Competitiveness and

challenges in the steel

industry
OECD Steel committee
74th session

Paris, July 1, 2013

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and conclusions contained in this document are based on various assumptions
that McKinsey&Company has developed regarding economic growth, and steel
demand, production and capacities which may or may not be correct, being
based upon factors and events subject to uncertainty. Future results or values
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analyses.
The analyses are partly based on information that has not been generated by
McKinsey&Company and has not, therefore, been entirely subject to our
independent verification. McKinsey believes such information to be reliable and
adequately comprehensive but does not represent that such information is in all
respects accurate or complete.

McKinsey & Company | 1

Contents

▪ Challenges in the steel industry –

cyclicality and increasing competition
from emerging economies

▪ Competitiveness of the steel industry

– beyond cost optimization

▪ Implications for enhancing competitive-

ness – few actions to launch and promote

McKinsey & Company | 2

The development of the industrial production index shows fundamental
differences by region
Industrial production index – mature regions
Points (based on 2005) China: 10.1% p.a.

600 Europe 1.5% p.a. ▪ China and Western Europe

North America
500 are the dominant players in
Europe (EU15) global consumers
400
300 ▪ While projections on China
200 are positive, mature regions
100 suffer from no growth
0
2008 09 10 11 12 13 14 15 16 17 18 19 2020
Years

Industrial production index – developing regions

Points (based on 2005)
250 ▪ Emerging regions follow a
Latin America Dev Asia +6% p.a.
200 growth trend line over the
MENA
next few years
150 Africa
▪ In all of those regions next to
100 GDP growth, some countries
have clear growth
50 stimulating drivers such as
0 energy and resources
2008 09 10 11 12 13 14 15 16 17 18 19 2020
Years

SOURCE: Global Insight; McKinsey McKinsey & Company | 3

Within major steel economies macro-economic factors
indicate uncertainty for demand and utilization
Debt GDP ratio ▪ Economically
Index (based on 2005)
uncertain markets in
2,0 traditional steel-
US consuming econo-
1,5 EU-15 mies
1,0 GER ▪ China's economy
China stabilizes while the
0,5 debt to GDP ratio in
the US and EU-15
0 has been increasing
2005 06 07 08 09 10 11 12 13 14 15 2016 steadily since 2008 in
combination with
Infrastructure spending strongly declining
Index (based on 2005) infrastructural
investments
4,0
▪ In addition to weak
China
3,0 GDP growth and
higher debts, infra-
2,0 GER structure investments
US in EU-15 countries
1,0
have declined more
EU-15 than 30% between
0
2005 06 07 08 09 10 11 12 13 14 15 2016 2011 and 2012

SOURCE: Global insight; McKinsey McKinsey & Company | 4

Current projections based on consumption forecasts indicate a
global slow-down
Apparent steel demand per region
Million metric tons Regional growth
2.8% p.a. Percent p.a.
1,797 2010 - 16 2016 - 20
3.5% p.a. 1,702
176 1 1
1,607
172
1,500 167 128 4 1
1,413 125
153 141 1 0
1,306 148 122
141
119
Europe 153 113 141
143
North America 94 141
Developed Asia 134 794 4 2
765
730
686
646
China 589
120 6 7
106
93
72 81
India 65
394 439 5 5
293 318 354
Other1 270

2010 12 14 16 18 2020

Share of China
45 46 46 45 45 44
Percent

1 Africa, other Asia, CIS, Oceania, MENA, Latin America

SOURCE: World Steel Association (WSA); McKinsey Steel Demand Model McKinsey & Company | 5
The steel industry is very volatile and with depressed profitability since
2008 – mature regions are losing in profitability
China Developed Asia Average
EBITDA margin
Percent1 Europe NAFTA

30 2003 - 08: margin

2000 - 03: price- improvement and 2008 - 12: margin deterio-
25 margin squeeze upstream integration ration and leveraging
▪ Margin
develop-
20 ment
follows a
15 negative
trend line
▪ Current
10 situation
worst for a
5 long time

-5
2000 01 02 03 04 05 06 07 08 09 10 11 2012
1 Based on a sample of 84 of the largest steel companies globally

SOURCE: Bloomberg; McKinsey analysis McKinsey & Company | 6

Within the entire steel value chain, profitability is challenged and margins
move to mining
HRC value chain1 profit pool split evolution since 1995, USD billions

