bold spirit - ArcelorMittal South Africa

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18 ArcelorMittal South Africa Annual Report 2010 Responsible pricing Background When Iscor’s mining interests were unbundled in 2001, the steel manufacturing side of the business had been losing money for some time. The architects of the unbundling correctly surmised that the steel business could not stand on its own without access to cheap sources of raw materials – hence the stipulation of access to iron ore at cost plus 3%. There was no suggestion at this stage that this benefit should be passed on to anyone – it was done purely to give Iscor a chance of surviving and building a long-term sustainable business. When the ArcelorMittal group acquired a controlling stake in Iscor in 2004, the competitive pricing and downstream industry development dialogue was initiated, but these were never a condition for the transaction, nor was there a link to the Sishen contract established three years earlier. Nevertheless, there was agreement that we needed to find a means to contribute to the development of downstream industries, whether through pricing reductions or other means. This was the chief motivation behind the introduction of the basket pricing methodology in 2006. Free market pricing We believe that a sustainable steel industry depends on fair and transparent steel prices. This has been much debated. The most natural method for setting prices would be to allow supply and demand fundamentals to determine the free market price. This approach is not possible in South Africa as we supply 68% of the primary steel product market, the logistical cost to move steel between South Africa and major steel markets overseas is significant, and the local industry competes in a world market characterised by protectionist measures. These factors all contribute to distort the forces that would determine a fair market price. A distorted market The international playing field is severely distorted by countries that apply trade barriers and subsidise exports to protect their local steel industries. Certain developed and developing countries impose protective measures against any perceived trade threat through antidumping or countervailing measures, even on a short-term basis. The USA serves as an excellent example of a developed economy that relies heavily on government protection against dumped and/ or subsidised imports from several countries, including China. The US Government has repeatedly demonstrated its willingness to take protective measures, even where these may be in conflict with precedent and convention and despite the threat of adverse political consequences. The South African steel industry has in the past been prejudiced by trade measures imposed to protect domestic industries by developing countries including India, Thailand and Argentina. The countries concerned were prepared to discard convention and impose trade measures in response to complaints from their local industries, even where the complaints were subjective and without substantiation. The South African steel industry was also at the short end of trade actions by the USA, the EU and China with the imposition of safeguard measures (although these were later withdrawn). The Gulf trade authorities recently imposed safeguard measures against all imports of certain profile products from the “whole world” (sic) to protect and advance the establishment of a steel industry in the Arabian Gulf countries. These safeguards will prevail until their own industries are able to compete. It is apparent that: • Governments from developed and developing countries are prepared to take extreme measures to protect domestic industries against subsidised and dumped imports • These governments often discard convention, taking trade actions deemed necessary despite attendant legal risks • By contrast, the South African government’s approach is much less active in protecting domestic industries • Businesses are usually required to initiate trade actions without assistance from government. This is a distracting, costly and lengthy exercise. • Exporters in contravention of international agreements are often able to delay court actions by taking decisions of the International Trade and Administration Commission on review or appeal, allowing them to continue exports. • In South Africa, these decisions are adjudicated by normal law courts that do not have the necessary background or experience in the intricacies of trade law. This can discourage pursuance of trade cases by domestic producers. In other jurisdictions, there are often specialised courts to consider these matters. Import parity pricing The next best choice is to use Import Parity Pricing (IPP), i.e. the price that an importer would have to pay to bring the commodity into the country. This price would equal the best international steel price available plus transport and associated import costs. This was the model that we adopted up to March 2006, an approach we felt was fair as our relatively low output volumes had little impact on global volumes and therefore market prices. Moreover, there is no import protection of any kind to steel imports into South Africa in sharp contrast to
19 ArcelorMittal South Africa Annual Report 2010 the overwhelming majority of steel producing countries in the world. Our current approach to pricing Our approach to pricing weighs the needs of all our stakeholders: local customers, exporters, the government and the company’s owners. We price our steel according to the average international domestic steel prices of a basket of representative developed and developing markets that account for 80% of the world’s steel markets. We believe the resultant basket price − as it has come to be called − is both fair and transparent. While the basket reflects what we believe to be an appropriate price in the South African market, it is necessary to maintain a degree of flexibility in our pricing and deviate from the basket from time to time. For instance, during 2010, prices deviated from this approach as a result of the dispute with Kumba which led to a sudden and sharp escalation in our iron ore costs. In order to protect our operations, we levied a surcharge on customers to offset the sudden volatility in the input costs of iron ore for the three months from May to July 2010. The detail is included in the chapter on Commercial Matters– Supply chain on page 37. Rebates to support the development of the local steel industry As part of our commitment to developing the steel industry in South Africa, we provide support for certain industries to facilitate their growth. One example of this is the strategic pricing rebates we offer to certain selected industries: • Our value-added export scheme subsidises certain operations in the beneficiation and export of steel products. In 2010 a total amount of R270 million was granted to valueadded exporters for 215 000 tonnes. This amounted to a 25% rebate on the average domestic steel price. This effectively passes on export parity pricing to these targeted value-adding industries with the intention of helping them to use their dormant production capacity and therefore increase export profitability. This scheme operates in all the downstream industries, but is mainly utilised by the pipe and tube industry and the wire rod industry. • We also offer strategic rebates to certain sectors to assist in building sustainable steel-related industries. This assistance is aimed at increasing local industry competitiveness against final product imports. For example, we rebate the steel supplied to the fruit and vegetable canning industry, as well as the bolt and nut industry, to enable them to be competitive against subsidised imports. While the debate has raged about the fairness of the benchmark pricing system, the downstream steelconsuming sectors of the economy have benefited by about R9 billion, being the difference between the import parity price and the benchmark; in effect, the revenue foregone by us. On top of this benefit, our ongoing rebate system, administered in co-operation with the dti, offers lower priced steel to certain consumers of steel. This rebate assists those companies that add 20% or more value to exported steel products. The total value of this rebate to the downstream sector has been R2 billion over the 5-year period to end December 2009. Over the same five year period, our calculated benefit of receiving iron ore at cost plus 3% from Sishen comes out at just over R11 billion. Taking into account both the rebate and the lower price we realise for steel sold on the benchmark pricing system, we have effectively passed through the total value of this benefit to the downstream industry over that 5-year period. However, over shorter periods, the benefits passed on to the downstream industry may not match the benefit of the ore supply at the cost plus arrangement. It is important to emphasise that steel pricing has to be viewed over a full cycle − typically 5 to 7 years − as the correlation between raw material prices and steel prices is affected by capacity utilisation and demand levels. Price controls On November 25, 2010, the South African cabinet issued a statement stating that it intended restricting the prices linked to the 21.4% Sishen mining rights to us and other steel producers to cost plus 3%. This restriction would be conditional upon a government-determined developmental pricing model that would limit domestic steel prices to no higher than the lowest quartile of global steel prices. Given the strategic role steel plays in the manufacturing sector, concern about steel prices is understandable. However, a variety of factors need to be taken into account in the consideration of an appropriate level of steel prices in any given market. For example, the sector is highly cyclical and therefore steel companies need to ensure that business decisions are made with long run sustainability in mind. Furthermore, other input costs such as coking coal need to be taken into account. Yet another factor is the need to continually re-invest in plant and equipment to keep pace with technology or market growth or both. Experience from other markets where price controls have been imposed is that this policy approach acts as a disincentive, discouraging further private sector investment and expansion in the affected sector and seriously curbing the ability of the sector to prosper.
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bold spirit - ArcelorMittal South Africa

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