Government, which has been sitting on the sidelines in the dispute between behemoths Kumba and ArcelorMittal, this week got into the ring and took the gloves off.
The department of trade and industry quoted an earlier Competition Tribunal finding that enforced divestiture, the sale of one of its steel plants to end ArcelorMittal’s dominance in the market, may be required as a remedy.
The warning from the department followed an announcement on Tuesday by ArcelorMittal, the largest steel company in the world, that it was imposing a surcharge, which it called the “Sishen surcharge”, on its steel products until its dispute with Kumba was resolved.
The surcharge, which is likely to increase steel prices by about 10% or R600 a tonne, would be repaid if ArcelorMittal wins the dispute.
The department responded by saying it will refer ArcelorMittal to the competition authorities for potential abuse of dominance.
The announcement occurred against the backdrop of soaring international demand for iron ore by Asian countries. Major iron-ore producers have reportedly broken with the tradition of establishing ore prices through annual contracts with customers such as China.
The Financial Times reported that global steel prices are set to rise by up to a third, pushing up the cost of everyday goods such as cars and domestic appliances, after miners and steelmakers agreed to a new ore pricing system.
The deal between iron-ore providers Vale and BHP Billiton with steel mills in China and Japan scraps the contract system used for the past 40 years and replaces it with quarterly contracts linked to spot prices.
The world’s three largest producers, Vale, BHP Billiton and Rio Tinto, could boost profits by $5-billion this year as a result, the FT reported.
Bloomberg reported that Vale had achieved a 90% cost increase on its ore through this process.
Potentially wide-ranging effects
The war between government and one of South Africa’s largest private companies has potentially wide-ranging economic and political effects, given the dominance of ArcelorÂMittal over the local steel market.
The move by ArcelorMittal may also undermine the department’s industrial policy development plans, which seek to boost certain sectors of the economy, including manufacturing. Competitive steel prices are seen as a key element of this endeavour.
The furious response by the department is unsurprising because it has said that ArcelorMittal’s prices for the local market have not reflected the preferential ore prices that it received from Kumba.
ArcelorMittal’s pricing regime — a longstanding cause for acrimony between the department and the company — has been called into question on a number of occasions.
In an announcement on Tuesday this week ArcelorMittal said it would be adding the surcharge “to partially mitigate the additional iron-ore cost, based upon the international spot price for iron ore that SIOC [Kumba subsidiary Sishen Iron Ore Company] asserts it is entitled to charge on iron ore supplied to ArcelorÂMittal, which entitlement ArcelorMittal disputes”.
This follows a notice from SIOC that it would no longer supply iron ore to ArcelorMittal from the Sishen mine at cost plus 3%. ArcelorMittal said it “has been left with no alternative but to inform its customers that it will, with immediate effect, adjust its commercial Âpricing policy”.
The dispute between the two companies is complicated further by the failure of ArcelorMittal to convert its share of the 21,4% mining rights to the Sishen mine — the rest of which are held by Kumba — into new-order mining rights by April last year.
The rights reverted back to the state and the department of mineral resources awarded prospecting rights on this portion to a little-known empowerment company with links to the ANC called Imperial Crown Trading 289. It has since decided to review this decision.
Arbitration
ArcelorMittal chief executive Nonkululeko Nyembezi-Heita said at a press conference that the money from the surcharge would be set aside until arbitration on the matter decided whether the cost-plus-3% contract still stood, or whether Kumba was entitled to claim higher prices. She said that should ArcelorMittal prevail in the case, the money would be returned to customers, with any interest incurred on it. But if it lost against Kumba the funds would go towards “partially mitigating” the increased iron-ore costs.
But the trade and industry department accused ArcelorMittal of forcing the local economy to pay for its “commercial error” in not converting its mining rights, which in turn led to Kumba’s unilateral decision to amend the supply contract.
This would “hamper our industrialisation efforts”, it said in a statement.
“ArcelorMittal has consistently argued there should be no link made between its costs of production and its pricing of steel in the South African market, in the context of a long period of concessional access to iron ore on a cost-plus basis,” the department stated.
“ArcelorMittal claims to price its steel according to a ‘basket’ of international steel prices comprising four countries: the United States, Germany, China and Russia.
“Producers in all of these countries are subject to commercial costs of iron ore. Hence the addition of an iron-ore surcharge to this basket amounts to double accounting.
