Steel's Dilemma

Dec. 21, 2004
Import complaints and bankruptcies mask structural problems that integrated steelmakers must address to survive.

On the face of it, the U.S. steel industry is maintaining its role as an industrial powerhouse. Only twice in the last 30 years -- in 1973 and 1974 -- have steel shipments in the U.S. reached higher levels than they have in the last five years. In 2000 U.S. steel shipments were at their highest level since 1981. What's more, the U.S. share of worldwide raw-steel production couldn't be more consistent. It was 12% last year and has fluctuated between 10.5% and 12.8% over the last 18 years. So why have 10 steel manufacturers in the U.S. declared bankruptcy since December? Worldwide overcapacity, devalued currency in other countries coupled with a strong U.S. dollar, skyrocketing natural gas prices, and a struggling domestic economy have exposed internal structural problems at U.S. integrated steel manufacturers. But rather than focusing their energies on fixing those problems, the integrated steel producers are arguing -- as they have for many years -- that the illegal dumping of steel from other countries is at the root of their troubles. "The industry needs a sustained period of import stability. That is the one fundamental issue," says Andrew Sharkey III, president and CEO of the American Iron & Steel Institute (AISI), Washington. Concurring with that view is Leo W. Gerard, president, United Steelworkers of America (USWA), Pittsburgh. "The problems . . . are not of our own making," he says. "Domestic producers are being flooded with steel imports." But those outside the steel industry, including analysts and economists, say that the biggest competitive headache for large integrated steel manufacturers is not imports, but the mini-mills in the U.S. that produce steel at lower costs using electric-arc-furnace (EAF) technology. "Don't blame imports," says economist Robert Crandall of the Brookings Institution in Washington. "The change in imports' share of the market from 25 years ago isn't more than 10%. The big integrated steel companies have lost much more market share -- almost 30% -- to mini-mills," he says. Over the last quarter century the mini-mills have taken away "essentially half the market" of big integrated producers through their dominance of the wire-rod, bar-steel, structural-steel, and sheet-steel markets. AISI's data support Crandall's argument. Its statistics show that mini-mills' share of raw-steel production capacity in the U.S. has jumped from 17.4% in 1971 to 47% last year. Data from the Steel Manufacturers Assn., Washington, show a similar increase -- 14% to 49% -- but in a narrower time frame, 1980 to 2000. And worldwide, EAF mills account for 34% of raw-steel production compared with less than 5% 30 years ago. By contrast, imports' share of total U.S. market shipments in 2000 was estimated by AISI to be 22.3%. That's only 10 percentage points higher than they were in 1973 and about eight percentage points higher than in 1993, a year before import levels jumped nearly five percentage points. "Dumping is illegal and that's why steel companies get so vocal about the issue," says Waldo Best, analyst with Morgan Stanley Dean Witter Inc., New York. "But on a scale of one to 10, it's down in the three-to-four range as a cause of their problems." Joseph Zoric, professor of economics at Franciscan University of Steubenville, in Ohio, agrees. "I don't see any evidence that imports are to blame" for the problems of the steel industry in the U.S., he notes. "It is competition from the U.S. mini-mills that has caused the reductions in market share and the reductions in jobs at large integrated mills. When you look closer, you see that the mini-mills are doing O.K. and that it is just the big integrated mills that seem to be having problems. "The integrated producers have relied on protection too much and not enough on looking to change for the long term," asserts Zoric. "Unless they face up to their internal problems and find a way to be competitive worldwide, no amount of protection . . . is likely to reverse" their shrinking market share. AISI data show that large integrated mills accounted for only 53% of raw-steel production in the U.S. last year, compared with 82.6% in 1971. Competitive Issues In fact, the problems of the large integrated mills have enabled U.S. mini-mills to gain market share. Those problems, which include top-heavy management structures, high labor costs, inflexible work rules, and outdated steel-making facilities, make many large integrated mills noncompetitive not only with U.S. mini-mills, but in global markets as well. "Integrated producers have excess [employment] levels and haven't spent enough on streamlining and cutting costs," says John Tumazos, a steel-industry analyst at Sanford C. Bernstein & Co. LLC, New York. "Bethlehem Steel Corp. has three times as many employees as sales warrant. It has more people standing around smoking cigarettes outside its headquarters building than Nucor Corp. (a successful U.S. mini-mill company) has inside its entire building." And Tumazos chides bankrupt LTV Corp. "It wasted over $1 billion of its capital" on two failed acquisitions and its failed Trico mini-mill joint venture. In addition, analysts estimate that big mills need to earn at least a 12% return to cover the cost of replacing their capital assets. They say that even during good years their profit margins are often lower than 8%. "The large integrated mills are unable to replace their capital assets," says Brookings' Crandall. "None of them has built a new integrated mill in 20 years -- they can't afford to. So technology from mills in developing countries has passed them by." As a result, U.S. integrated mills often are at a $100/ton cost disadvantage for hot-rolled steel compared to steel produced at mills such as Pohang Iron & Steel Co. Ltd.'s mill in Korea, where labor costs are lower and technology is newer, and at Brazilian mills where there is lower-cost and better-grade iron ore. That's why analysts and economists believe that rather than prop up weak companies with subsidies or erect temporary import barriers, it is time to let noncompetitive mills go out of business. "You need a healthy steel industry, not a situation where you are trying to support the dead and dying," says Crandall. Tumazos agrees. "The worst thing the government can do is