Financial Daily from THE HINDU group of publications
Saturday, Feb 23, 2002
Industry & Economy - Steel
Excess capacity in steel industry -- Easy money the main culprit
A. S. Firoz
EXCESS capacity is at the root of the steel industry's problems worldwide. The recent OECD talks were more or less centred on this understanding, and concrete action is being proposed to eliminate the estimated excess capacity. While the identification of such capacities may prove difficult for the OECD, the organisation's overall understanding of the malaise itself seems faulty.
There is no clear estimate of the excess capacity, except that it is substantial. One reads of numbers in excess of 150 million tonnes of crude steel. However, many working on the subject have refused to go beyond 75 million tonnes. That is about 8.9 per cent of current production, and 9.1 per cent of consumption.
In any industry automobiles, capital goods, shipbuilding or passenger aeroplanes the corresponding number is likely to be much higher. In the worst-case scenario, assuming an excess capacity of about 150 million tonnes, the numbers would double. In the last few years, capacity utilisation in the industry hovered in the 91.1-94.9 per cent range, with 92.2 per cent being estimated for 2001. These could be dream numbers for many other industries, but not for steel. By its very nature, the steel industry needs to keep capacity use to the maximumWhile fuller capacity utilisation may be ideal, newer technologies also offer substantial flexibility. Over the years, the share of the mini-mills, known for their flexibility in operation and the ability to break even at lower capacity utilisation, has been on the rise. Statistics show that the steel industry worldwide has always had significant surplus capacity. But the problem has taken a slightly different form in recent years. According to the estimates of the World Steel Dynamics, the world's leading steel information service, the effective crude steel making capacity worldwide increased from about 841 million tonnes in 1997 to 907 million tonnes in 2001.
This involved an increase of effective excess capacity from 42 million tonnes in 1997 to 66 million tonnes in 2001. More important, against this 66 million tonnes of effective capacity expansion, annual consumption grew only 33 million tonnes. This is the first major problem. There is an urge to keep the operating rates high when the market is not as large.
The real problem in the industry comes after that. Despite the low growth in consumption, the competitive forces in the market led to excess production. The annual production increased from 799 million tonnes in 1997 to 840 million tonnes in 2001 that is, by 41 million tonnes.
In the process, in 2000 and 2001, the industry globally produced 13 million tonnes and 14 million tonnes of extra crude steel. All this was added to the stock the market carried from earlier years. And this excess production was responsible for the unprecedented turmoil in the market.
While there is no refuting the above, linking excess production to excess capacity and trying to seek remedies for the industry's current problems only through capacity cuts may not be the right step.
One has to go into the factors that create and recreate those conditions that perpetually bring excess steel into the market. It is the soft budget constraint that the industry has been faced with, at least till recently, that has been largely responsible for perpetual excess production of steel globally.
The soft budget constraint syndrome, manifest in the easy availability of funds from banks or the equity market (for investment in projects as well as for day-to-day operations) in total disregard of the profitability of the operation, makes it possible for firms to slash prices in competition. In a fixed price regime, as prevailed in the erstwhile socialist economy, the problem is seen in the firm's lack of interest to reduce cost and achieve higher levels of efficiency.
While the soft budget constraints are not specific to the steel industry alone, the fact that the output in this industry has been maintained at high levels despite falling and unprofitable prices shows that, like many other industries, steel is also a victim of this malady. It is also important to note that the massive capacity cuts and bankruptcies took place in the US only after the lifeline funding for steel companies was cut.
It is the abundance of capital to invest that was at the root of the easy availability of funds to the industry. For years, it looked more attractive to invest in steel, despite the well-known fact that the industry had excess capacity. Where else could the capital go? Even today, there are investors eager to put their money in steel despite the current crisis. It is a fact, however, that such ventures are fewer today.
Let us assume that certain capacities are closed. The question is: Where will the equipment go? Will it be destroyed totally so that it cannot be reused? If not, it may find its way to another country, or even to someone else's premises to be reused once again by some enterprising person, who might draw up a financial proposal for bank funding for the project!
If one goes by the efficiency criterion, again, the question is: Which of these capacities could be termed inefficient? Can one ask a steel rolling mill or an electric furnace in remote Africa to shut down because it cannot match the operational or cost efficiency of a plant in, say, Japan or Europe? This will not work.
Also, investment in steel is region-specific. For example, irrespective of whatever happens in the rest of the world, any project in China may look attractive. The project may not even be competitive but, just because there is abundant capital, capacity addition may take place.
This may also happen in Russia, where global funds may head that way with the impression that steel production is more competitive there than anywhere else. Very little can be done about such investments until global capital resources find more attractive destinations.
All talk of capacity cuts, therefore, will have to be seen alongside the issues related to fresh investment and operating finance for steel companies. It may be easier to operationalise remedial measures in the area of finance than to resort to complicated exercises to identify surplus capacities and have corporates close them down.
(The author is Chief Economist at the Economic Research Unit, Joint Plant Committee. The views are personal)
Send this article to Friends by E-Mail
Stories in this Section
The Hindu Group: Home | About Us | Copyright | Archives | Contacts | Subscription
Group Sites: The Hindu | Business Line | The Sportstar | Frontline | Home |
Copyright © 2002, The
Hindu Business Line. Republication or redissemination of the contents of
this screen are expressly prohibited without the written consent of
The Hindu Business Line