Analysis of Steel Sector

7/28/2019 Analysis of Steel Sector

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ContentsABSTRACT ................................................................................................................................................ 3

INTRODUCTION ....................................................................................................................................... 4

CATEGORIES OF STEEL ........................................................................................................................ 5

ROUTES TO STEEL ................................................................................................................................ 6

BASIC OXYGEN STEELMAKING (BOS) .............................................................................................. 6

ELECTRIC ARC FURNACE STEELMAKING (EAF) ................................................................................ 7

PRODUCT MIX ..................................................................................................................................... 9

GLOBAL SCENARIO ................................................................................................................................ 10

US Influence on Global Steel Industry .............................................................................................. 11

Global steel consumption demand led by BRIC nations ................................................................... 13

Flat Steel Prices ................................................................................................................................. 14

Long Steel Prices ............................................................................................................................... 15

CHINA - UNDISPUTED LEADER OF GLOBAL STEEL INDUSTRY ............................................................... 16

INDIAN SCENARIO ................................................................................................................................. 22

PROFITABILITY ACROSS VALUE CHAIN .................................................................................................. 31

COST DRIVERS ....................................................................................................................................... 32

INDUSTRY COST DYNAMICS .................................................................................................................. 35

RESOURCE DEMAND ......................................................................................................................... 36

HOT METAL : COST CURVE ................................................................................................................ 37

Iron-Ore Supply still in the hands of a few.................................................................................... 39

Iron ore prices- to rise with demandsupply mismatch ............................................................... 40

Coking Coal Supply getting Concentrated..................................................................................... 44

COKING COAL-TIGHTNESS AHEAD ................................................................................................ 45

Ferroalloys - Soaring high, to climb higher ................................................................................... 48

Cycles getting shorter ................................................................................................................... 51

PRICING OUTLOOK ................................................................................................................................ 54

COMPANY SECTION.............................................................................................................................. 57

INDIAN STEEL COMPANY POSITIONING ............................................................................................ 57

POSITIONING ACROSS VALUE CHAIN ................................................................................................ 58

VALUATIONS OF COMPANIES ........................................................................................................... 59

SAIL ................................................................................................................................................ 59

TATA .............................................................................................................................................. 63
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JINDAL STEEL & POWER Ltd .......................................................................................................... 67

JSW Steel Ltd ................................................................................................................................. 71

SESA GOA ...................................................................................................................................... 75

RISKS...................................................................................................................................................... 79

THE WAY AHEAD ................................................................................................................................... 81


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ABSTRACT

Initiating coverage on the Indian steel sector with an attractive stance based on a bullish

outlook for steel demand and prices. Robust steel prices will be sustained as demand

momentum remains buoyant, enabling global steel producers to pass on the cost-push

inflation from tight raw material and freight markets.

Access to high-quality, low-cost iron ore reserves offers Indian steel companies an edge over

regional and global peers. Further, low labor costs and a fast-growing domestic market make

India a natural hub for steel production, in our view. Despite these fundamental strengths,

valuations remain at about 30% discount to regional peers v/s 10% premium over the past

two years. Moreover, Indian steel producers are rapidly expanding capacity to gain global

size.

Global steel industry:

Resources segment remains in the midst of a sweet spot of a steel cycle

Supply squeeze and high supplier concentration to keep resource prices higher

Non-integrated steel making companies remain vulnerable from rising input costs

Steel prices continue to remain firm but short term fluctuations to remain duringinventory adjustment

and tactical negotiations with the iron ore/ coal supplier

Given its captive rich iron ore resource, Indian steel industry is well placed

But increasing cost of coking coal might dampen Indian profits

Indian companies are leveraging aggressively

While resource intensive companies are getting bigger by acquiring steel makingcompanies

Smaller steel making companies are expanding rapidly and integrating backward

Winners: Players with focus on resources/ high profitability, growth & reasonablefinancial.


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METHODOLOGY

PRIMARY DATA

I interviewed two members of the research team of IFCI financial

services and one member of Edelweiss Capital. Visited Hanuman Blast

Furnace(Silvassa)

SECONDARY DATA

The project is based on the secondary data collected from the

companies websites & the ministry of steel. Various books,magazines,

newspapers and articles also provided valuable information.


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INTRODUCTIONGENERAL CHARACTERISTICS

Steel is an alloy of iron and carbon, containing less than 2% carbon, 1% manganese

and small amounts of silicon, phosphorus, sulphur and oxygen. Steel is the mostimportant engineering and construction material in the world. It is the most important,

multi-functional and most adaptable of materials. Steel production is 20 times higher

as compared to production of all non-ferrous metals put together.

Steel compared to other materials of its type has low production costs. The energy

required for extracting iron from ore is about 25 % of what is needed for extracting

aluminium.

There are altogether about 2000 grades of steel developed of which 1500 grades are

high-grade steels. The large number of grades gives steel the characteristic of a basic

production material.

CATEGORIES OF STEEL

Steel market is primarily divided into two main categories - flat and long. A flat

carbon steel product is a plate product or a (hot or cold) rolled strip product. Plate

products vary in dimensions from 10 mm to 200 mm and thin flat rolled products

from 1 mm to 10 mm. Plate products are used for ship building, construction, largediameter welded pipes and boiler applications. Thin flat products find end use

applications in automotive body panels, domestic 'white goods' products, 'tin cans' and

the whole host of other products from office furniture to heart pacemakers. Plates, HR

coils and HR Sheet, CR Sheet and CR coils, GP / GC (galvanized plates and coils)

pipes, etc. are included in this category.

A long steel product is a rod or a bar. Typical rod products are the reinforcing rods

made from sponge iron for concrete, ingots, billets, engineering products, gears, tools,etc. Wiredrawn products and seamless pipes are also part of the long products group.

Bars, rods, structures, railway materials, etc. are included in this category.

Sponge Iron / Direct reduced iron (DRI): This is a high quality product produced by

reducing iron ore in a solid state and is primarily used as an iron input in electric arc

furnace (EAF) steel making process. This industry is an integral part of the steel

sector. India is one of the leading countries in terms of sponge iron production. There

is a number of coal-based sponge iron / DRI plants (in the eastern and central region)


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and also three natural gas based plants (in the western part of the country) in the

country.

ROUTES TO STEEL

Two methods of making steel are dominant in modern steel industries all over the world:

Basic Oxygen Steelmaking (BOS)

Electric Arc Furnace Steelmaking (EAF)

BASIC OXYGEN STEELMAKING (BOS)

The Blast Furnace is large steel structure about 30 metres high. It is lined with refractory firebricks that

can withstand temperatures approaching 2000o

C. The furnace gets its name from the method

that is used to heat it. Pre-heated air at about 1000oC is blasted into the furnace through

nozzles near its base.

The hot air blast to the furnace burns thecokeand maintains the very high temperatures that

are needed to reduce theoreto iron. The reaction between air and the fuel generatescarbon

monoxide. This gasreducestheiron (III) oxidein the ore to iron.

iron (III) oxide + carbon monoxide iron + carbon dioxide

Fe2O3(s) + 3 CO(g) 2 Fe(s) + 3 CO2(g)

Because the furnace temperature is in the region of 1500C, the metal is produced in a molten

state and this runs down to the base of the furnace.

The furnace temperature is also high enough to decompose limestone into calcium oxide.

calcium carbonate calcium oxide +carbon dioxide

CaCO3(s) CaO(s) +CO2(g)

This oxide helps to remove some of theacidicimpurities from the ore

calcium

oxide+silica calcium silicate

CaO(s) +SiO2(s) CaSiO3(l)
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The impurities are removed react with calcium oxide to make a liquid slag that floats on top

of the molten iron. The slag is collected after the denser iron has been run out of a tap hole

near the bottom of the furnace.

Blast furnace iron + scrap steel

ELECTRIC ARC FURNACE STEELMAKING (EAF)

The Electric Arc Furnace (EAF) offers an alternative method of bulk steel manufacture. It

makes steel from what would otherwise be unsightly and environmentally damaging scrap

metals. It also consumes much less energy than the BOS furnace. Every tonne of EAF steel

uses about 7.4 GJ of energy compared with about 16.2 GJ for every tonne of BOS steel.

Furnace design

The EAF is a kettle-shaped structure with a removable lid. The three graphite electrodes that

heat the furnace pass through this lid, which can be swung back when the furnace is being

charged. The hearth of the EAF, where the metal is melted, is lined with a chemically basic

and refractory material.