subsidize losing companies and perpetuate the weak. There will always be a domestic steel industry in the U.S. The question is whether we will supply 65% or 85% of our [domestic] needs. And, notes Morgan Stanley's Best, "Any attempt to save failing companies just puts off the inevitable." Best's view is echoed by integrated steelmaker AK Steel Corp., Middletown, Ohio, which Best describes as "the poster child for the new steel company" because it went from "worst to first" in efficiency and strategy among U.S. integrated steel producers after Tom Graham (now retired) became CEO in the mid-1990s. "If they are weaker companies that can't survive on their business plan and production facilities, they ought to go under," says Alan McCoy, AK Steel's vice president, public affairs. "We don't think that the government and taxpayers should be the bank of last resort for failed steel companies with a flawed business plan." Besides, adds Best, "If the steel industry is going to be reborn in the U.S. let it be reborn with new management and new strategies. Otherwise, it is throwing good money after bad. If you want a viable steel industry in the U.S., you have to change management." Adds Franciscan University's Zoric, "Big mills in the U.S. are inefficient producers compared to mini-mills and to foreign producers. If they don't change, if they don't become more flexible, they will just continue to lose market share," he says. Analysts insist that U.S. steel producers must be competitive on price. "The only thing that matters to most users of steel and metal fabricators is price, not where it is made," because most users of steel view it as a commodity, Best notes. "Service and quality aren't as critical because [most manufacturers that use steel] are only going to make a few bends or drill a few holes." The exceptions: auto and appliance manufacturers that need higher-quality steel with fewer impurities and domestic supplies because of just-in-time production. Change Imperative That attitude among buyers means that steelmakers must shift to a low-cost mentality that Best says will require "a lot of changes" at traditional integrated steel companies. "They will have to reduce overhead costs and labor costs, change how raw materials are purchased, and make changes to their manufacturing strategy," including the adoption of new technologies. In addition, large integrated producers should seriously consider "selling off their coke- and iron-ore-making facilities and start buying those things on the open market," Best notes. "Integrated mills need to get out of steel making and start to import slabs and semifinished steel from offshore and roll that into the final product. They should evolve more and more into a finishing business because of the inherent cost advantages" that other countries have in iron ore and coke supplies or in blast-furnace technology. Others see even more drastic changes. "I think that the integrated companies will eventually combine their operations with mini-mills either through mergers or through contracts," says Crandall. "They will have to turn to mini-mills as their raw-material supplier or sell off to the mini-mills. Otherwise, all they can do is phase down because they are terribly inefficient at producing the raw steel." But for those consolidations to occur, either companies will have to go out of business or the government will have to address the retiree-pension and health-care liability issue. No healthy steel company wants to assume either of those current liabilities, which analysts estimate add $25 to $30 to the cost of a ton of steel made by large integrated mills, or the additional costs that would accrue from a plant closing. "The fact is that every steel company has looked at buying every steel company in the U.S.," says Charles A. Bradford of Bradford Research Inc., New York. "But if you're relatively strong, you do not want to be saddled with the liabilities of a weaker company or union contracts that make it difficult to close factories." AK Steel's McCoy agrees. "When you start to look at union contracts, it would be a disservice to our shareholders [to acquire a company] because our bottom line would suffer [due to the] millions of dollars in obligations for health care and pensions" of retirees. However, without consolidation the U.S. might fall farther behind in the global steel industry. Based on its 1999 output of 11.3 million tons of steel, the U.S. Steel Group of USX Corp. is the largest U.S. producer, but is only the 11th largest steel company in the world, according to the International Iron & Steel Institute. What's more, rationalization already is taking place in other countries. In the aftermath of several mergers in the last three years, three steelmakers in the European Union in February agreed to merge later this year to form the world's largest steel company with a projected output of 46 million tons. NKK Corp. and Kawasaki Steel Corp., the second- and third-largest steel-makers in Japan, in April announced a merger to form the world's second-largest steel producer by 2002. As for import relief, even though President Bush last month asked the International Trade Commission to investigate whether the steel industry has been hurt by imports -- an investigation that won't be complete until December -- most analysts don't see the Bush Administration intervening to any great extent unless it is to gain leverage to obtain fast-track trade negotiating authority from Congress. And they point to comments by Commerce Dept. Secretary Donald Evans, who said the government wants to "free the worldwide steel industry from 50 years of government subsidies and intervention" as evidence of that. "There is not a lot of political collateral to be gained by helping the U.S. steel industry," says Morgan Stanley Dean Witter's Best. But Bradford disagrees with his colleagues and expects a three-year quota to protect the mills. "It is the American attitude to help the underdog, to defend the weak." However, he adds that any use of quotas or tariffs "is bad economics. The EU and Japanese mergers are signs that U.S. steel producers are being left behind. If we continue to support the inefficient and failing companies, not only is that type of investment useless, it is detrimental to both the domestic steel industry and downstream users of steel in the U.S."

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