Young analysis; (*f: forecasted and *e: estimated)

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Global Steel 2011 trends, 2012 outook

Global capacity utilization trends

The steady rise in steel demand in 2011, especially in the emerging markets, indicates that capacity utilization levels are expected to average about 80%. Steelmakers are predicting a more stable recovery of demand in 2011, and it is likely that global capacity utilization rates may inch back toward the highs of 2007 and early 2008.

Source: Chronic oversupply hits cyclical headwinds China Steel sector, JPMorgan, 6 August 2011, via Thomson ONE; (*f: forecasted and *e: estimated). Source: World Steel Association (19802009A, 2010P=preliminary data), Ernst & Young estimates.

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Authors
If you would like to discuss any of the content within this paper, please contact one of our authors.

Anjani Agrawal
Indian Mining & Metals Leader Tel: +91 982 061 4141 anjani.agrawal@in.ey.com

Michel Nestour
EMEIA Mining & Metals Transactions Leader Tel: +44 20 7951 4936 mnestour@uk.ey.com

Pierre Mangers
Leader, Ernst & Young Luxembourg, Advisory Strategic Direction, Metals and Cleantech Tel: +61 8 9429 2216 pierre.mangers@lu.ey.com

Angie Beifus
Senior Analyst, Mining & Metals Tel: +61 2 9248 4032 angie.beifus@au.ey.com

Subhashish Sarkar
Strategic Market Intelligence, Mining & Metals Tel: +91 124 470 1703 subhashish.sarkar@in.ey.com

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Global Steel 2011 trends, 2012 outook

Ernst & Youngs Global Mining & Metals Center

With a strong but volatile outlook for the sector, the global mining and metals industry is focused on future growth through expanded production, without losing sight of operational efficiency and cost optimization. The sector is also faced with the increased challenges of changing expectations in the maintenance of its social license to operate, skills shortages, effectively executing capital projects and meeting government revenue expectations. Ernst & Youngs Global Mining & Metals Center brings together a worldwide team of professionals to help you achieve your potential a team with deep technical experience in providing assurance, tax, transactions and advisory services to the mining and metals sector. The Center is where people and ideas come together to help mining and metals companies meet the issues of today and anticipate those of tomorrow. Ultimately it enables us to help you meet your goals and compete more effectively. Its how Ernst & Young makes a difference.

Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. 2012 EYGM Limited. All Rights Reserved. SCORE Retrieval File OC00000170 1112-1316449 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. www.ey.com/miningmetals

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