The sequence of operations is similar to that in the BOS furnace, except that, after charging,

the charge must be melted down.The furnace charge melts when an electric arc passes

between the electrodes and the scrap metal. The temperature around the arc rises to 1200oC

and a 100 tonnes charge can be melted in about 60 minutes.

The four main stages are (roll over the highlighted word to see the pictures

1. Charging with a mixture of metal and lime.

2. Melting the metal and scrap using electric arcs from the graphite electrodes. After this

some more lime is added to clear out the oxides in the next step.

3. Blowing with oxygen to oxidise elements such as carbon, silicon and manganese in the

scrap metal. As in the BOS furnace, carbon monoxide escapes as a gas. The oxides of the

other elements are acidic and combine with the basic lime to make a neutral slag, which is

poured off the surface.


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4. Tapping the metal itself by running it out through the furnace spout into a ladle. The liquid

in the ladle is now ready for secondary steelmaking and casting. Further treatments of the

metal from the EAF take place in much the same way as steel from the BOS plant.

scrap steel

STEEL MAKING PROCESS

Source: Bloomberg

DIFFERENCE BETWEEN BOS & EAF

Blast Furnace iron Directly reduced iron

Fuel coke Natural gas or crude oilReducing gas carbon monoxide mixture of hydrogen and carbon

monoxideTypical furnace temperature 1500oC 800oCState of metallic product Liquid SolidTypical furnace height 30 metres 40 metresContinuous or batchprocess?

Continuous Continuous


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PRODUCT MIX

RODUCT WISE Applications

Semis Blooms, Billets & Slabs

converted into finished products in

the company's processing plant

sold to rerollers for conversion to

finished products.

Long Products

Structurals

Crane Rails

Bars, Rods & Rebars

Wire Rods

used in mining, the construction of

tunnels, factory structures, transmission

towers, bridges, ships railways and other

infrastructure projects

Flat Products

HR Coils, Sheets & SkelpPlates

CR Coils & SheetsGC Sheets\ GP Sheets andCoils

construction of tanks, railway cars,

bicycle frames, ships, engineeringand military equip-ment and

automobile and truck wheels, frames

and body parts

manufacture of bridges, steelstructures, ships, large diameter

pipes, storage tanks, boilers, railway

wagons and pressurevessels;

weatherproof steel plates for the

construction of railcars

Tubular Products

Pipes are longitudinally or spirally welded from

hot rolled coils for conveying such things

as water, oil and gas.

Railway ProductsRails

Wheels, Axles, Wheel Sets

used primarily to upgrade and expand the

existing railway network in India
http://www.sail.co.in/products_SemisBloom.asphttp://www.sail.co.in/products_Structural.asphttp://www.sail.co.in/products_CraneRail.asphttp://www.sail.co.in/products_Bars&rods.asphttp://www.sail.co.in/products_wirerods.asphttp://www.sail.co.in/products_HRCOIL.asphttp://www.sail.co.in/products_Plates.asphttp://www.sail.co.in/products_Plates.asphttp://www.sail.co.in/products_CRCoil.asphttp://www.sail.co.in/products_GPCoils.asphttp://www.sail.co.in/products_GPCoils.asphttp://www.sail.co.in/products_Tubularproducts.asphttp://www.sail.co.in/products_Rail.asphttp://www.sail.co.in/products_Rail.asphttp://www.sail.co.in/products_Wheels.asphttp://www.sail.co.in/products_Wheels.asphttp://www.sail.co.in/products_Rail.asphttp://www.sail.co.in/products_Tubularproducts.asphttp://www.sail.co.in/products_GPCoils.asphttp://www.sail.co.in/products_GPCoils.asphttp://www.sail.co.in/products_CRCoil.asphttp://www.sail.co.in/products_Plates.asphttp://www.sail.co.in/products_HRCOIL.asphttp://www.sail.co.in/products_wirerods.asphttp://www.sail.co.in/products_Bars&rods.asphttp://www.sail.co.in/products_CraneRail.asphttp://www.sail.co.in/products_Structural.asphttp://www.sail.co.in/products_SemisBloom.asp


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GLOBAL SCENARIO

World Growth rate to moderate but developing nations to maintain momentum

Source:World Bank

World growth eased from 3.9% in 2006 to 3.6% in 2007. The slowdown was led by the US

where growth slowed from 2.9% in 2006 to 2.2% in 2007. Much of the decline was direct

fallout of the weakening housing market, with residential investment falling rapidly, and

tightening credit conditions for both firms and consumers tightening.

Among developing countries, growth remained firm at 7.4% in 2007, after an equally strong

7.5% in Z006, underpinned by continued strength in East and South Asia. If China and India

are excluded, activity in low-and middle-income countries slipped by 0.2 percentage points to

5.7% in the year.

Outlook: In 2008, global growth is expected to moderate further, as the effective cost of

capital remains elevated for financial institutions, firms, and households. Weak domestic

demand is expected to keep the US GDP growth below 2% in 2008, while growth in Europe

and Japan should continue to ease under the additional weight of appreciating currencies.

However, on an aggregate, growth in developing countries is expected to be robust in both

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2005 2006 2007 2008f 2009f

World

US

EU

Japan

Developing

Countries ex.

India & China

Brazil

Russia

India

China


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2008 and 2009, remaining at or above 7%, mainly because of strong domestic momentum in

most of them.

US Influence on Global Steel Industry

The US influence over the fortunes of the steel industry has been falling drastically over the

last few years with consolidation within the steel industry and consistent huge annual jump in

China's steel demand and supply. Now US accounts for just 7% of the global steel production

and approximately 10% of the global steel consumption. US domestic steel demand decline

was significant last year. However, the US steel price levels were reasonably maintained and

had little impact on global steel prices, which increased significantly. This was possible due

to reduced US steel production, higher exports by steel companies and lower import as the

dollar kept depreciating.

Shrinking US share in world crude steel production

Source: IISI

US steel prices have already shot up 12% during January 2008 (among all the gloom over

possible US recession) since the beginning of the year. This is a strong indicator of the shape

of things to come in months ahead. Even US steel price levels would remain at elevated

levels through most of 2008 and would positively surprise all stakeholders.

US recession worry overdone, steel demand may improve

After three years of less than 2% Fed rates from November 2001 to November 2004, fed rates

started rising at a regular interval to reach peak of 5.25% in June 2006 and remained constant

there till June 2007. The US consumer, fully leveraged during the low interest rate regime,

had to bear higher EMIs as interest rate kept rising. As long as housing prices were rising

they were somehow able to finance these larger EMIs against house mortgages. However,

when it peaked and started falling even that option was not viable. The increase in income

levels was just not good enough to meet the requirements of increased EMIs and default

started happening. This, eventually, blew up into the major sub prime crisis.


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The US Fed, though initially late in responding to the crisis, has been aggressively cutting

rates since September 2007. It has already brought it down by 225 bps to 3%. Further Fed

rate cuts but at a slower pace is expected.

What is to be noted here is that though pessimism is high, the real genesis of the problem is

being sorted out to a large extent with these aggressive rate cuts (last 125 bps in eight days)

and probable tax rate cuts. The bulk of the sub-prime crisis to be resolved in the next two

quarters. The bad loans would start turning good and when the reports of that start coming in

the media then positive sentiment would be back. The worst is already behind and the steel

sector in the US has already seen a domestic demand slowdown since

early last year. The domestic steel demand in US is expected to improve from H22008.

US Fed meeting & Fed rates for last decade(%)

Recently it has been further cut by 75 basis points down to 2.25%. The sharp 300 bps Fed

rate cut (since Sep 2007) should help to revive the interest sensitive US household

construction and automobile sector with some lag effect .


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Global steel consumption demand led by BRIC nations

BRIC (Brazil, Russia, India and China) countries, which accounted for about 41% of global

steel demand in 2006, are again expected growth drivers with 12.8% for 2007 and 11.1% for

2008 as per IISI last estimates. Overall, 77% of world growth in 2007 and 71% in 2008 is

expected to take place in BRIC. China's apparent steel use is expected to grow 11.4% in 2007

and 11.5% in 2008, accounting for 35% of the world total. For India, forecasts for apparent

steel use point to an increase of 13.7% in 2007 and 11.8% in 2008.

