Micro-economics project report

Microeconomic aspects of supply and demand in

Vishakhapatnam Steel Plant

Presented by:

Sudheesh S (PGP25157)

Sunit Chandan (PGP25158)

Sushovon Nayak (PGP25159)

Swapnil Thakre (PGP25160)

Swati Chaurasia (FPM10018)

1
 INDEX
Background 3
Scope of Study 3
1. Introduction 4
1.1. Raw materials, Production Technology and Varieties of Steel 4
1.2. Components of Cost of Production 6
2. World Steel production 8
3.0 Indian scenario 8
3.1. Budget 2008 Impact 8
3.2. Comforting facts 9
3.3. India Demand & Supply 10
4. Vishakhapatnam Steel Plant (VSP) 11
4.1. Vizag Steel Plant production trends in 2008 11
4.2. Micro –Economic Outlook 13
4.3. Graphical representation of collected data 135
4.4. Projected Outlook for the year 2009-10 19
5. Future outlook of the competitors 19

2
Background
We are analyzing the micro–economic aspects of the supply and demand situation in the steel industry
and Visakhapatnam steel plant in particular .The salient points of our project are as follows:

The demand of steel pre July 2008 driven primarily by huge infra spending courtesy the Chinese

Olympics

The demand of steel post July 2008

The present demand of steel driven mainly by domestic demand from India and China

The adverse impact of the financial crisis on the bottom line of VSP
The rejuvenating impact of the Budget 2008 on the steel industry in India

Scope of Study
The steel industry being an oligopolistic industry is dominated by a few capital intensive players as the

entry and exit costs (barriers) are very high. During the course of the project ,we have analyzed the
various factors which affect the demand and supply of steel and the performance of

VSP(Visakhapatnam Steel Plant).Further, this industry being an oligopoly, we have also compared its

performance vis- a-vis the other big players in the industry such as SAIL, Tata Steel and JSW (Jindal Steel
Works)

We would basically be applying the demand and supply concepts which we had studied in management

economics-I in real life .The graphs mentioned in the presentation explain how the above mentioned
concepts have played a key role in the determination of production targets of VSP.

3
 1. Introduction
Steel is crucial to the development of any modern economy and is considered to be the backbone of the
human civilization. Steel is essential for infrastructure, energy delivery, transportation, housing,
construction, and vital consumer goods. Few statistics that will emphasize importance of steel in modern
economy:
 In 2008, 1.3 billion tons of steel was used all over the world.
 More than 90% of all the metals are steel.

1.1. Raw materials, Production Technology and Varieties of Steel

Steel is iron that has most of the impurities removed. Steel has a consistent concentration of carbon
throughout (0.2 to 2.14 percent depending on the grade). Alloys with higher carbon content are known as
cast iron because of their lower melting point and castability. Apart from Carbon, other alloying materials
used are manganese, chromium, vanadium, and tungsten.

Pictorial representation of the process of converting iron ore to steel is shown below.

Source: www.sail.com

4
Following are the three modern day processes of producing steel:

 Blast Furnace (BF)/ Blast Oxygen Furnace (BOF) route is the most popular way of producing
steel, accounting for nearly 57% of total production. The BF/BOF route is good for volume
production, but involves huge capital costs.

 The Electric Air Furnace (EAF) is rapidly gaining popularity globally and uses sponge iron/scrap
and coke to produce steel. EAF route is flexible to produce different grades of steel. However,
EAF growth is constrained by power and scrap supply constraints in India.

 COREX, a new modern smelting technology has been recently introduced in India. It does not
require coke in producing steel and therefore could become popular with Indian steel majors in
time to come.

There are more than 3500 grades of steel available today; with about 75% of these developed in the last
twenty years. Finished steel products can be broadly classified into flats and longs.

Longs are used in construction, infrastructure and heavy engineering. Flats are mainly used in making
automobiles, commercial vehicles and consumer durables. Hot rolled (HR) steel and Bar & Rods are the
most popular varieties of steel produced in India. HR coil and sheets are used in making cold rolled
products, pipes and tubes, automobile components, electronic equipment like fridges and for
construction purposes. Currently HR Coils and Sheets account for about 26% of the total domestic
production and its share has been gradually rising over time. Bars and rods are typically used more
extensively in the construction and engineering sectors.

