Speech by Jean-Sébastien Jacques at Steel Success Strategies Conference

21 Jun 2011

Good morning Ladies and Gentlemen

Is the Steel industry engaged in an inter-galactic battle?  As a dedicated Star Wars fan, I would argue that we are not in a full-scale battle but there are certainly forces of conflict within our galaxy, with some more challenging than others.

What I will try to do this morning, in the next 10-15 minutes, is to provide you with a Tata Steel perspective on this topic.  This will be the perspective of a company which primarily operates in India and in Europe and I am looking forward to hearing what the other panellists have to say on this topic

The way we look at our business is by taking a long-term perspective. When we invest in a new steel plant or a mine, we don’t invest for ourselves but for our children and even our grandchildren

To better understand the challenges faced by our industry, let us remind ourselves of the 8 mega-trends (or forces) that our industry is facing. The first 3 trends are as follows:

1. We are operating in a global economy and the steel market is now one global market
2. There is a structural rebalancing of the world economies between the so-called mature economies and the developing economies
3. Urbanisation – the rise of mega-cities, with the obvious increase in steel demand for construction, industrial and consumer products

The next 3 trends are:

4. The significant growth in China’s steel demand and in other regions, and their dependency on imported raw materials, have contributed to a scarcity in resources around the globe
5. Climate change and the environment are now high on the agenda of politicians and communities. This is not only an issue in Europe, it is a key issue in India and across South East Asia as well
6. Technology is the key differentiator and could become a game changer for some of the challenges the industry is facing

And 2 last trends:

7. There is a war for talent and our industry is competing for people against other industries

Last but not least:

8. Consolidation is continuing in other industries such as mining, but in our industry it has slowed on an international level. I will come back to this point in my presentation.

In this context, what are the key challenges faced by the Steel Industry / Galaxy?  As Tata Steel we have identified 5 key challenges:

1. China’s growth and strong appetite for resources have led to conflict between the steel industry and the miners on the pricing of raw materials
2. This in turn has led to a race for the acquisition of resources from both the mining and the steelmaking industries
3. What looked like a global M&A or a consolidation battle in the steel industry a few years ago has become less active for the moment, however, there is still consolidation on a regional level. India is gaining importance both for its resources and as a growth market in the eyes of foreign companies and this will lead to increased M&A or partnerships in the region
4. The challenges we face on the Environment and Climate Change may be the most important battles we, as an industry, encounter because they will affect our future in some regions as well as the perception our customers and communities have of us.  At the end of the day our licence to operate is given by our local community

Finally:

5. Our industry is constantly challenged to develop breakthroughs in technology, to provide solutions, whether it’s to do with the environment or any other challenge that our customers or we ourselves may face.

Let me take you through some of those challenges.

Challenge # 1 – raw material prices and volatility

High steel demand in China has resulted in a high level of raw material demand globally as China is increasingly reliant on seaborne iron ore and coking coal.

With a tight demand/supply balance, iron ore and coking coal prices today are more than 5 times higher than in the year 2000.

In addition, the steel industry has been forced to accept quarterly and monthly pricing, which has not only increased the risk profiles of our businesses, but also those of our customers.

The impact of this is illustrated by looking at the movement of the basket of raw material costs for a non-integrated steelmaker. For the decade preceding 2005, the cost averaged $80/t and fluctuated within a $30/t range.

But since 2005 the picture has changed completely. Raw material costs increased to an average of $280/t, with a significant increase in volatility and a variation of $325 between the lowest and the highest cost level.

Challenge # 2 – raw material asset quest

It is, therefore, no surprise that the miners have systematically been digging into the steel industry’s profit pool. The mining industry now captures around 65% of this profit pool, while in 1995 it only captured around 20%.

With steel companies coming second in the pricing game, several companies have joined the race for resources and are investing upstream. At Tata Steel we are no exception and we are building up a portfolio of mining assets with projects such as our Direct Shipping Ore project in Canada and the Benga Coal project in Mozambique.

We are not the only one in this race

• Chinese producers are actively investing in mining projects, for instance:
  • Wuhan Iron and Steel has stated publicly that it wants to become self-sufficient in iron ore
  • Hunan Valin holds a substantial 16% in Fortescue, one of the largest new iron ore companies
• Indian companies as well – Jindal Steel & Power acquired a licence to explore and mine coal in the northwest Tete province of Mozambique

And the list goes on …

Challenge # 3 – M&A activity

In contrast with the acquisitions that have taken place in the mining sector, M&A activity in the steel industry has dropped since the financial crisis.