Global per-capita steel consumption exceeded 200 kg for the first time in 2006, according to

statistics just published by the International Iron & Steel Institute. The institute puts global

consumption of crude steel per capita in 2006 at 202.2 kg, up 8% from 187.0 kg the previous

year. UAE (1,724 kg), Qatar (1,336 kg), South Korea (1,073 kg) and Taiwan (1,032 kg) topthe list. China's per-capita consumption was 291 kg, an 82% increase in five years while

India's per-capita consumption was 42 kg per person, greater than 50% over the last five

years.

Steel DD-SS

(mn tonnes)2006 2007 2008E

Production Consumption Production Consumption Consumption

World 1227.5 1120.9 1343.5 1197.7 1278.6

BRIC 571.2 457.8 550.0 516.6 573.9

BRIC(%Share) 46.5 40.8 41.0 43.1 44.9

China 423.3 357.4 489.0 398.1 443.8

China(%Share) 34.5 31.9 36.4 33.2 34.7

India 46.26 43.1 53.6 49.0 54.8India(%Share) 3.8 3.8 4.0 4.1 4.3

Source:IISI


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Flat Steel Prices

US flat steel product prices have been strengthening due to lower inventory levels. Exports

activity of coils by many producers has been reducing domestic supply and has been good

enough to offset the weakness in domestic end user demand for new residential building and

automobiles. Further support has come from continued low imports of flat steel products due

to depreciated dollar and high freight rates.

North European prices had been flattish for a while now due to higher domestic production

coupled with high imports driven by price premium to other markets and strong currency

against the dollar. Imports are expected to moderate, going forward, as price premium decline

with rise in prices elsewhere leading to firming of prices in Q2/Q308.

Elsewhere, globally demand seems to be exceeding supply. Strong Chinese domestic demandand rising raw materials prices has lead to continuing sharp jump in Chinese domestic prices,

leading to both reduction in exports and increase in export prices. This, in turn, has helped

demand-supply balance at global level and led to improvements witnessed in price levels

globally.

Global HRC prices US$/t

450

500

550

600

650

700

750

800

850

900

Jan-0

7

Feb-0

7

Mar-07

Apr-07

May-0

7

Jun-0

7

Jul-07

Aug-0

7

Sep-0

7

Oct-07

Nov-0

7

Dec-0

7

Jan-0

8

china export FoB Shangahi

china domestic shangahi (incl.

17% vat

Turkey Export FOB

US domestic FOB Midwest mill

N.Europe domestic Ex-Works

India domestic Mumbai (incl

Excise/Sales/VAT)


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Source: Steelbb

Long Steel Prices

Long steel prices reflect the mood of the economy at large and are a direct play on the

construction sector: infrastructure and real estate. Spectacular price jumps have been seen inBRIC nations and West Asia, where strong economic development is underway. North

American prices have started increasing last month while European prices are expected to

rise this month. The price rise has been a function of both strong demand and surge in raw

material prices. Interestingly, after a sustained rise last year, prices have been softening in

some regions of China since the year beginning. More time is needed to attribute this to any

slowdown in construction activities in China, as most Olympics projects reach competition

stage or to any effect of the latest tax adjustments.

`


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CHINA - UNDISPUTED LEADER OF GLOBAL STEEL INDUSTRY

China's GDP grew 11.4% YoY in 2007. This is the fastest clip since 1994 and the fifth

consecutive year it has grown more than 10%. China's steel production in 2007 reached 489

MMT, a 15.7% rise on 2006 and constituting 36.4% of the global crude steel production of

1343.5 MMT for 2007. China's growth enabled the global steel production to grow 7.5%.

Excluding it, global steel production grew a mere 3.3% in 2007. China's annual steel

production is larger than the aggregate of the next seven largest steel producing nations put

together. China also constitutes about one-third of the global steel demand and more than half

of the increment demand. There is no doubt the global steel industry fortunes these days are

determined most by China.So much so, that Chinese steel production and consumption have

grown at a CAGR of 24% and 18%, respectively, over the past five years.

Chinese production & Consumption

Source: China Customs Statistics

Chinese production growth has shown a declining trend.

Chinese steel exports and net exports(000 tonnes)

Source: China Custom Statistics

Chinese net exports have been declining recently.


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As production considerably outpaced its domestic growth rates, China emerged as a net

exporter of steel for the first time in 2005.

Since then, the possibility of a rapid surge of surplus steel from China and a subsequent slump

in steel prices has been hanging like the sword of Damocles over the global steel industry.

This has been the single largest concern for steel markets and investors globally.

In Action: Curbing production & exports China hikes export taxes on steel, coke &

ferroalloys

Attempts to curb production and exports of steel

Source:Steel Business Briefing

Chinese government is really serious about curbing growth of energy intensive industries

such as steel. Not only has it adopted several macro-tightening measures (going slow on

approvals for new projects, encouraging consolidation, closure of small and fragmented

capacity), it has also announced several administrative and fiscal measures to control exports

and reign in a ballooning trade balance.

As seen from the chart above, the initial impact of these measures is evident by the three

consecutive month-on-month decline in net exports. Therefore any real threat of large

supplies out of China depressing global prices is not forseen. More so, from an Indian


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perspective, China has not been a major source for imported steel (till 2004 it was a net

importer). At the margin, even for small quantities that get imported by India annually, a

large share is accounted for by the CIS countries (such as Ukraine etc.).

China hiked steel export tax spike for 34 finished steel products begining 2008. The changes

are as under:

Semis (billets, slabs, ingots) - 25% now from 15%

Welded pipes (Tubes) - export tax introduced at 15% from no taxes

Narrow strips (all HR/CR/galvanized/coated) - 15% now from 5%

Wire rods & bars (long products - rebar) - 15% now from 10%

Sections (only cold-formed) - 15% now from 10%

Stainless steel (200 series) - 10% now tax from 5%

Export tax not changed for the following:

HRC, HR plate, HDG or CRC

H-beams, I-beams, angles, and channels will remain at 10%

Some market insiders had feared HRC exports may be slapped with a 15% export tax

- up from a current 5%; and that HDG may lose its 5% rebate

Steelmaking raw materials

25% export tax for coke and semi-coke, pig iron and DRI from 15%; hike of 10%

20% export tax on ferroalloys from current 10-15%. Includes high carbon

ferrochrome, ferro-nickel and ferro-vanadium.

Ferroalloys: Manganese alloys and ferrosilicon - no specific mention in the release

from China Government. However, traders are expecting them to be included in the

20% slab.

Impact

China's government has primarily targeted construction steel products, which are the

mainstay of their domestic demand growth. Long steel products that too mainly bars and rods

(only 5% tax hike) constituted only 15% of the carbon steel imports from China to India, for

April-December 2007. This would marginally help producers of long products.


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Almost 30% of Indian steel imports were from China for April-December 2007. Within this,

more than 85% were HR coils/strips, CR coils/sheets and plates. These were left untouched in

the recent Chinese export tax hikes. This is negative news for Indian players as these

excluded product categories would now be relatively more attractive for higher imports from

Chinese steelmakers. We recommend caution and careful scanning of steel import data from

China for the next few months, for probable negative surprises.

China has also targeted raw materials with strong domestic supply like coking coal, coke and

ferroalloys, to primarily conserve its resources and substantially increase steel production

costs of global peers. This would not only help revive the competitiveness of Chinese steel

companies, which have been uncompetitive due to their heavy dependence on import of iron

ore whose prices have sky rocketed.

Accounting for 40% of world coke trade, China's export negotiations are often carried out

one to one. Chinese large coke enterprises were prepared for the tax hike and had prescribed

on the previously signed supply contracts to re-fix the price if tax goes up. Coke prices have

been revised upwards drastically in the first month of 2008 post the tax hikes from China and

are quoting above $450/ t fob.

What explains the absence of a slowdown in steel imports from China despite tax hikes?

China's steel product exports were back in business in December 2007 with a rise of 16.59%

MoM to reach 4.78 MMT. This was down 13.9% YoY, however. Chinese finished steel

monthly exports had been consistently drifting lower for the previous few months from 7.1

MMT in April 2007 to 4.1 MMT for November 2007, caused by the previous export tax

adjustments by China in June 2007. Rise in December exports can be attributed to

expectations of hikes in export taxes from January 1. However, the new export tax policy has

turned out to be less harsh than expected, as the Government did not increase export tax on

flats and plates, but on low value-added products, whose exports were already cut anyways.

