Capacity consolidation will improve cost efficiency of steelmaking

Well before the unmanageable surplus capacity and unrestrained exports by China came to be seen as the bane of the world steel industry, experts, including Lakshmi Mittal, prescribed "capacity consolidation" as the principal remedy for many of the ills of the industry. To the extent that capacity has been brought under a single umbrella, the experiment has given good results in India.

Sajjan Jindal-led JSW Steel has been at it since 2004, when it acquired long products maker South Indian Iron & Steel (SISCO) from Lakshmi Machine Works. Capacity expansion followed the merger, giving the unit economies of scale and sorting out coke and iron ore supply issues. Nearly half a decade later, JSW acquired and then merged with itself a highly debt-ridden Ispat Industries, owning a 3.3 million tonne hot-rolled coils plant. On completion of that merger, Jindal said, the development "will give us a lot of synergy in operation and economies of scale. We can now go for brownfield expansion at Vijaynagar in Karnataka (where JSW has large operations) and Dolvi (where the Ispat plant is) in Maharashtra."

But what good capacity consolidation could do is best exemplified by the central government taking over a collapsing IISCO in 1972 and subsequently making it part of Steel Authority of India Limited (SAIL). Now, instead of steel being made using the globally-discarded twin-hearth technology at IISCO's Burnpur plant, there is a new 2.5-million tonne (mt) mill equipped with one of India's largest blast furnaces of 4,160 cubic metres.

The phoenix-like rise of IISCO or JSW returning the two bought mills to normal working are what consolidation under a resource-rich and strong management could achieve. India requires more of this.

A steel market marked by weak prices cannot sustain sick capacity that resulted from bad management and funds leakage. This has left quite a few mills ripe for takeover. But the ranks of potential bidders for sick assets have thinned as the steel outlook is not likely to improve soon. The joint lenders forum is telling steel companies that are unable to service loans to get new investors and sell non-core assets to pare debts. From some of the leading steel groups to many upstart mills, all remain responsible for the industry's bank debts climbing to around Rs 3 lakh crore.

In China, consolidation is seen as an integral part of restructuring of the crisis-ridden steel sector. The 1.2-billion tonne (bt) Chinese steel industry is nursing over 300 mt idle capacity. This enormous capacity overhang in the world's largest steel-producing country and an identical amount outside China, combined with a forecast that global demand will fall 0.8 per cent in the current year to 1.488 bt, are responsible for keeping prices low, notwithstanding sporadic but unsustainable improvements.

To placate criticism for not doing enough to eliminate surplus capacity, Beijing has announced shaving of 150 mt capacity by 2020, including 45 mt this year. Projected as part of this programme, two central enterprises, Baosteel and Wuhan Iron & Steel, with crude steel production of 34.93 mt and 25.77 mt, respectively, in 2015 have begun "strategic restructuring" talks, which will hopefully result in a merger and subsequently to elimination of redundant assets and cost cutting. Many watchers are, however, pointing to high execution risks relating to consolidation of financially-strong Baosteel and debt-ridden Wuhan. Consolidation will gain pace if the third centrally-owned Ansteel group (with 2015 crude steel output of 32.50 mt) joins the Baosteel-Wuhan union. China has at least one bad experience with consolidation, when Hebei Iron & Steel was formed. The merger has not yielded the desired result by way of elimination of non-performing assets, as the units which came under the Hebei umbrella doggedly refuse to surrender their independence. The silver lining, this time, is the Chinese Prime Minister Li Keqiang's firm declaration of the state's intent to eliminate overcapacity in coal and steel with funds in place for rehabilitation of workers who would lose jobs.

Consolidation offers merged entities the benefits of synergy between the joining units, cost reduction, efficient logistics management and a bigger pool of knowledge. ArcelorMittal epitomises what consolidation can achieve. Consolidation success will, however, be ensured if the managements of merging units do not pull in different directions.