100% = 54 23 125 156 230 135

Iron ore 8
▪ In the medium
15 17 term, the value
Coking
11 pool in steel will
coal 7
44 42 remain in favor of
46
22 the raw material
producers
▪ There might be
shifts in between
Steel 22 years, but
making 81 32
78 28 demand and
(HRC) supply for steel
61
combined with
35
cost for marginal
26 27 producers will
stabilize EBITDA
distribution
1995 2000 05 10 2011 2017
1 HRC assumed to represent 85% of total hot-rolled flat products. Flat production assumed to use 85% of pig iron as raw materials. Assuming 1.6 t of
iron ore per tonne of pig iron and 0.5 tonne of coke per tonne of pig iron

SOURCE: McKinsey Steel Model, McKinsey Mining Value Pools Model McKinsey & Company | 7
From a perspective on the EBITDA pool, emerging regions benefited most
from the China-driven boom of the last decade
HRC value chain EBITDA pool Mining Non-OECD steel OECD steel
USD billions
CAGR
2003 - 2012
164 17%

136

38
121 33%

56
58
39
37
10 9%
28
13 42
14
16 7 15 -1%

2003 2007 2009 20121

1 Based on preliminary estimates

SOURCE: McKinsey (BMI Value Pools Model) McKinsey & Company | 8

Contents

▪ Challenges in the steel industry –

cyclicality and increasing competition
from emerging economies

▪ Competitiveness of the steel industry

– beyond cost optimization

▪ Implications for enhancing competitive-

ness – few actions to launch and promote

McKinsey & Company | 9

Margin development in steel is a major issue, driven by external factors
and plant situation
1 Development of industry attractiveness
USD per ton of HRC Typical factors driving/challenging competitiveness

Brazil 2 ▪ Supply balance

▪ CO2 and technology
922 challenges
753 ▪ …
Industry-
462 wide
460 497 factors
256

Price Cost EBITDA Price Cost EBITDA

2008 2012 Intrinsic Regional
industry factors
Western Europe player and conse-
actions quences
953

657
698
255 622 4 ▪ Asset quality 3 ▪ Access to raw
and actions materials/resources
35
▪ Operational ▪ Fx-rate and cost
performance inflation
Price Cost EBITDA Price Cost EBITDA
▪ … ▪ Regulation
2008 2012 ▪ …

SOURCE: SBB, MEPS, McKinsey Flat Steel database McKinsey & Company | 10
 1 Globally competitiveness of some regions gets challenged through
erosion of cost position – example Europe/Germany
Europe 1st quartile
Global HRC cost curve1, ex works, USD/t
Other
2002 German plants
Marginal
800 1st quartile
manufacturer
600 Europe
400 ~ 55%
200
0

Q1 2013 1st quartile Marginal

Europe manufacturer2
800 ~ 47%
600
400
200
0
Marginal
1st quartile
manufacturer2
Europe
2017E
800 33%
600
400
200
0
0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 800 850 900
Cumulative capacity, Mt
1 Operating costs excluding SG&A, considering captive raw materials, standard utilization (90%)
2 90% of capacity

SOURCE: McKinsey flat steel cost model; steel press; VDEh; WSA McKinsey & Company | 11
 Direct emissions
2 Steel will remain a source of CO2 emissions which is a
Indirect emissions
consequence of the process …
Percent, 2010e

Global CO2e emissions Steel CO2e emissions

100% = 49.4 GtCO2e per year 100% = 4.0 GtCO2e per year

Ferro-alloys2
Agriculture 4
Mining1
13.3 24.4 Power 17

0.7 Steel (Power)

Forestry 15.0
5.6 Steel (Direct) Power 9
1
1.7 Steel (mining
2
2.9 5.5 and ferro-alloys )
Waste Petroleum 70
6.8 3.0 3.9 5.0 and gas Direct
Building 12.1 Cement
Chemicals
Transport Other
industry

1 Includes mining and beneficiation of iron ore, coal, limestone, and ferro-alloy ores
2 Production of Ni, FeCr, FeSi, FeMn, SiMn and Al consumed during steel production

SOURCE: McKinsey (Steel CO2 Model; Global Carbon Cost Curve 2.1) McKinsey & Company | 12
 2 … however, technology differences can lead to significant differences
in emissions
BF route
PCI coal Ferroalloys Coke Fuel (including Electricity Pig Iron Limestone Mining
smelting off-gas)