The fall in exports earlier was helped by curtailed production by small Chinese mills who

were finding it tough to cope up with a sharp jump in cost of production due to sustained rise

in raw material prices. This resulted in reduced supply in domestic markets. This, coupled

with continuous strong domestic demand and prices, led to diversion of exports to domestic

markets. Subsequently, Baosteel raised Q108 steel prices for China, leading to a rise in

China's domestic steel prices. This would ease margin pressure. The blast furnaces, whichwere earlier closed down should soon be back in action, thus increasing supply.


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In addition, massive 10.8 MMT/year of new HRC capacity is going to be on stream in China

within just a month, substantially increasing the supply. Following Ningbo Steel's

commissioning of its 4 MMT/year HRC mill on Dec 26 2007, central China's Wuhan Steel

and north-east China's Beitai Steel will commission their new HRC mills, with respective

capacities of 2.8 MMT/year and 4 MMT/year in late January.

For FY07, China's steel exports aggregated 69.1 MMT, product exports were 62.68 MMT up

45.8% while semis exports stood at 6.43 MMT down 28.9%. Steel products imports fell to

17.1 MMT. Net exports of steel products in FY08 zoomed 82.3% to 44.57 MMT against

24.44 MMT in FY07.

Forecasting steel export from China has always been a contentious issue. China Iron and

Steel Association has forecast steel exports would decline by 20 MMT in 2008 to 50 MMT.

Jim Jia, Managing Director of mysteel.com, in his recent presentation at the Seventh Asian

Steel Conference in Mumbai, gave an aggressive target of China's steel export falling below

30 MMT for 2008. General expectations of a substantial fall in steel exports from China have

been building up of late.

But total steel exports from China in 2008 to likely sustain the current year levels of close to

70 MMT. Though exports of semis (billets/slabs) and long products should slump further,

any slowdown in exports of flats and plates is not seen. These constitute bulk of steel exports

and have been left out of the latest steel export tax hikes.

China's steel production for 2008 is expected to be 540-550 MMT, 50-60 MMT increment to

2007 figures. IISI predicts FY07 consumption in China would be 398.1 MMT. It will be

closer to 420 MMT. IISI has forecast demand growth of 11.5% to 443.8 MMT, an increment

of 45. Similar expectations of sub 50 MMT incremental demand, just falling short of the

increment in supply are there. Thus, it would make sense for smart Chinese steelmakers to

export rather than increase its inventory levels, even if it has to be at some lower margins.

Even in the event of a slowdown in steel exports from China, India is unlikely to benefit, as

any reduction if any, is likely to be significant for European destinations (similar to trends

seen for the US in FY07) where price premiums are coming down. There are risks of EU

antidumping duties and freight costs again shooting up. India, given its geographical

proximity and benign demand environment, remains a soft target. Also, as stated earlier,

HRC, CRC, HR plate, beams and HDG, constituting more than 85% of imports to India, have


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been left out of hike in export taxes. So general expectations of the Indian steel industry

getting some relief in slowdown of steel imports from China looks untenable.

China monthly steel exports(mt)

Source:SteelBB

China steel products-Monthly exports(tonnes)

Source: Bloomberg


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INDIAN SCENARIO

Healthy outlook driven by sustained Indian domestic growth rate

The Indian steel industry is standing on a firm footing with accelerated growth in GDP and

expansion in physical infrastructure creation. Steel demand is highly dependent on general

economic activity, construction and automobiles.

Steel Business Briefing

Strong demand momentum driven by infrastructure creation, rising consumption

Empirical evidence suggests that for developing economies such as India, steel consumption

correlates highly with GDP/IP growth. The Indian economy has been growing at a robust 3-

year average of 8.6%. Sustainability of this trend will necessitate massive infrastructure

creation. Indias Planning Commission estimates the total investment needs for

infrastructureincluding roads, ports, power, airports, and railwaysat about US$320 bn

over the next five years. Moreover, India is on the cusp of a massive increase in city

population driven by rapid urbanizationthis in turn will drive the need to build adequate

urban infrastructure.

The steel sectora basic building block for constructionwill clearly be a direct beneficiary

of this infrastructure spend and rising urbanization trend. Simultaneously, higher purchasing

power of a rising middle-class (estimated at 355 mn people, about 32% of the population) and

easy availability of credit with benign interest rates is resulting in a consumption boom,

driving strong incremental demand for automobiles and consumer durables. Steel demand in

India is primarily driven by construction, capital goods and automobile segmentsall of

which have robust underlying momentum. As a result, steel demand in India is expected to

grow at a healthy rate of 9% over the next three years.


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Population living in urban areas and as a proportion of overall population

Source: CEIC

Indias growing urbanization trend to drive consumption and demand in the long term.

Indias GDP, IP and consumption yoy growth

Source: CEIC

Medium term outlook for GDP and industrial production should drive steel consumption.

This is also consistent with the empirical top-down evidence that for developing countries

such as India, elasticity of steel demand to GDP growth is in the range of 1.1x-1.3x. So, if the

GDP growth trend has to be sustained at 7%-8% range, steel consumption should grow atabout 9%.

Based on the Planning Commission's estimate of the most likely level of infrastructure

investment, total GCF in infrastructure during the Eleventh Plan (2007-08 to 2011- 12) is

expected to be Rs.20017.76 bn (at 2006-07 prices) or US$ 500 bn (at exchange rate of Rs.40

per US dollar) against Rs.8805.15 bn anticipated from the Tenth Plan (2002-03 to 2007-08) at

a CAGR of 7.5%. This is expected to give a fill up to the demand for long products.


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Infrastructure boom just getting larger and larger

Source :GOI

Expected annual infrastructure Investments in India

Source: GOI

Growth(yoy) in fixed asset investment, infrastructure index

Source: CEIC

Encouraging trends in the near term.


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Change (yoy) in cement despatches(construction) and automobile sales

Source: CEIC

Tata Nano, the world's cheapest car, a quantum leap into the future

The Tata Nano, recently unveiled in the Auto Expo 2008, has received high appreciation

from both consumers and experts. Its entry would lead to the emergence of a new consumer

segment and serve as a major growth engine of domestic auto steel demand. Flat steel is a

direct play on car volumes, which would see a sustained jump with the success of the Nano

and the response expected from other auto players. Production capacity can be the only

constraint as demand in this new segment is expected to outstrip any supply.

Beyond the boost for the Indian automotive sector in a few years, India is likely to emerge as

a global small car development and manufacturing hub giving a big boost to domestic steel

demand. Also, there has been a lot of debate with regards to the stress it would put on road

and infrastructure, which is not adequately developed. The solution for this lies is better

infrastructure, which would only improve steel intensity and consumption.

"Hamara" Bajaj follows suits unveiling prototypes for mass cars and Lite trucks

Just 48 hours before the Tata 'people's car' made its debut, another ultra low-cost car, this

time from the Bajaj stable, made its appearance. The prototype vehicle will serve as the basic

platform for the Renault-Nissan-Bajaj ultra low-cost (priced at around $3,000 or Rs.125,000)

car. Bajaj may invest around Rs.7 bn in the venture. Bajaj is pushing to expand the

relationship with Renault-Nissan to 'Lite' trucks as well. The company showcased two Lite

trucks alongside the car prototype on auto expo. This is just the beginning and this new


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market segment with bring in humongous incremental demand for the steel industry mainly

flat products.

Indian passenger car market

Source: SIAM

Indian steel demand robust but inventories are up; India to turn net importer of steel

for FY07-08 for first time in a decade

Indian steel consumption is growing at a record rate of 12.6%. This is almost twice the 6.6%

growth in supply to 38.05 MMT by domestic players during April-December 2007. For

FY08, Indian finished steel production is expected to be 55.5 MMT, which lands it into top

five steel producing nations in the world.

Imports have jumped 68.9% YoY from 2.93 MMT to 4.96 MMT during April-December

2007. In contrast, export growth merely moved 9.1% to 3.85 MMT. This trend is likely to

continue and India is likely to emerge as a net importer of steel for FY07-08. Rupee

appreciation and high freight charges have affected export attractiveness. The Indian steel

industry has also failed to leverage the domestic consumption growth facing pressure from a

spurt in steel imports from China, leading to higher inventories, which are up 17.8% to 0.45

MMT.