“Further, since at least January 2009, ArcelorMittal has been pricing steel above its own international ‘basket’ price.”
But Nyembezi-Heita said that the thinking behind the benchmark pricing model is to place local downstream manufacturers on the same footing as those in other markets.
“Market prices are always driven in large part by costs,” she said.
“There isn’t any industry where cost doesn’t play at least some role in determining what your ultimate market price is — The fact that we are using domestic prices in those [four other] markets should not hide the fact that those prices do have cost drivers underpinning them —
“Globally if iron-ore prices increase, coking coal prices increase, you will expect market prices to move up and that what is happening at the moment,” Nyembezi-Heita said.
“It is not correct to think that our prices in South Africa are completely divorced from costs. They are not. It’s just perhaps that the link is more indirect.”
She said the company was not just experiencing a general rise in costs, but also a specific event peculiar to ArcelorMittal, to which the company needed to respond.
“There is no real point ducking the issue,” she said. “We simply are not in a position to absorb that level of cost increase.”
Surprise
Kumba, meanwhile, expressed surprise at ArcelorMittal’s decision to impose the surcharge.
“Kumba had offered reasonable interim pricing proposals to which Mittal gave no response at all. It is Kumba’s understanding that Mittal’s pricing is based on a basket of prices similar to [international pricing parity] and that the prices charged by Mittal take no account of raw material input costs,” a company spokesperson said.
“Kumba’s understanding is that Mittal already charges the equivalent of international pricing parity. Theoretically thus, Mittal has already historically been charging at the top end of the possible pricing spectrum for its steel. Any further upward adjustment thus appears improbable.”
Nyembezi-Heita pointed out in her briefing that, despite arguments that ArcelorMittal was not passing on the benefits of preferential ore prices, the company’s profit margins were about 15% over the past five years, whereas Kumba had achieved margins of 55% in the same period.
Kumba responded, saying: “Profit margins are determined based on many factors, including efficiencies in the operations. Kumba is not able to comment on the precise extent of Mittal’s profit margin, other than to note that relative to other steel companies, Mittal has made significant returns and its margins have been significant. It is noteworthy that Mittal’s shareholders have made significant windfall profits over the past five years.”
Kurt Benn, portfolio manager at Cadiz Securities, said that although ArcelorMittal South Africa was introducing a fairly big change that would affect downstream industries, historically the local market has been able to withstand larger hikes.
He said ArcelorMittal had “breathing space” in terms of its price relative to import parity pricing of around 5%, and that the increase left the company with a further 5% to claw back the loss on its margins from Kumba.
“This is a political battle as well as an economic one,” he noted.
“The move to bring in a surcharge brings to the fore the impact of the other parties’ decision, namely Kumba and the department of mineral resources [to award the prospecting rights to Imperial Crown Trading 289], and the effect of those decisions on the downstream industry.”
According to Benn, the import parity price for steel is estimated at roughly between R6000/ton to R6300/ton, given various factors, including transport costs, that affect the price.
With rising costs of iron ore worldwide, the costs of steel globally are likely to rise, said Benn, although prices are unlikely to move immediately given excess production capacity across the globe and resultant Âdiscounting.
“But the bottom line is that local steel prices will go up,” he said.
Much would be determined by the outcome of the arbitration process between Kumba and ArcelorMittal.
But he noted that despite the likely increases for the local market, they would “not mean the end of the world for economic recovery”.
This is because steel’s contribution to the cost of manufactured products is, in many respects, far less than that of other commodities such as copper, labour and energy, said Benn.
‘Morally wrong’
ArcelorMittal’s customers did not welcome the surcharge.
Kobus Marais, chief executive of DSE Structural Engineers and Contractors, part of the Aveng group and one of ArcelorMittal South Africa’s largest customers, said that the surcharge made little sense.
“My feeling is that we have always been told that raw material inputs have never been involved in their benchmark price and now [it appears] they are,” he said.
The company will be forced to pass on the increase to its clients, which they in turn would not welcome, said Marais.
If the surcharge raised prices dramatically, he said, the company might be forced to consider importing steel, but it was loath to do so.
“We believe it is morally wrong. We want to support local industry, but when it comes to rands and cents it could make sense to consider imports,” he said.