Mining and raw

Coke Sintering /
material BF BOF Downstream
making Pelletizing
processing

About 0.50 for 0.3 3.4

0.2
transportation 1.7
21% ▪ Technology
of raw materials 4% 2% differences
not included About 0.18 for 6%
10% between
transportation
12% integrated
0.2 of finished
0.2 route and
0.8 products
43% EAF route
not included
result in
significant
emission
levels
EAF route ▪ However,
Ferroalloys Fuel (including Coke Mining Pig Iron & DRI Electricity input factor
smelting off-gas) salso change
EAF route
Mining and raw require
material Pelletizing DRI making EAF Downstream additional
processing power supply

About 0.2 for 0.2 1.0

transportation 8%
0.5
of raw materials
not included 39%
About 0.2 for
0.1 transportation
0.2 0 33%
of finished
products 5%
not included
Total CO2 footprint
1 CO2 emissions linked to off-gas are allocated to the process step where the gas is used

SOURCE: McKinsey Steel CO2 Model McKinsey & Company | 13

 3 Some raw material supplying countries get challenged by appreciation
of their currencies and cost inflation
Currency development of
"commodity countries" Price evolution
Exchange rate changes Consumer price index growth
(2006 - 13) (2006 - 13)
▪ Commodity countries
Percent Percent
37 exposed to external 41
factors
▪ Cost base for raw
materials inflating
▪ The rationale that inflation
results in devaluation
does no longer seem to
hold true 19
▪ Overall economics of raw 15 15
11 material countries will
challenge markets
(higher cost makes steel
2 less attractive)

EUR/ REAL/ AUS/ US Europe1 Australia Brazil

USD USD USD
1 Eurozone countries

SOURCE: Global Insight; OANDA; McKinsey McKinsey & Company | 14

 3 Brasil shows how regionally attractivity of a production base
can deteriorated
Development of factor costs in Brazil
Million metric tons

Supply chain cost

Energy cost Labor cost USD transport cost/t coking
USD/MWh USD/hour coal
180 12.0 17

+52%
11
+288% +272%

46 3.2

2003 2012 2003 2012 2003 2012

SOURCE: Ministério das Minas e Energia, Aneel, Economist Intelligence Unit, James F. King McKinsey & Company | 15
 3 Also, import and export taxes influence competitiveness, while EXAMPLES
protecting or even taking away the need for continuous improvement

Import duties for steel products Export barriers for raw materials

Import duties and taxes1 Semi-finished products Export duties, iron ore India
Percent Finished iron & steel products Percent Export bans
18 20
2 - 17 ▪ Indonesia export
ban on iron,
16
except for miners
14 that build local
processing facili-
2 - 12 12
12 ties from 2014
3 - 10 ▪ Bans on scrap
10
5 - 10 exports in Indo-
8
8 nesia, Mongolia,
5 - 7.5 Saudi Arabia, and
6 5 many other
countries2
4
2
2
0 0
0
Brazil China India Turkey South Pre 03/2011 Post 03/2011
Africa

1 Average applied MFN tariffs

2 In addition China, Russia, Ukraine, India, Guinea, Iran, Argentina, Kazakhstan, Pakistan, UAE and Vietnam impose export taxes

SOURCE: WTO, OECD, European Commission McKinsey & Company | 16

 4 Due to low economic attractiveness new assets have been built manly
outside OECD

Capacity
mt
2,200
2,000
1,800
1,600
Non-OECD
1,400
1,200 +720

1,000
800
600 OECD
400
+105
200
0
2004 05 06 07 08 09 10 11 12 2013
Year

SOURCE: McKinsey Crude steel capacity database McKinsey & Company | 17

 4 Assets had been ageing over time and lose potential
structural advantages
Age comparison BOF route

Average European steel

plants, % of capacity Average CIS steel Average India steel
older 25 years Average US steel plants plants plants
100
95 92 81
77 71

18 18

2000 2013 2000 2013 2000 20013 2000 2013

Average
converter 182t 204t 204t 217t 203t 236t 93t 139t
size (TAB
weight)

SOURCE: VDEh Plantfacts; Experts Estimate McKinsey & Company | 18

 4 In some regions the asset base calls for reviewing EUROPE EXAMPLE

sustainability of assets and to be rebalanced Economical

challenged

Location: River port Sea port Inland

Average BF age, years
0 ▪ Majority of European
Poor Marginal Average
5 blast furnaces have
10 – An average age of
15 more than 35 years
20 (not considering
relines)
25
– An average blast
30
furnace capacity of
35 below 2 million
40 tonnes
45 ▪ Additionally, more than
50 60% of European BF
55 plants have logistical
60 disadvantages (located
65 inland with either river
port or rail access)
70
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Average BF size, Ktpy