HRC, plates and CRC constitute bulk of the imports. This is because they are exempt from

latest export tax hike from China. For April-December 2007 steel imports from China stood


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at 1.47 MMT (almost 30% share) with flats and plates constituting more than 85%. So, any

slowdown in imports from China is not forseen.

Indias net exports of steel

Source: JPC

Witnessing a Decline in the recent past

Capacity, Production & Consumption of steel in India

Source: SBB

Steel consumption continues to sustain rapid growth

Supply-side response: Not massive despite announced plans

India stacks up as the sixth largest steel producing nation in the world. The Indian steel

industry has been operating at average capacity utilization levels of 90% over the past three


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years. Of this, the major producers comprising large integrated players (the organized sector)

have been operating near peak utilization levels. Therefore, incremental growth in

production, in our view, will be driven by ramp-up of recently built capacity, and/or

commissioning of new brownfield/greenfield capacity.

There has been a flood of new capacity expansion plans announced over the past three years,

both by existing players and potential new entrants. This has been mainly in the form of

signing MoUs (Memorandum of Understanding) with governments of states which are

endowed with iron ore/coal deposits. If these MoUs were to materialize, it would lead to a

massive trebling of existing capacityfrom about 50 mn tpa currently to about 150 mn tpa

by 2012outstripping the forecast demand trends. India will then have to turn into a major

exporter of steel to support the incremental output growth. This would, however, be negative

for steel pricing trends (as is being witnessed in China currentlywith massive increase in

output, in excess of domestic consumption growth rate, domestic prices are lower than

international prices).

However, the translation of a majority of these MoUs on paper into actual facilities on the

ground may be hindered because of persisting roadblocks, which include:

land acquisition for greenfield projects has encountered policy hurdles and is taking

longer than anticipated. No clear roadmap/guideline in place as various players

experiment with different models with varying rates of success;

no consensus on an adequate relief and rehabilitation policy (including skill

development for employment, etc.) for the displaced families to win them over;

every single MoU is hinged upon the respective state governments allocating suitable

deposits of iron ore for the steel project. There are multiple applicants for each iron ore

block and there is no uniform objective criteria to hasten this process;

securing environmental and forest clearances have become a long-winded procedure,

accentuated by a proactive civil society movement

lead-times for equipment suppliers (mining as well as engineering) have considerably

increased due to a surge in order books over the past few years;

with increasing attraction for white collar jobs, there is a shortage of skilled labor.

Therefore it is not expected that Indias production, and net exporter status would change

over the medium term.


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CAPEX

Massive investments ahead: Production capacity targets for 2012 & 2020 jump further

The Indian steel sector is likely to see investment of Rs.2750 bn by 2012 based on estimation

of Rs.40 bn investment per MMT of additional capacity. According to the Steel Ministry, in

the most likely scenario the steel production capacity in the country is expected to touch 124

MMT by 2012. Brownfield expansion plans over the next five years are expected to add 40.5

MMT capacity to the existing capacity of 56.84 MMT while greenfield projects are expected

to add 28.72 MMT.

Supply jump is supported by buoyant demand growth expected to remain above 10% for the

next five years according to the Steel Ministry. Furthermore, taking into consideration the

intentions expressed by various steel investors including multinationals, domestic steel

majors and FDI, the likely capacity achievable by 2019-20 will be around 275 MMT.


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Building steel castles in the airSteel projects in India are easier to plan, but difficult to

execute

Summary of announced steel projects

Source:SteelBB


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PROFITABILITY ACROSS VALUE CHAIN

Profitability Trend 4-5x rise 2x rise Flat

Capital Intensity Low High Medium

Control over resources remain key to profitability

0

10

20

30

40

50

60

0

20

40

60

80

100

120

140

1992

1994

1996

1998

2000

2002

2004

2006

2008

RESOURCE PRICES

Met coal(LHS) Iron ore (RHS)

(USD/Tonne)

0

100

200

300

400

500

600

1995

1997

1999

2001

2003

2005

2007

(USD/Tonne)

HR Coil Steel Price

0

50

100

150

200

250

0

100

200

300

400

500

600

700

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

CR-HR Spread

CIS CR Spot Price

CR Coil Steel Prices

USD/Tonne)

0

20

40

60

80

100

120

140

2003 2005

COAL

Op. Cost Freight

Profit

5x

(USD/Tonne)

0

5

10

15

20

25

30

35

40

45

50

2003 2005

IRONORE

Op. Cost Profit

4x

(USD/Tonne)

0

100

200

300

400

500

600

2003 2005

Op. Cost Profit

Hot Rolled Coil

2X

(USD/Tonne)

0

100

200

300

400

500

600

700

2003 2005

Op. Cost Profit

1x

Cold Rolled Coil

(USD/Tonne)

RESOURCES ProcessinPure Iron & Steel Making


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COST DRIVERS

Source:Bloomberg

EAF: Production cost(USD/Tonne)Without Captive inputs Price(USD) Input/Tonne Output Cost(USD)

Scrap(100%) 330 1.08 356

Other inputs 80

RM Cost - - 436

Conversion+ overhead - - 40

TOTAL - - 476

BF+ Other: Production cost(USD/Tonne)Without Captive inputs Price(USD) Input/Tonne Output Cost(USD)

Iron ore contract price(cif) 84 1.8 151

Met-Coal Contract price cif 138 1 138

Other inputs+ overheads - - 100

TOTAL(Liquid Steel) - - 389

Casting+ rolling - - 60

TOTAL - - 449

Hot Rolled Operataing Cost - - 449


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Steel prices to rise atleast 15% during 2008: Price rise to come in stages. Very bullish for

1H1CY08, Cautious for H2CY08.

Indian steel majors have hiked prices by firm $40/t-$60/t after initiating 2008 with a modest

hike of US$15/t-30/t. The price rise is in line with sharp rise in global steel price levels. Further

price rises in Q2CY08 to aggregate at least 15% during 2008is expected. The price rise would

vary across product categories and would be higher for long steel products compared to flat

steel products. Most of the price rise is expected due to sustained raw material cost pressures.

Cost of production to shoot up by US$120/t of crude steel.

Long term contract prices for 2008-09 of key raw materials namely iron ore (up 57% to

US$80.8/t), coking coal (up 66.7% to US$160/t), coke (>60%), ferroalloys (>60%), scrap,

energy costs via thermal coal(>50%) and freight charges(>25%) are all expected to shoot up

sharply. These will aggregate up to US$120/t for non-integrated steel companies.

Raw material cost pressures to sustain at least for medium term.

The cost push in raw material prices is due to the inability of suppliers (mine development

takes minimum two to three years on average) to match fast increase in demand driven by

China, other BRIC nations and West Asia. Aggressive sustained consolidation in the already

highly consolidated raw material industry (further in line is BHP-Rio, CVRD-Xstrata),

increasing new mine development cost and appreciating local currencies against the dollar are

adding further pressure. Other factors explained later in the report.

Steel industry business model to change in 2008.

Steel product price rises are increasingly turning out to be just a pass through of the cost push

from raw materials. Though demand is good enough to pass on the bulk of the cost increment,

it is not robust enough for steelmakers to cream a buffer over highly significant costincrements. The situation is similar globally, regions and production processes.

Backward integration key to success - coking coal, ferroalloy-ores, iron ore plays best

placed.The existing mining operations have not seen any significant jump in production cost.

So mineral, steel and ferroalloy companies with captive ownership of key raw materials (iron-

ore, coal, coking coal & ferroalloy ores) would gain enormously as any increment in revenues

will flow almost entirely to net profits!


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Weakness over US recession a good time to buy - Big jump in US domestic HRC prices,

shock to the system! According to latest industry reports, US domestic hot rolled coil (HRC)

prices have shot up $73/t during Jan 2008 (up 12%), putting fob mill price at $699/t. HRC

prices are now 24% higher than the 12-month low of $564/t in July 2007. This surprise rapid-

fire price rise dispels the apprehensions of global steel prices softening in the face of a US

recession. If there is no impact in the US' own dockyard, one can discount the impact on global

steel price levels.

Biggest Gainers

Miners owning coking coal, ferroalloy ores & iron-ore.

Vertically integrated steel & ferroalloy companies.

Gainers

Steel companies with high ownership of key steelmaking raw materials.

Steel companies with visible concrete steps in this direction.

Losers

Low ownership of iron-ore, coking coal & maintaining status quo.