As shown in this graph M&A deal values in the steel industry declined from over $86bn in 2006 to only around $20bn in 2010.

Five years ago, as Mittal was taking over Arcelor and Tata and CSN were battling over Corus, consolidation and globalisation seemed to be the trend the industry was going in.

But the mindset of steel companies has changed during the recession. We have learned a few lessons that have made us more cautious in our approach to industry consolidation. We have learned that:

1. Stretched balance sheets are a burden in a downturn
2. Non-Chinese companies have struggled to build positions in China
3. Strategic shareholdings are protecting a large number of companies from hostile takeovers, and
4. The global steel company model is not necessarily a recipe for value creation.

So today most steel companies are more value-driven, as financing is less easy to access and, as a result, consolidation is continuing on a more regional level, as we have seen in China and more recently in Japan.

As far as India is concerned, we anticipate more acquisitions and partnership activity as India combines richness in iron ore resources with a fast-growing market for steel. Several international steel companies are looking at India and trying to enter the market: Posco, ArcelorMittal, Sumitomo Metal Industries, Nippon Steel.

India is today a very exciting place to be!

Challenge # 4 – Climate Change and the Environment

The next key challenges faced by the steel galaxy is in relation to Climate Change and the Environment

These charts provide carbon emissions data by the top emitting countries or regions for the year 2000 and 2007

The message here is that Climate Change is a global battle. China has during the first seven years of the new millennium overtaken the USA and European Union in its emissions, while India has overtaken Japan and Russia.

So it is unfortunate that there is no global agreement on Climate Change yet.

Today, steel producers in Europe are in the front line, facing punitive environmental legislation.  Phase 3 of the EU Emissions Trading Scheme will be rolled out in 2013 and there will no longer be a 100% free CO2 allocation for European steelmakers,  not even for the best performers in the industry who are likely to end up with a shortfall of about 7%.   

Climate Change and the Environment are very high on our agenda in India as well and Tata Steel has the ambition to take on a leading role there.

Ultimately, we will all have to tackle this issue, as that is what our communities, our customers and our governments will expect over time.

Challenge # 5 – Technology

New technology could be a game change for our industry in several areas including the Climate Change issue:

• It can reduce our dependency on hard coking coal
• Provide us with the ability to source cheaper raw material grades
• Help us operate under new environmental frameworks, and
• Improve our product offering to better serve our customers

To give an example:

Tata Steel is working with the ULCOS consortium comprising 48 European companies and organisations, including suppliers to the industry, research institutes and universities. The aim of this research and development initiative is to investigate new steel production processes that would drastically reduce CO2 and other greenhouse gas emissions compared to current production methods.

As part of this initiative ULCOS has built:

• The HIsarna smelting reduction pilot plant at Tata Steel IJmuiden, and
• The Top Gas Recycling BF demonstration plant at ArcelorMittal Florange

We hope that these projects can deliver technology to revive the competitiveness of European steel producers operating under a more punitive environmental framework.

Technology also offers us the opportunity to serve our customers better. In a world where energy and cost efficiency is becoming more important, new products such as high-strength ultra-light steels (HSLA) and functional coatings could help change the perception of the steel industry in respect to our impact on the environment.

How is Tata Steel positioning itself to face these challenges?  There are at least four elements to our game plan, which are:

1. To leverage and grow our position in India to fully benefit from the growth in the Indian market
2. To continue investment in upstream integration where we can create value
3. To differentiate our products and services in Europe to avoid competing in the commodity markets
4. To put a new emphasis on the development of new technology and products through a strong R&D function

To conclude, I want to highlight that we operate in a competitive industry, so some of these challenges we will face individually, such as our strategies towards M&A, upstream investment and developing new products and technology to better serve our customers’ needs.

However, there are also challenges that we, as an industry, can and should tackle together. These are :

1. The rebalancing of pricing power with the miners
2. Using the world’s resources more efficiently
3. Working with authorities to reduce emissions and operate in an environmentally friendly way

We need to work together to change the perceptions about our industry, so that we are no longer perceived as part of the problem but as part of the solution by our customers and, more importantly, by our communities in which we operate.

Ladies and Gentlemen

Thank you

View the slides that accompanied the speech