Good Steel Made Cheaply Brazil does it amazingly well. And U.S. manufacturers are reaping the benefit.
(FORTUNE Magazine) – A little more than a decade ago, you might have said that the Brazilian town of Volta Redonda was Bethlehem, Pa., with palm trees. Both cities sprawled around their biggest employers--huge, pollution-belching integrated steel mills where coke ovens, blast furnaces, and steel shops roared all day, every day. Now Bethlehem can only wish it were Volta Redonda. The hometown mill of Bethlehem Steel is shut. Its furnaces are cold. Pieces of the company are being dredged out of bankruptcy. But in Volta Redonda, about 80 miles west of Rio de Janeiro, rivers of red-hot metal still flow. The Presidente Vargas Steelworks, erected with U.S. help during World War II, has been expanded and modernized to world-class standards. After heavy investments in pollution control, the city's air is clear, its streets clean. This year the mill's owner, Companhia Siderurgica Nacional (which translates as National Steelworks Co.), should have its best year ever. That's in part because CSN converts iron ore to quality steel at a cash cost lower than that of any steelworks outside Brazil.
CSN isn't the only Brazilian company that knows how to make steel cheaply. All of Brazil's big steelmakers turn out steel at costs as much as 40% below those of comparable mills in the U.S., says steel consultant Donald Barnett of Economic Associates in Great Falls, Va. CSN's two biggest competitors, Usinas Siderurgicas de Minas Gerais, best known as Usiminas, and Companhia Siderurgica de Tubarao, or CST, both say it costs them less than $120 a metric ton to make slab, multi-ton chunks of semifinished steel. In the U.S. the cost is about double that. Some Russian and Chinese mills get within range of Brazil's costs, possibly thanks to fuzzy accounting. But Brazil, now No. 8 among steelmaking nations, has huge reserves of the world's best iron ore and an unmatched transportation system to deliver it to a group of well-managed steelworks. That combination is unbeatable.
U.S. makers of autos, appliances, machine tools, and what-have-you would get a big competitive boost in fending off imports and exporting to the rest of the world if they had unlimited access to cheaper steel. They don't. Like other developed countries, the U.S. protects steel and, under heavy union pressure, tries to guard its steelworkers' jobs. Yet last year, when the Bush administration put heavy tariffs on steel imports, Brazil still increased shipments to the U.S. by 22%, to 3.6 million tons. For the first time it replaced Mexico as the No. 2 U.S. steel supplier, after Canada.
Brazil managed to slip through the tariff fence because Washington opened a hole. The U.S. set a high pre-tariff quota for slabs of semifinished steel and allocated over half of that to Brazil. Then Brazil got extra allotments for interstitial-free steel, the high-quality stuff used to stamp out such items as auto body exterior panels.
What motivated these exceptions is a big change starting to hit the U.S. steel industry: More and more of the hot end of steelmaking, the business of turning ore to iron and iron to steel, is leaving the U.S. Increasingly, U.S. mills will import low-cost slabs that they then roll, hot and cold, into value-added plates, sheets, and coils of metal for sale to their U.S. customers. How fast this shift takes place depends partly on the strength of the dollar and on how quickly the U.S. steel industry consolidates and cuts costs. But its effect may be powerful: It could put some profits back into the industry and could mean that you'll pay less for your next Buick or GE refrigerator. The Boston Consulting Group estimates that a company that divides steel production between an offshore, low-cost producer of slabs and a U.S. converter could have a cost advantage of 10% to 20%.
Sierra Club members can relax. The U.S. steel business won't be exporting pollution and exploiting the workers of the Third World. While Brazilian steelworkers don't earn what they would in the U.S., they're some of the best-paid industrial employees in Brazil. As for polluting, all but three of the country's dozen steelworks have qualified for ISO 14001, the international environmental protection standard. The rest are on the verge of doing so. Steelmakers insist that federal environmental regulations in Brazil are now as tough as those in Germany, which are about the world's most stringent.
It wasn't always this way. As recently as the late 1980s, Brazil's steel industry was a disaster. From its start in the 1940s with the U.S.-supported Vargas mill, making steel from iron ore, like running railroads and ports, was a government task subject to the dictates of national ego and aspirations rather than the market. Some 70% of Brazilian steelmaking capacity was government-owned. Steelworks were wrapped in red tape and bloated with a pugnacious workforce. From 1982 to 1990, CSN had 12 strikes.