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INDUSTRY COST DYNAMICS

There has been a fundamental shift in the cost structure for steel production over the past few

years. Cost inflation has impacted all key componentsenergy prices, key inputs such as iron

ore and coking coal, freight charges and labor costs. Not only has this inflated operating costs,

but the capital costs have also increased over the past several years.

As the mining industry failed to keep pace with incremental demand growth from a rapid surge

in steel production in China, prices of two major inputsiron ore and coking coalincreased

2.6x and 2.7x, respectively over the past five years.

Iron ore contract prices is expected to rise further by 30% in FY2009E . The analysis indicates

that over the past three years there has been a close correlation between six month trailing

average premium (prior to the date of contract settlement) and the actual contract settlement. If

this relationship holds for the FY2009E negotiations it may be realistic to assume a 30% rise for

contract prices.

A surge in sea-borne trade for these bulk commodities has also impacted the freight markets,

where freight rates have on an average increased by 180% (Baltic Dry Index) over the past four

years.

A majority of the increase in these cost elements is more structural (and therefore more sticky)

in nature than cyclical (which is largely largely reversible). As marginal projects need to deliver

on the expected ROIC (to cover the cost of capital), a high-cost structure will act as a floor for

steel prices and support a high-price regime in the medium term.

India enjoys certain natural advantages which lends ia a sustainable competitive edge to emerge

as a hub for steel production and consumption:

Acess to high quality iron ore reserves

Competitive labour cost (despite poor productivity)

Skilled labour force with mining and steel making experience

High domestic demand gowth


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RESOURCE DEMAND

EFFICIENCY AGE : 1978-1988 Incremental steel demand/supply from the western world/ matured economies

EAF : Scrap preferred inputs

Iron ore and coal took back stage

IRON AGE:1988-TILL DATE

Iron ore and coal taking centre-stage Incremental steel demand largely

0

5

10

15

20

25

30

35

40

0

100

200

300

400

500

600

700

800

900

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Blast Furnace EAF % of EAF

Steel DemandRising:

BF Output

Rising

EAF output

Rising

SLowdownShare of EAF

rising

Rising Demand/Output

Share of EAF

falling

RESOURCE DEMAND TO RISE

FURTHER

WorldWorldCeudeSteelProduction(mnTonne)


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HOT METAL : COST CURVE

Tight Iron-Ore

situation

Company

Country

Tight CoalSituation

Company

Country

Russia is best placed.

India and Brazil have iron-ore advantage.

China enjoys coal advantage

If we take the case of South Korea onwards where there is tightness in irone-ore as well as coking

coal HRC price will be:

HRC Cost @$450/t= Hot metal cost @$320/t+ Processing Cost @$130/t.

0

50

100

150

200

250

300

350

400

Russia India Brazil China USA South Korea Japan Germany France

Others

Iron ore

Coking

coal

Labour

Hot Metal/ Cost Curve

US$/t


US$/t


US$/t


US$/t


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Best Case (USD/

Tonne)

Greenfield Capital Cost

(USD/ ton)

1200

Operating cost 450

EBIT @ 16% ROCE 192

Depreciation @ 5% 60

EBITDA 252

Cost of Production 450

Selling Price of saleablesteel

702

Base Case (USD/

Tonne)

Brownfield Capital Cost

(USD/ ton)

900

Operating cost 450

EBIT @ 16% ROCE 144

Depreciation @ 5% 45

EBITDA 189

Cost of Production 450

Selling Price of saleablesteel

639


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Iron-Ore Supply still in the hands of a few(refer to hot metal cost curve)

Iron-Ore:Global Demand(mn tonnes)

Countries Steel

outpu

t

BF Iron Ore

requirement

Source/Availability Imports

China 349 87% 548 Local Net Import 275

Europe 220 58% 230 Local Net Import 154

North

America

128 44% 101 Local - -

Russia+CIS 113 84% 171 Local - -

Latin

America

45 64% 52 Local - -

Japan 112 74% 151 Net Import 132

Korea 48 56% 48 Net Import 42

India 38 55% 38 Local - -

Others 116 - - Net Import 131

World 1132 68% 1138 734

Iron Ore: Global Supply concentrated in few hands

Countries (mn

tonnes)

Key Players

Australia

Latin America

India

238

240

80

Rio

BHP Billiton

CVRD

India(fragmented)

137

101

218

80

Others(CIS/Africa/Canada) 176 Others 198

Total 734 734

Local iron ore situation

Countries Status Structure

China Fragmented Largely govt. owned and

village ownership

Poor quality, high cost

India Fragmented High quality, low costNorth America Consolidated -

Russia+ CIS Consolidated -

Latin America Consolidated -

Supply concentration and tight coal situation remain the key

factors

62%

of the

total


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Iron ore prices- to rise with demandsupply mismatch

Next year contract prices likely to go up significantly, high level of spot prices

Source: World Steel (IISI)

Incremental

Supply

(mn tonnes)

BHP Billiton 35

Rio Tinto 60

CVRD 130

Kumba 15

India 15

Others 30

Total 285

Iron-ore long-term contract prices hike likely to beat best of estimates

Mn tonnes Realistic case

05 06 07 08E 09E 10E

Steel Ouput 1139 1240 1352 1446 1533 1610

%growth 7 9 9 7 6 5

Pig iron +DRI 850 930 1014 1085 1150 1207

Iron ore 1315 1439 1568 1678 1779 1868

% Pig iron +DRI 75 75 75 75 75 75

Incremental

Demand (over 07)

- - - - - 299


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The iron ore industry is highly consolidated with more than 70% of the sea-borne trade being

controlled by three private players namely CVRD, Rio Tinto and BHPBilliton. Add to this

the fact that visible action for merger between BHP and Rio has begun and CVRD is also in

advanced merger talks with another mining giant Xstrata.

Iron ore is consumed in crude steel production through blast furnace (65% share) and DRI

processes with total consumption being approximately 1.65 times of global steel consumption

through these processes. Blast furnace process accounts for more than 85% of China's steel

production, which has been growing at a staggering pace of 50-60 MMT each year resulting

in an incremental iron ore demand of almost 80 MMT each year. It is increasing accepted that

China steelmakers would remain dependent on iron ore imports for many years to come.

Iron ore spot prices correlate highly with contract markets

Source: CRU


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India is endowed with abundant deposits of high quality iron ore reserves. Of its 24 bn tonnes

of estimated iron ore reserves ,(6% of total global iron ore reserves), about 70% is high-grade

haematile with an iron(Fe) content of more than its requirement. As a result, India is also a

large exporter of iron ore (accounting for 8% of global sea-borne iron ore trade in 2006), and

a key supplier to China.

Thus, a rise in contract iron ore prices in FY2009E are likely to be a big positive for Indian

steel producers with access to captive high quality iron ore reserves. Any pass-through of

higher iron ore prices by global steel producers may lead to higher realizations for Indian

companies as well, but without a corresponding increase in raw material costs.

While the industry is currently divided over iron ore exports, till the time the Indian steel

industry builds enough beneficiation / sintering / pelletization facilities (which consume

fines), exports of iron ore will continue.

Triggers for iron ore prices settling above market expectations

CVRD has cancelled about 5 MMT of iron ore shipments to China in the first quarter,

supporting spot iron ore prices as talks over term prices continue

Rio-Tinto has already announced selling 15 MMT of iron ore in spot markets for FY08

against 4 MMT in FY07. Rio, in the past, has been accused of being soft in long-term

contract prices for iron ore. However, with BHP's hostile bid looming, it is expected to

bargain tough to bolster its claim of higher valuation for its stock. Entering big time in spot

sales in FY08 is a step in this direction and is likely to weigh heavy on price negotiations.

BHP Billiton has already announced its intention of settling FY08 iron ore prices on CFR

basis unlike earlier practice of fob basis with CVRD. Given the prevailing high dry bulk

freight charges, it wants to leverage Australia's proximity to China and boost its net profits. In

January 2007, freight charges for 160,000t cargo for Western Australia-China were around

$16/t and Brazil-China was $37/t. Prevailing prices have now shot up to $35.50/t and

$82.50/t, respectively. This implies that freight cost advantage for China to import from

Australia as opposed to Brazil has increased from $21/t to $47/t, that is, a gain of $26/t,

which itself is 50% of the long-term price of iron ore for last year. What is interesting to note

here is China snubbing BHP's proposal comes a week before BHP's announcement of a likely

takeover bid for Rio-Tinto!