SOURCE: VDEh Plantfacts; McKinsey McKinsey & Company | 19

 4 In contrast greenfield plants can effectively compete MODEL RESULTS

against these low positioned plants in mature region – example Europe

HRC cost
USD/t Result
731 ▪ Once capacities are
688 59
603 642 offshored, there will
Depreciation2 69
61 50 be no economies to
HRC 28 24 51 relocate quantities
conversion back to Europe

Slab cost (incl. 672 ▪ Greenfield plants of

Transport 551 530 569 new entrants will be
to EU) able to compete at
any price in Europe,
especially from
MENA
MENA CIS Brazil Europe
4th quartile4
Greenfield3
1 Including EU exports; In HRC equivalent; includes HRC and all downstream products
2 Based on capex of 1,200 USD/t for integrated plant, 300 USD/t for EAF slab plant; 170 USD/t for HRC mill; depreciation period 20 years
3 Without captive raw materials
4 Incl. CO2 costs based on a CO2 price of 20 USD/t

SOURCE: McKinsey McKinsey & Company | 20

Contents

▪ Challenges in the steel industry –

cyclicality and increasing competition
from emerging economies

▪ Competitiveness of the steel industry

– beyond cost optimization

▪ Implications for enhancing competitive-

ness – few actions to launch and promote

McKinsey & Company | 21

EU launched a programme to support steel industry

Programme elements
▪ Assessment of impact of existing and new policies and legislation on competitiveness
Regulatory
framework ▪ Support sustainable steel production to boost demand and EU market share
▪ Fight VAT evasion and black markets in steel
▪ Promote steel end-use sectors, e.g., through simulating demand for alternative fuel
Boosting demand vehicles and renovation of buildings by energy and resource-efficient construction

▪ Ensure to eliminate or reduce tariffs and non-tariff barriers on third markets for EU steel
and raw materials
Level playing field ▪ Update anti-dumping and anti-subsidy regulations
▪ Monitor scrap markets and include coking coal in the list of critical raw materials
▪ Create regulatory environment conducive to sustainable growth (renewable energy,
Energy, climate, impact of the ETS on electricity prices, energy efficiency)
resource policies ▪ Support internationally binding agreements on climate change and GHG

▪ Integrate steel industry into RDI programme for energy-efficient products

Innovation ▪ Support R&D efforts for new technologies, and shift focus to up-scaling and pilots,
including steel/raw materials/recycling

▪ Promote skills relevant to the steel industry going forward

Skills and
restructuring
▪ Work with member states and industry on alleviating impact of restructuring or plant
closures on local labor markets and societies

SOURCE: EU Commission McKinsey & Company | 22

Competitiveness should be promoted in a focused way

▪ Discover market and customer opportunities for steel and adjust

Company accordingly (specialized assets, productivity focused assets, depending on
A
specificaction market opportunities), recognize substitution risks
▪ Optimize internal performance further and do some structural adjustments

▪ Monitor implications of competitive assets outside OECD which change the

game, and reflect on unpredictable (opportunistic) tradeflows

Macro-economic ▪ Promote industrialization levels with industrial GDP contribution and

initiatives to establish right incentives, permissions and timely execution
B
secure competi- ▪ Allow for consolidation in steel where possible and secure no more legacy
tiveness assets remain kept up
▪ Secure level playing field to allow for sustainable production, e.g., to allow
for environmental standards, avoid structural penalties and/or bottlenecks,
e.g., in energy

SOURCE: McKinsey McKinsey & Company | 23

 A In some applications, the profile of steel used will dramatically change
and high value add grades will be increasing in importance due to light
weight concepts
Material demand North America China
Material mix in automotive in automotive Europe RoW
Percent mt ▪ In applications,
the profile of
Steel HSS2 steel will change
100% 100% – Need for light-
Carbon fiber 46 40
0.5 weight appli-
Plastics 9 12 cations due to
5 environmental
Magnesium 5 requirements
15 12 – Need for high-
Aluminum
Lightweight strength steels
-70% for safety and
29% share1 +273% power applica-
tions
38 HSS2 – Alternative
Steel (< 550 MPa) 52 solutions due
to new power-
14 train concepts
67% 11 (incl. BEV and
13 hybrids)
– Feasible com-
Other non- binations of
19 20 high-strength
lightweight3
structures and
light panels
2010 2030 2010 2030 2010 2030
1 HSS, aluminum, magnesium, plastics, carbon fiber
2 High-strength steel (> 550 MPa)
3 Mainly other metals, glass, fluids, interior parts