All of Brazil had a miserable time in the 1980s with hyperinflation, declining GNP, unemployment--the whole catastrophe. Among the state-owned steel companies, only Usiminas made money. At CST alone, the government covered $1 billion in losses in the ten years after its founding in 1983. But then, in the early 1990s, the government began to sell off its national companies, including all the state-owned steelmakers, and in 1997 it privatized Companhia Vale do Rio Doce, owner of most of those great ore reserves.
The Brazilian steel industry ever since then has been doing what ought to have been done in the U.S. It shrank from 35 companies to nine and is now dominated by four firms: industry leader Usiminas, plus CSN, CST, and Gerdau. All but Gerdau are integrated flat-steel producers--they feed coke and sinter, a conglomerate of unmelted iron ore and dollops of other minerals, into blast furnaces, move the resulting liquid pig iron to basic oxygen furnaces, and then continuously cast slabs. CST mainly turns out multi-ton slabs of semifinished steel and exports a third of it to the U.S. and the rest to Asia and Europe. Usiminas and CSN sell some slab but convert most of what they make into a full range of higher-value hot- and cold-rolled steel--plates, sheets, and coils of coated metal. These three leaders together accounted for about two-thirds of the 29.6 million tons of raw steel produced in Brazil last year.
Much of the rest of Brazil's steel is so-called long product: billets and blooms that become beams, rod, rebar, and eventually wire, nails, and shopping carts. As in the U.S., long product is mostly made by mini-mills operating scrap-fed electric-arc furnaces. The dominant mini-mill company is Gerdau, a family-managed business that was never state-owned. Headquartered in Porto Alegre, it owns nine mini-mills in the U.S. and Canada that last year produced 3.3 million tons of steel.
Brazil's flat-steel producers thought they were headed for real trouble a year ago when the Bush administration parked its free-trade principles, invoked Section 201 of U.S. trade law, and imposed duties of up to 30% on most steel imports. Prices went up for all steel users and their customers. Hot-rolled steel, produced in the next steelmaking step after slab, went from around $220 a ton to as high as $400. But as can happen when governments mess with trade, the results weren't what the politicians might have expected. U.S. imports of steel went up in 2002, not down, increasing over 8% in weight and about 5% in value, to 29.7 million metric tons, worth $12.1 billion.
More than 95% of the increase in steel imports was in one category, semifinished--largely slabs because of that high pre-tariff quota. You're right. It takes a steel company's rolling mill to convert slabs to something useful. Ohio's AK Steel annually purchases up to 800,000 tons of imported slab. In 2002, Oregon Steel bought 500,000 tons. California Steel in Fontana, Calif., was the biggest importer of slabs, most of them from Brazil's CST.
California Steel is emblematic of the changes that are going to make the U.S. steel industry more globally interdependent. It owns the rolling mills, but not the iron-and steel-melting furnaces, that once belonged to bankrupt Kaiser Steel. That's the part of the business on its way out in the U.S.: Many U.S. blast furnaces are old, small, and inefficient, and the environmental-protection hurdles to building new ones are far too high.
Even if they weren't, the economic case for new furnaces would be hard to make. The U.S. integrated companies' toughest competition isn't imports but the low-cost domestic U.S. mini-mills, led by Nucor in Charlotte. The mini-mills, which operate scrap-fed electric-arc furnaces, have traditionally focused on the long-products market. But they're taking aim at the sheet-steel business, increasing quality by putting pig iron instead of scrap in their furnaces. To fend off that assault, integrated steel companies will have to keep driving down costs. A way to do that is to buy imported slabs. Rinaldo Campos Soares, the CEO of Usiminas, agrees: "The U.S. will no longer invest in the hot end, the blast furnaces. They will be dependent on slabs."
That helps explain why U.S. imports of semifinished steel hit a record of nearly eight million tons last year. Slabs arrive from other countries, but Brazil is the biggest source, thanks largely to those deposits of low-cost, high-iron-content ore. "The Brazilians scrap some ore that's the quality used by U.S. mills," claims Charles Bradford, a New York City steel consultant. Brazilian ore has three times the iron content of U.S. ore and is easier to process. The Brazilian steel industry association has calculated that the major raw materials for Brazil's integrated mills cost $76 per ton of liquid steel, vs. $108 in the U.S., even though Brazil has to import all its coking coal.
CVRD, the world's biggest producer and exporter of iron ore, sold 136 million tons of iron ore and pellets last year, but it's in no danger of running out. That was 0.3% of its reserves. CVRD not only mines the ore but also delivers it. It owns one railroad, shares ownership of another with steel companies, and moves two-thirds of Brazil's rail freight. There are two highly efficient rail systems out of CVRD's mining complex in the state of Minas Gerais. Each one ties mine to steel mills to domestic customers to ports.