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Rail freight of iron ore hiked from January 7 2008 to burden Indian steel companies by more

than 6% while iron ore companies are required to pay further 60% congestion surcharge on

the basic freight. New hikes are in addition to the usual busy season surcharge of 7% apart

from 2% development surcharge.

Indian iron ore leader NMDC has already raised their long-term prices by 47.5% to Rs.1783/t

from Rs.1209/t effective retrospectively from October 1 2007. These rates are still well below

the international long-term market rates. NDMC is likely to further raise prices once long-

term price negotiations for FY08 are settled. Domestic giants seem to be more active now.

This means there is no respite for Indian steel players in FY08.

10-15% ad valorem (or by value) duty on export prices of iron ore has been proposed by the

Indian Steel Ministry in the new pre-Budget (expected on February 29) recommendations

sent to the Finance Ministry. The proposed duty to curb exports would be based on current

fob prices for exports, replacing a system of fixing specific rates on every tonne shipped out

of the country. The current duties have had no impact as iron ore exports continue to grow

with rising prices. The tax payable under the new duty structure will change with fluctuating

prices. China's move of increasing export duty on coke by 10% may lead to acceptance of the

proposal in some form.

Forecast: Conditions are just ripe for iron ore long-term prices for 2008-09 to jump 57% to

US$80.8/t ahead of increased market expectations of 30-50%. Extremely sharp upwards

movement being witnessed in scrap prices across markets in last month is a good indicator of

its high probability. However, price negotiations to linger for the next few months. They are

unlikely to settle sometime soon like last year when the process was completed by Christmas.


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Coking Coal Supply getting Concentrated(refer to hot metal cost curve)

Global coking coal demand (mn tonnes)

Countries Steel

Output

BF Coking coal

requirement

Source/Availability Import

China 349 87 304 Local -Europe 220 58 128 Net import 60

North America 128 44 56 Local 0

Russia+CIS 113 84 95 Local 0

Latin America 45 64 29 Net import 29

Japan 112 74 84 Net import 84

Korea 48 56 27 Net import 27

India 38 55 21 Net import 18

Others 116 - - Net import 10

World 1132 68 744 228

Supply: Concentrated in few hands

Countries (mn tonnes) Key Players

Australia 125 BHP Billiton/Mitsubushi

Anglo/Mitsui

Rio Tinto

45

12

10

Canada 26 Elk Vally

X strata

20

10

USA 26

Indonesia 19

Russia 12

Others 20 Others 131

Total 228 Total 228

Local Situation

Countries Status Structure Nos %of output

China Fragmented Large state

owned

119 47

State owned

local

2,000 16

Town & Village 32,000 37

North America Consolidated

Russia+CIS Consolidated

Coking coal supply concentration is rising

~50% of the total

~70% of hard cokingcoal


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COKING COAL-TIGHTNESS AHEAD

Coal prices are likely to rise, again on rising imports from China/Asia and slower additional supply

Incremental

Net Supply

(mn tonnes)

China 105

Australia 25Canada 15

Russia 10

Africa/Others 10

Total 165

Coking coal tightness to resurface; Prices to go up

Mn tonnes Realistic case

05 06 07 08E 09E 10E

Steel Ouput 1139 1240 1352 1446 1533 1610

%growth 7 9 9 7 6 5

Pig iron 795 871 946 1012 1150 1127

Coking Coal 731 801 870 931 1779 1037

% Pig iron share 70 70 70 70 70 70

Incremental

Demand (over 07)

- - - - - 166


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Coking coal/coke - short supply in India, supply squeezing grips China as well

Coking coal international trade dynamics are quite unlike other steelmaking raw materials

with China constituting just 5.7% of the total global imports while India's 10.6% share is a

little more significant. Going forward, with maximum demand growth coming from China

and India, the supply-demand balance would undergo major change. Indian steel production

capacity targets for 2012 and 2020 have been revised upwards sharply to 124 MMT and 275

MMT, respectively. China growing @50MMT plus for years now likely to continue

similarly.

For 2008, India is likely to witness the highest growth rate in coking coal import @ 20.8% to

29 MMT, twice the 14 MMT import expected from China, against the global average growth

rate of 2.2%. India currently imports almost entirely from Australia, which has been plaguedby port congestion for most of 2007.

Coking Coal imports-Key importing nations

Source:Steelguru

On the coke front, India mainly imports from China and partially from the US. China has

recently increased the export taxes on coke by 10-25%. This has sent raw materials prices

spiraling mercilessly.

China has also recently released a new list of 146 coke companies constituting 12.6 MMT of

coking coal capacity. These were slated to close by end of 2007. This list is additional to the

first list, involving 20 MMT/year of coking capacity released in October 2007 with the same

closing deadline for end of 2007. These targets when implemented even with some delay

would substantially curtail supply.

Luo Bingsheng, Executive Vice Chairman, China Iron & Steel Association, recently

announced that inventories of coking coal in some steelworks are less than 10 days. There is

some scare buying in the coking coal market. Indeed, the supply of coal is traditionally short

before the Chinese New Year because most coal mines stop the production for holidays.


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However, the short supply is extremely serious this year. Recently in northern China there

has been increased inspection of truck load limit of 55 MMT, which has become a logistic

problem.

Further, a majority of Indian steel companies are sitting on very low coking coal/coke

inventories.

In the latest developments, there have been floods in the Queensland region in Australia,

which severely hampered the coking coal mining operations. A curtailed supply in 2008 from

the main supplying nation is expected.

Coking coal imports,consumption and production (mn MT)

Source: Ministry of Coal

India relies heavily on imports to satisfy its demand for coking coal

India does not enjoy the same advantage in coking coal. As per estimates of the Geological

Survey of India (GSI), India has about 245 bn tonnes of coal reserveshowever, coking coal

deposits comprise only 13% (32 bn tonnes) of it. Therefore, the Indian steel industry has to

largely rely on imported coal (mainly from Australia). Despite the coking coal handicap,

captive iron ore and low labour costs make Indian steel producers among the lowest cost

producers (such as Tata Steels Indian operations and JSPL).

Forecast: Latest coking coal spot prices are reported to be above US$200/t against last year's

contract prices of US$96/t. Market conditions are getting extremely tight each passing week.

Contract prices for FY08-09 to settle at record levels of US$160/t, up 66.7% YoY. Spot

prices of coking coal and coke to significantly rise further even from these levels.


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Ferroalloys - Soaring high, to climb higher

China with a huge jump of more than 50 MMT in steel production year after year has been

leading the demand for ferroalloys. With supply failing to catch up this has led to huge jump in

prices of ferroalloy ores. Now, the Indian steel production capacity looks set to zoom during the

next decade. The Indian Steel Ministry has upgraded the target for 2012 and 2020 to 124 MMT

and 275 MMT, respectively. The fortunes of ferroalloy producers (though mainly integrated

ones) is going to be in an upswing for years to come. This is likely to be among the hottest

sectors, going forward.

Ferrochrome demand in China climbed last year with a huge jump in production of stainless steel

and steelmakers substituting the alloy for nickel, which rose to a record US$51,800/t on the LME

in May 2007. China, the world's largest ferrochrome user, probably imported three times more

ferrochrome last year than in 2006. China imported 1.24 MMT in the first 11 months as

compared with 449,385 ton during the previous year. It also increased imports of chrome bearing

rock by 40% to more than 6 MMT. Ferrochrome prices in the EU have shot up to US$ 1.21 a

pound, up 55% from the 2007 average of US$0.78. With rising demand from China, increasing

costs, low stocks and the absence of new production capacity, prices may top US$1.5 this year.

China had exported 2.93 MMT of ferroalloy in January-November 2007, up almost 50%. Japanwas China's main export destination with 1 MMT of ferroalloy or 34.6% share followed by

South Korea with 0.33 MMT or 11.4% share. With increase in export tax increasing to 20% from

earlier 10-15%, exports are expected to come down while prices are likely to rise further. Earlier

in October 2007, the Chinese government had canceled the preferential electricity rates for

Chinese ferroalloy plants forcing the producers to increase prices.

