State hand-outs to EC steel companies have led to overcapacity and helped fuel a price war in the industry. Private British steel firms are particularly concerned as the subsidies are damaging their ability to attract capital. Stephanie Cooke takes a look at how different financial cultures are causing havoc in the sector.
The European steel market is in bad shape. Not only is it being swamped with cheap exports from eastern Europe, but it has been hit by US anti-dumping duties which have effectively closed the gates to the American market.
Asger Peterson, director of state aids at the EC competition directorate, explains that the EC has close to zero growth in steel. It is an inelastic, capital intensive industry and there has been a 30% drop in prices since 1989. The EC is losing an export market of about two million tonnes in the US, due to its anti-dumping duties. The US is also imposing anti-dumping duties on Japan, Korea, Taiwan and Brazil. As a result, these countries are exporting elsewhere, so that there is now a total of six million tonnes in the market.
So who is to blame? Few in the industry are willing to admit it, but the fault lies mainly with Europe's steel-makers themselves. While it is clear that eastern European imports - although only about 4% of the total market - are driving prices down, the failure of Europe's state-owned companies to put their industries in order in the lead up to the single market, has left them very vulnerable to a downturn.
Government bail-outs, particularly in Spain and Italy, and, some would argue, in France, have resulted in overcapacity and mounting debts. Furthermore, as the state-run companies are now selling furiously at rock-bottom prices in order to repay their debts, they are fuelling the price war started by the EC's eastern neighbours and sweeping the rest of the industry downhill, too.
To help deal with the last steel crisis of the late '70s, the EC stepped in to control production with emergency powers granted by the European Coal and Steel Commission (ECSC). And, to act as a guideline on policy, a steel code was drawn up in 1981. By the end of 1985, when the restructuring was completed, the European steel workforce had almost halved and labour productivity had more than doubled. Producers began to concentrate on higher-value specialised lines.
'It wasn't just a question of closing down mills. There was a whole change in the management of the industry,' says a senior industry official. The change, however, did not spread to state-owned steel manufacturers. Governments continued to subsidise the industry as they saw it as an important employment provider, although part of the purpose of the code was to discourage aid. Furthermore, many of these state subsidies were given without adhering to the so-called market investor principle. This is intended to ensure that a commercial investor would find any funding acceptable. The code stipulates that this principle should be used in state aid cases.
Just when the industry had succeeded in cutting a total of 32 million tonnes out of its capacity, another 21 million was added when Spain joined the Community in 1986. This brought the figure back up to 161 million tonnes. Since then Spain has managed to drop four million tonnes. In current negotiations with the EC, the Spanish government has proposed to cut 1.3 million. However, industry experts reckon that three million has to go. The cuts have so far mainly been within privately-run firms. The focus is now on the giant state-run companies, CSI and Sidenor. Unfortunately, the government is finding the streamlining process much more difficult to implement with these companies.
It is Italy, however, that is regarded as the biggest culprit on to state hand-outs. This is because, as one of the founding members of the Community, it has had more time to sort its industry out. As with Spain, severe overmanning and indulgent working practices have kept Italian state-owned mills in the red, even the brief steel boom in the late '80s did not improve matters. Little effort has been made to reduce its capacity.
A steel industry official explains the sector's dilemma, 'The capacity cutbacks in the first half of the '80s were not sufficient at the time. Then, of course, we moved into the boom of the late '80s. During that time the Italians and the Spanish were not making a profit - or an inadequate profit, or even making losses. Subsidised industry of this sort should have cut back, but it didn't. Now we have a drop in demand and the mills are still there, so we're all fighting with each other and even the once profitable companies aren't making money.' Private steel companies in Britain are deeply concerned about state subsidies in other EC countries, not only because they have led to overcapacity and lower prices in the industry as a whole, but because they damage their own ability to attract capital. As long as Britain's competitors have ready access to state coffers, shareholders are wary of investing in UK companies. 'British Steel has rationalised pretty ruthlessly throughout the recession. But investors are concerned that its competitors are state-owned,' says James Capel's steel analyst, Euan Fraser.