SOURCE: McKinsey "Lightweight, heavy impact"; advanced industries perspective 2012 McKinsey & Company | 24
A However, competitiveness of aluminum relative to steel has
dramatically increased due to falling price differential …
Averaged monthly price of steel and aluminum Steel, European CRC
USD per tonne Aluminum, LME daily official

Al is ~ 3.0 x steel price Al is ~ 2.4 x steel price

(2000 - 07) (2009 - 12)

3,500
▪ Steel to
aluminum
3,000
spreads have
been shrinking
2,500
▪ However,
current gap
2,000
between 2 raw
materials
1,500 is over USD
1,200/tonne
1,000

500

2000 01 02 03 04 05 06 07 08 09 10 11 12 2013

SOURCE: MEPS Transaction Prices HRC; London Metal Exchange McKinsey & Company | 25
 HIGH-LEVEL
A … with the result that after "cost in use" calculations the ESTIMATES
aluminum disadvantage is affordable and attractive
Body panel example, high-strength steel (HSLA) to aluminum cost bridge
Indexed

Cost disadvantage in some

applications has reduced to less
than 1 EUR/kg, thus provides a
real alternative
209
251

20 156
54
30 +41%
110

152

Price per Higher per Lower Net Increased Additional Increased Net per part
steel part lb landed density of material scrap coatings/ tooling costs
(indexed raw material aluminum cost post pro- life
to 100 for cost1 requires cessing
mild steel) fewer lbs

SOURCE: Interviews; ISIS; SRI; The Aluminum Association; FKA Weight Reduction Report McKinsey & Company | 26
A Ongoing innovation has been a source for enhancing competitiveness

Specific CO2 emission (Average BF/BOF and EAF) Specific dust emission
Metric ton CO2 per t crude steel Kg dust per t crude steel
2.5 10
8
2.0 -45% 6
-96%
4
1.5 2
0 0
1960 70 80 90 2000 2007 1960 70 80 90 2000 2007

Specific energy consumption Accident rate

Metric ton coal equivalent per t crude steel Number of accidents per million working hours
2 80
60
-88%
-41% 40
1
20

0 0
1960 70 80 90 2000 2007 1970 80 90 2000 2007

SOURCE: Wirtschaftsvereinigung Stahl, plant facts, McKinsey CO2 model McKinsey & Company | 27
B Capabilities of producing high value added products increase, with
require producers in OECD countries to invest in more competiveness

High value add capacity additions 2012 - 14 and capacity evolution 2000 -
13
kt ▪ Downstream steel
production is signi-
New CRC 38.0 ficantly built up in
90% of emerging regions,
capacities in with focus on value
New HDG 8.2 "new world" add
▪ Relevance of
113 152 205 221 224 = 100% producers in mature
world and therefore
RoW CRC 25% steel production in
29% 30% 29% 29%
those regions is
decreasing

Loss of
▪ Steel mills need to
RoW HDG 47% 46% have the funds to
49% 51% 51% share EU-27
compete in these
EU-27 CRC 8% -8.3% dynamic develop-
7% 5% 5% ments
5%
EU-27 HDG 20% 18% 15% 15% 15%

2000 05 2010 12 2013

SOURCE: VDEh Plantfacts 2012; McKinsey Analysis McKinsey & Company | 28

B Less predictable trade flows require monitoring and countermeasures
if the conditions do not match
Major export flows 2006 and 2011 Exports Emerging
Million metric tons (origin and destination region given) observations

2006 2011 ▪ Production

11.3 13.9 flows due to
regional
6.4 imbalances
4.5 CIS-Western Europe change due to
– FX changes
Western Europe- 11.6 10.5
and cost
North America advantages
(e.g., Brazil)
China-Other 14.7 12.2
20.7 16.8 developing – Country
Asia development
combined
Developed with local
CIS-MENA Asia-China
consumption
7.6 6.3 trends (e.g.,
23.7
12.9 Russia)
– Surplus
Latin America- capacity and
North America Developed
Asia-Other
change of
developing addressable
7.2 Asia markets (e.g.,
6.0
Europe to
US)
Developed
Asia-North
America

SOURCE: ISSB trade flow data base McKinsey & Company | 29

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