BC: STEEL 101
Analysis: Mergers of the doomed
WASHINGTON, Dec 05, 2001 (United Press International via COMTEX) --
Steel making is a classic high capital requirements, high fixed cost, commodity-producing business, which is additionally bedeviled by the tendency of Third World countries to think they need a steel company. Like railroads, shipping or airlines, in other words. Don't put your money there.
This is the basic economic reality forcing the potential merger announced Tuesday between U.S. Steel and Bethlehem Steel, as well as the business tie-up announced Wednesday between Nippon Steel and Japan's No. 5 steel company, Kobe Steel. Decade upon decade, the business simply does not return investors enough to cover its cost of capital.
As is well known, steel is a hugely capital intensive business. It is also labor intensive; for example, Bethlehem Steel's employment costs in 2000 were 32 percent of sales. Since a steel mill, once built must be operated at close to full capacity to be cost effective, and is totally immobile, local labor unions are able to seize the opportunity at a steel mill site to force up wages. In addition, in U.S. steel mills, pension obligations are a huge burden, with Bethlehem, for example, having $3 billion of un-funded pension and health care obligations in November 2000, even after the huge bull stock market of the 1990's.
Hence the most efficient countries in which to locate a steel mill are those in which capital is cheap, labor costs low and labor unions weak. In addition, since there are substantial economies of scale in steel manufacturing, even with modern "mini-mill" technology, the company needs to have a large "domestic" market available, in order that it can run at sufficient scale to operate at competitive costs.
Naturally, these requirements cut across one another. In India, for example, labor costs are low, but the unions are very strong. Hence the Steel Authority of India, India's largest (state-owned) steel company, makes huge losses. Likewise, where capital costs are high, as in Brazil, steel companies also lose money, in spite of being located close to exceptionally large and cheap supplies of iron ore. In Europe and the United States, on the other hand, capital costs are relatively low, but strong unions and expensive labor remove the benefits of this advantage. Hence, in these countries, the industry is heavily protected, with "antidumping" suits brought against foreign steel-makers that appear to have a cost advantage, and their imports thereby kept out of the domestic markets.
Even where natural capital costs are high, and the domestic market small, steel mills have still been built. Third World countries generally want to have their own steel company and, in the past, the international lending institutions have been willing to provide them with low cost capital to enable them to have one. Venezuela, for example, has a domestic market only about half the size necessary to absorb the output of its steel company SIDOR, yet the company was developed with World Bank and international loan capital in the 1970's, and was located around 600km from even the major domestic market, up the Orinoco River. A further difficulty for the company was that the trucking unions lobbied to prevent the company building a river port to ship out product, so steel products had to be trucked to market across a mountain range, on difficult roads. Naturally, the company was hugely loss making and subject to repeated debt defaults when oil prices dropped in the mid 1980's and Venezuela could no longer afford such expensive toys.
This pattern was repeated in country after country across the Third World, most of which had domestic markets far too small to use the output from a plant of economic scale. Consequently, when world steel prices dropped, the companies defaulted, and creditors lost their money.
However in these cases the steel plants, which of course still existed, essentially lost their capital cost. At this point, with relatively cheap Third World labor, it became possible for them to undercut competitors on the world market, and keep the world price of basic steel products continually depressed. Most such plants still lost money, even with their capital costs written off, but they provided relatively well paid jobs, and that was what counted for the local politicians.
U.S. steel producers argue that, while the business in the U.S. will never be economically attractive, it is strategically essential. This is 19th Century bunkum -- steel is of course necessary for 21st century weaponry, as it was for 19th, but so are many other materials, most of which are in much shorter supply. If the U.S. steel industry were to close down tomorrow, steel for military uses would be obtainable from Canada and Mexico, both of which are at least theoretically staunch U.S. allies with much lower labor costs. Only if U.S. foreign policy were so catastrophically bad that the country found itself fighting World War IV without any allies whatever would steel availability become a problem, and by that stage it would be pretty low on a very long list thereof.
U.S. steel making can therefore be allowed to die, to the extent it is unprofitable, with the capital returned as far as possible to shareholders and the steel mill sites turned into industrial archaeology theme parks. To this end, it would be desirable if U.S. Steel were to carry out a cash takeover of Bethlehem Rather than a merger. Such a cash takeover would return useful cash to Bethlehem stockholders, and thereby de-capitalize this dying industry.
Leave steel making to Japan, with the cheapest capital costs in the world (of both debt and equity) and a docile workforce, and to South Korea, with relatively cheap capital costs and a workforce that is both docile and relatively cheap. Allow Third World countries to play at steel making if they want -- it keeps the world price down -- but don't lend them the money to do so.
Like the airlines, a deeply unattractive industry that seems fated to soak up U.S. capital, so steel making can then be a deeply unattractive industry that soaks up Japanese and South Korean capital. Smart shareholders will avoid both money-pits.
By MARTIN HUTCHINSON, Business and Economics Editor
Copyright 2001 by United Press International. |