Hopes are now pinned on the EC's latest emergency plans to restructure the industry. It is estimated that another 30 million tonnes of capacity has to go, involving between 50,000 and 100,000 job losses and a minimum of 6 billion ecus (£4.8 billion) in redundancy payments and closure costs. Added to these daunting figures are the problems of imports from eastern Europe, the additional eight million tonnes of capacity in former East Germany, and the import duties in the US. 'During the previous steel crisis we had limited import quantities under voluntary restraint agreements,' says DG4's Peterson. 'We can't just close off imports now. We are trying to talk to former Comecon countries to persuade them to be more sensible, but we are faced with a very different moral situation.' The US started imposing import duties last autumn in retaliation for alleged dumping and subsidising by European producers. Some of Europe's producers are still selling into the US, either because the range of duties varies among companies and products, or simply because they have no other choice, but the market is off limits for most. 'America hasn't put up the shutters yet, but they have pretty well closed them,' says an industry official. Unless steps are taken to stop state aid these problems will not be resolved and the current round of restructuring will be of little help in the long run.
When the EC had finished knocking the industry into shape at the end of 1985, it strengthened the steel code. In its new form, all types of aid were forbidden except certain kinds of research and development, environmental investment and social benefits in cases of closures. US industry officials believe that it is not strict enough. But officials at the EC seem to view it as almost too harsh.
Just as the new code was established, Italy asked the EC Commission for more time to restructure. The request was granted two years later. Meanwhile, Spain and Portugal were given three-and five-year extensions, respectively, for eliminating subsidies - time spans which have since proved too optimistic.
Nor did the new code prevent France's state-owned Credit Lyonnais from injecting FF2.5 billion (£260 million) into Usinor-Sacilor, the giant state-owned steel producer; or the French government from subsequently topping up Credit Lyonnais's balance sheet by FF3 billion (£310 million) and raising the bank's stake in the steelmaker to 20%. Both moves were approved by the EC on the recommendation of a firm of Swiss consultants. The consultants were hired after British Steel lodged a protest against the loan. The approval was based on the market-investor principle. The EC's rationale did not impress industry observers, or Usinor's competitors, who noted the company's FF3.1 billion (£312 million) in losses for 1991. One industry source said, 'I think it is astonishing. I don't think a normal bank would do it.' James Capel's Fraser adds, 'It's a pretty flimsy argument. It amounts to a backdoor form of subsidy.' Another big problem is that the code does not include many types of finished products, such as tubes and other construction materials. This makes it easier for Britain's continental competitors in specialist products to receive subsidies for their materials. Recently, for example, the Spanish specialist producer, Piezas y Rodajes SA (Pyrsa), bought a new foundry after it received grants of around 9 million ecus (£7.1 million) and a guarantee on a loan of around 3.8 million ecus (£3.02 million). Pyrsa products are not covered under the steel code, but the EC ruled that the aid could be allowed under the broader regional aid provisions of the Treaty of Rome. These provisions allow aid up to 75% of the cost of the project. The EC stated that in Pyrsa's case the combined aid only amounted to 52.4%.
A complaint was made against the decision by Andrew Cook, chairman of Europe's biggest steel foundry, the Sheffield-based Andrew Cook plc. Cook took the case to the European Court of Justice. Since then, he says, evidence has surfaced that the grants were 'overcapitalised', meaning that the true cost of the foundry was much less than originally indicated. 'In actual fact it's probably beyond the 75% ceiling if you take the true cost,' he says.