The railroad lines and ore deposits have been around a long time. What was lacking until the companies were privatized was efficient management of the transportation system and steel companies with entrepreneurial drive. That changed quickly after the mills got into private hands. During the 1990s some two million tons of inefficient melting capacity were taken out of production as mills were closed and old lines were replaced with modern equipment. Since 1994 the industry has invested $12.4 billion in hot-end equipment and completely new rolling mills and finishing lines. CST alone has invested $2.2 billion just since 1996. It added a second blast furnace in 1998. Now it's planning a third furnace and starting up a $400 million, two-million-ton hot-rolling mill, its first effort to add value to slabs. About 10% of the industry's new investment has gone into environmental control equipment and systems. Usiminas is truly green. It has a big agricultural station near its mill that raises grasses, shrubs, and trees used in a reforestation program; so far it has planted three million trees.
After a decade of modernization, Brazilian steel output per man-year has more than tripled, from 141 tons to 470, while quality has improved. The jump in tons per man-year reflects a huge drop in industry employment, from 178,000 to about 64,400 workers. CST spent $26 million on severance pay in the first month after it was auctioned off, immediately reducing its payroll from 6,000 to 4,200. CSN reduced its payroll from over 16,000 in 1991 to under 9,000. Usiminas went from 13,000 to 8,000, mostly by attrition. Romel Erwin de Souza, general manager of its mill, says he has no more than two people doing what three did before, partly because of better equipment and training, partly because relations are better between workers and management, now flattened from many to few layers.
There have been no strikes at any steel company. A change in union attitude helped. However, Nelson Geraldo Siva da Cunha, steel-sector technical director at once labor-besieged CSN, also says, "We changed the way that we deal with the unions." Steel and CVRD executives are still deferred to and cosseted, but where hot metal runs, there is a willingness to take the advice of the people who do the work and little hesitation on their part about giving it.
For Brazil, steelworkers do well. The average CSN mill wage is about $490 a month, a sum that understates the money's buying power, especially in the mill towns. And everybody gets a 13th-month payment as well as profit participation and production-target bonuses. CST says if you include those, its blue-collar workers make between $720 and $780 a month.
The Brazilian industry's biggest problem is that much of the modernization has been bought with borrowed money. The companies are burdened with an Everest of debt on which they pay interest at rates that can be triple those in the developed world. Moreover, since Brasilia vacuums capital out of the domestic market, most of the money was borrowed abroad and so is tied to the dollar. When the real drops, as it did last year when it fell from 2.3 to 3.5 to the dollar, the debt goes up with offsetting charges to income. Because of their low costs, the steel companies have sensational profit margins before interest, financial charges, and taxes--so-called Ebitda. Last year, for example, CSN reported almost $780 million in Ebitda on revenues of $1.6 billion. Yet it still had a consolidated net loss of $67 million.
Despite their cost advantages and good ore, Brazilian steelmakers other than CST have not built their business on exports. Up until last year, almost all the expanded steel output in Brazil was absorbed at home. Exports hovered at ten million tons or less until they popped in 2002, to 11.7 million. But now if the steelmakers want to expand, they'll have to export more. The domestic market will expand slowly. While steel consumption is relatively low, the country has a mountain of economic and social problems to sort out.
CSN has been boosting its export efforts for several years. Gerdau is encouraging an integrated mill that it recently took over to concentrate more on exports. Usiminas is using a subsidiary, Cosipa, to expand foreign sales while it largely tends to domestic needs. And while CST will divert two million of its five million tons of capacity to its new hot strip mill, reducing exports by that amount, the planned new blast furnace will be lit in a couple of years and will replace that.
All of Brazil's big integrated mills have room to expand, although it would be a tight squeeze at several that are adjacent to cities. But right now they're on hold, watching to see whether the Bush administration will rediscover free trade in advance of this year's hemisphere-wide negotiations over the Free Trade Area for the Americas. Washington has, in fact, been less protectionist than might appear. Section 201 tariffs decline annually. Slab quotas go up each year. Scores of steel products have been excluded from the new tariffs with only modest pleading.
The U.S. soon won't have much choice but to opt for fewer barriers to steel imports, especially semifinished. And the Brazilians know it. CST's CEO, Jose Armando de Figueiredo Campos, ticks off one U.S. blast furnace after another that will need relining or replacement in the next few years. "They will never spend $60 million to make a full reline of those furnaces. The furnaces will go down. But experience says rolling mills never go down. You can always get rolling mills to operate again if you can source the slab. So we are waiting." The Brazilians won't get all the business, but anybody who wants to be in steel in the future ought to see what Expedia has to offer in the way of flights to Rio.