China has recently announced a second batch of closure of 45 ferroalloy plants with 91 outdated

production units with a total capacity of 120,000 ton, located in the inner Mongolia region. In

October, China had announced the first batch of 204 ferroalloy plants with a total of 302

outdated production units and 1.17 MMT/ year of ferroalloy capacity, which were to shut down

production by the end of 2007.

Back in India, Tata Steel, which was the biggest supplier of chrome ore, has stopped selling to

outside parties. They are selling their ore only on toll conversion basis to those who have

agreements with them. All these are pointers to the huge shortage of the alloy and the present

price increases can not only sustain but also maintain upward momentum for few years to come.


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Ferroalloys prices (US$/lb)

Source: Bloomberg

Freight rates cost pressures shaping up trading dynamics

Dry bulk freight rates at end-2007 were more than double the end-2006 levels. Thus, Asian peers

are finding nearby countries like India relatively attractive. China, along with Malaysia and

Thailand, accounted for almost two-third of steel imports during the period.

Ocean freight rates are substantially below the all-time high, reached in November. This has

been due to a combination of factors like seasonal slowdown, easing traffic at Australian ports,

short-term stoppage of exports from CVRD in Brazil, flooding in Australia and South Africa

resulting in coal exports slowdown etc. The underlying tone remains strong and with fuel costs

persisting at high levels,dry bulk freight charges would bounce up again from these levels in the

coming months.


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Freight charges will be back in action soon

Source:Bloomberg

Aggregate Cost Increment Forecasts

Hike in resource prices 2008-09E(%)

~Increase in steel prod.costs

US$/t

Iron ore 57 50

Coking Coal 66.70 48

Coke >60

Thermal Coal >50 3

Ferro Alloys >60 7

Freight Charges >25 120

Total 120

To sum up, the cost of production can shoot up to $120/t for blast furnace steel producers

without vertical integration. With captive ownership of various resources, proportionate cost

increase can be prevented.

EAF players using scrap are worse off as sharper price jumps are being witnessed in global scrap

prices. Turkey prices for America scrap have reached CFR US$460/t, a massive 31% jump from

US$350/t levels in early November 2007.


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Cycles getting shorter

Supply-side shocks are causing steel spot prices to contract, with the average cycle

now lasting only a year in Asia

This is expected to continue till 2009 or at least while China remains a major net

exporter of steel to the region

Ironically, shorter spot price cycles lead to flatter, or more stable, contract price

cycles(see graphs below) which means the average selling prices of steel products do

not change much year to year (see graph) in a short cycle if the entire cycle plays out

in a year

Stable contract prices should lead to stable margins and returns. Lower volatility of

earnings and returns should, in our view, be rewarded by markets with higher

valuations.

Normal steel cycles Shortened steel cycles

Contract prices generally follow the same peaks and valleys in a normal, longer, spot price cycle.

But shorter spot cycles, however, can flatten the contract price cycles.


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Shorter Cycles: Normalized price through the cycle

Source: Goldman Sachs

In a flatter contract price cycle, ASPs do not change much year to year. In a more consolidated

steel universe, the more tangible benefits of consolidation, such as structurally higher steel

prices, in an industry as global as steel can be enjoyed by all. Therefore expect prices, profits and

returns to be structurally higherwhich should result in higher valuations.

High prices to be sustained

Indian steel prices are linked to East Asian steel prices, adjusted for import tariffs, exchange rate

fluctuations, freight rates, etc. Domestic steel prices are generally pegged at a certain discount to

the landed cost of imported steel to discourage domestic buyers from resorting to imports. In the

past five years, domestic HRC steel price has been at a discount of 5% to landed cost of imported

metal.

Domestic discount/premium to landed cost


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Demand- supply and other conditions dictate premium/discount of domestic prices to landed

cost.bull run in steel prices will be sustained over the medium term, and prices are not likely to

retrace to historical long-term average levels. With raw material and freight markets showing no

signs of easing off, risks remain on the upside.

On the raw material side, iron ore and hard coking coal prices are likely to increase by 30% and

20% respectively, for FY2009E.


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PRICING OUTLOOK

Indian steel makers hike steel prices beginning Feb 2008 by firm US$40/t-US60/t after

modest hike of US$15/tUS30/t last month.

Steel Authority of India Ltd has raised prices by Rs.1500/t- 2500/t after raising Rs.600-700/t forlong products, cuts rebates by same amount for flats last month.

RINL has raised prices by Rs.3000/t- 3500/t after raising Rs.800/t for round steel products,

Rs.1000/t for TMT bars, Rs.1200/t for semis and Rs.1200-1500/t for structural products last

month.

Tata Steel has raised prices by Rs.2000/t- 2500/t after raising by Rs.800-900/t last month and

Ispat Industries has raised prices by Rs.2000/t, after raising it by Rs.600-800/t last month. Other

private players have hiked prices similarly.

Domestic price hike in line with global price trends

World leader ArcelorMittal and China majors like Baosteel and Anshan had already declared

significant price hikes beginning Q1CY08 and have continued the trend for coming months.

Turkish producers are contracting rebar at $720-725/t fob for March deliveries. This is up from

$635-645/t last month and $555-560/t in October 2007, a 30% jump in just three months!

In Dubai Gold & Commodities Exchange (DGCX), rebar futures prices are going up rapidly.

The DGCX rebar price, which started December at $653.6/t for February contracts has now shot

up to $803.4/t, so it has put on incredible $150/t or 22.9% in just one and a half months. Prices

for March and April contract stood at $836.2/t and $845.2/t, respectively. Even though DGCX is

new in the rebar market, it has fast become a barometers of price movements in the physicalmarket and future expectations.

Price hikes to come in stages

Recent price hikes are just a beginning. More hikes by the next quarter is expected. Globally,

strong consumption trends in Brazil, Russia, India, China and the West Asia are offsetting

weakness in the US. Even in the US, prices are rising despite a fall in end user demand, driven

by demand from steel service centers where inventory levels are low, as also a fall in imports and

jump in exports.


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Raw material cost pressures for iron ore, coking coal, coke and scrap; higher energy costs and

freight charges have substantially increased the average cash costs of steel industry and price

rises are necessary to sustain margins.

The dollar has been depreciating sharply over the last year and this trend is expected to continue

this year as well. So offset for currency exchange losses arising out of this there is upward

pressure on all commodities and similarly on steel products.

How the product price hikes will offset this cost push varies with product categories. It is higher

for semis and long products and lower for flats (HRC, CRC) and plates. However, even for HRC

huge 17% (approximately) price rise would only help to sustain margins. The ongoing supply

tightness in the Indian steel industry to enable steel producers to pass on the bulk of the cost

increment is expected. However, it looks unlikely that they would be able to cream a buffer. We

forecast steel product prices will rise atleast 15% during the year.

With varying demand inelasticity and supply pressures across product categories, percentage

price push from steelmakers would also vary significantly. Long steel products fueled by

booming infrastructure and real estate is likely to lead to price growth this year. Flat steel

products price growth is likely to be comparatively weaker given import pressure from China.

Gainers & Losers

Vertically integrated blast furnace producers stand to cash windfall as they benefit from price

hikes of steel products without facing significant raw material cost pressures. Mineral companies

(though few in India) owning these resources are best placed. Potentially, their net profit growth

can surpass the best of expectations. Those with a high degree of self-sufficiency of key raw

materials like iron ore and coking coal also stand to gain and so would be one's taking visibleconcrete movements in that direction.

Those with limited or no captive resources would struggle to maintain their operating margins.

Given that the industry, at present, is in a comfort zone of record margins levels, even some

compressed operating margins are bearable. However, the problem lied in the radical shoot up of

valuation of steel companies with little discrimination and with the likelihood of many among

these delivering performance below expectations, this would likely be corrected, going forward.


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Snakes and ladders

Biggest Gainers + Miners owning coking coal/Iron-ore & Ferroalloy Ores

+ Vertically Integrated Steel & Ferroalloy Companies

Gainers + Steel Companies with high ownership of key steelmaking raw materials

+ Steel Companies with visible concrete steps in this direction

Losers - Low ownership of iron-ore, coking coal & maintaining status quo


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COMPANY SECTION

OLIGOPOLY FRAGEMENTED

Differentiation

Uttam

Bhushan

Jindal Steel

Mukund

Kalyani

Visa Steel

Monnet

JSPL Steel

JSW Steel

Sail

Tata Steel

Cost Leadership

Industry

Surface

Denote

Future

Strateg

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Analysis of Steel Sector

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