Nevertheless, Cook is pessimistic about the outcome of the court case. 'I reckon they will support the Commission. It's a hopeless business,' he says. 'Whilst this stalemate exists, the UK industry is being blown out of the water because we will always have to charge a higher price. The Spanish can go on losing money until doomsday and their government will always be there to support them.' Cook has also lodged a series of complaints about alleged subsidies by the Basque regional government and the Spanish government to the steel foundry Fundix, based in the Basque city of Vitoria. The most recent of these was a government loan the equivalent of £6 million at 1% interest over 25 years. The EC is still examining the complaint. Once again, however, Fundix's products lie outside the jurisdiction of the steel code, so the Commission's decision will be guided by the wider provisions of the Treaty of Rome.
Unfortunately, Cook's complaints are minor compared with the proposed bail-out for Spain's giant, state-owned companies. This involves aid totalling 3.98 billion ecus (£3.16 billion) to the giant steel company, CSI, and 505 million ecus (£400 million) to the specialist producer Sidenor.
While the Commission recommended the smaller Sidenor application for approval in November (it was accompanied with plans for a 31% reduction in capacity and 39% reduction in the labour force), the CSI proposal was returned with a request for further capacity cuts. The Spanish government has so far not met the EC's demands. 'It's up to them now. If they want to continue producing they need aid, and the EC has said that in order for them to have this, the ratio of capital to capacity reduction must be improved,' says Costas Andropoulos, who reviews state-aid steel cases for DG4.
Italy's state-owned Ilva is proving equally problematic. Last July, the government requested approval of L650 billion (£275 million) in aid to the firm, which was also tied to a restructuring plan. But the government has requested extra time in order to revise its plan. 'They are working from scratch,' says Andropolous. While governments stall and the EC waits, private industry suffers.
Competitors of Spanish CSl are complaining that aid is effectively being used to block entry to the domestic market. For two years British Steel had its eyes on a family-run business called Aristrain, a large producer of heavy beams and columns. After several attempts to buy the company it was absorbed by Ensidesa, one of CSl's subsidiaries, in a deal that one industry official called 'very strange'. British Steel believes they were being leaned on not to sell to foreigners. An industry official's only comment on this was, 'There is a Spanish problem much bigger than Andrew Cook's.' Another problem is that state aid, directly or indirectly, allows loss-making steel giants to expand outside their domestic market. In 1989, shortly before receiving its loan from Credit Lyonnais, France's Usinor embarked on the equivalent of a £600-million programme of acquisitions and joint ventures. Among its purchases: steel distributor, ASD, Britain's largest independent. 'Clearly the loan helped to restore the balance sheet after an intense period of acquisitions,' says James Capel's Fraser.
As with aid cases in many industries, the problem often boils down to radically different financial cultures. Ian Blakey of the British Independent Steel Producers Association says, 'while the Anglophone culture aims for high rates of return and growth prospects, it is not like that in France where the explicit purpose of state aids is to support industry. The French take a longer-term view. Part of the work of the common market has got to be to eventually reconcile these opposing philosophies. It's a very big problem.' The answer lies in the marketplace. 'The Italians got into a political system of ownership which is not managerially efficient,' says a steel industry official. He points out that the biggest steel plant in the world - with 11 million tonnes capacity compared to an average of three to four million for most mills - is located in Taranto on the heel of Italy. It is far away from customers and may soon be an industrial dinosaur.
Yet, despite its problems in the sector, Italy contains some of the world's most profitable mills - the tiny family-owned mills of Brescia in northern Italy. These firms make their steel products from melted-down scrap metal. They were used as models for similar, larger mills in the US. They are less capital-intensive than the giant foundries and can afford to price more competitively.
They have been extremely effective in the finished product market in Italy, at Ilva's expense. 'Finished steel (beams, girders, etc) production is being taken over by the Brescians,' says an industry source. Six months ago one of these tiny mills bought an Ilva subsidiary, Piombino, which produces heavy beams for construction companies - a sure sign of the private sector's health.
'The Italians are very clever people when the state doesn't have its dead hand on them,' says the official.
The state might want to take note, and when it comes to enforcing the steel code, the EC should hold the mill up as an example.