5
 1.2. Components of Cost of Production

The prominent components of the costs of production of finished steel are:

Raw materials
Power costs
Interest payments
Taxes and duties
Other expenses

Raw Materials: Raw material costs forms roughly about 62% of the total cost of production. This only
emphasizes on how important sharp movements in raw material prices mean for the steel industry. The
basic raw materials that are used in producing steel are iron ore, coal and limestone. India is fortunate to
be endowed with one of the largest iron ore deposits in the world. Limestone is also available in sufficient
quantities and as such do not pose much of a problem. India also possesses one of the biggest coal
deposits (approximately 197 bn tones) in the world. However, Indian coal is mostly unfit for coke
production because of its high ash content of 25-40%. Coal fit for coke production comprises less than
15% of total reserves. As such, Indian steel giants have to resort to importing coking coal from foreign
countries.

6
Power costs - The steel industry is an energy intensive industry with power and fuel contributing as
much as 10.1% of total production costs. It has been estimated that the global steel industry account for
nearly 4% of the total energy consumption in the world. Most steel majors like SAIL, TSL and JSW have
captive power plants but smaller players have to depend on outside supply. As such, erratic supply
forms a major obstacle for growth of these producers.

Interest payments - Steel is a capital-intensive industry and as such many companies resort to outside
borrowings, mostly in form of long-term loans. Interest payments always used to form on average
between 7 – 9% of the total costs but have recently come down to as low as 3.2%. Interest coverage ratio
has also shot up to nearly 10 after hovering above the zero levels for a number of years. Also, it is
important to note that the recent good turn in the sector has enabled many companies to pay off their
long-term debts early and, in general interest payments have come down industry-wide.

Taxes and duties - Excise duties, sales tax, other direct and indirect taxes further push up costs in the
steel sector. Total taxes contribute more than 16% of total costs. Here, the government can play an active
role and provide structured concessions for new and old capacities.

Other expenses - Wage bills, depreciation costs and distribution expenses are among the other major cost
components.

7
 2. World Steel production
World crude steel production for the first five months of 2009 was 449 mmt, a -22.4% decrease over the
same period of 2008. Asia produced 294 mmt of crude steel, a decline of -8.8% over the first five months
of 2008. The EU produced 50.7 mmt of steel from January to May 2009, down by -44.4% compared to the
same months of 2008. North America showed a -49.3% decline, producing 29 mmt during the first five
months of 2009.

10
5
0
-5
-10
-15
-20
-25
-30

World Monthly Crude Steel Production

3.0 Indian scenario

Steel sector witnessed a roller coaster ride in FY09, wherein the first half of the fiscal witnessed a
significant spurt in demand due to expanding oil and gas sector, large infrastructure spending coupled
with growth in housing, consumer durables and auto sectors.

However, the third quarter experienced a significant fall in the steel demand on account of the global
financial crisis. Difficult times prevailed until the Reserve Bank of India and the Central government
announced various monitory & fiscal initiatives and thus, the demand once again started picking up
during fourth quarter of fiscal.

3.1. Budget 2008 Impact

Increased focus on infrastructure development would result in development of highways,
ports, bridges etc, which will consequently increase the demand for steel.

Increased spending on government programs such as JNNURM scheme will result in higher

8
 steel consumption.

Plans to cover long distance gas pipelines would mean increase in demand for steel pipes and
tubes.

Increase in tax exemptions for citizens would result in higher disposable income that will likely
trigger increased demand for consumer durables, white goods etc, thus eventually boosting the
demand for steel.

Currently, with the government's increased emphasis on the infrastructure, the sector is poised for
significant growth over the medium to long term.

As such, the growth in demand for steel would always be higher than the GDP growth rate. The National
Steel Policy has outlined that per capita steel consumption in rural India, too, should go up from 2 kg at
present to 4 kg by 2019-20. Presently, the demand for steel in the country is more than the combined
capacity of the integrated and secondary steel producers in India and by 2020; India would emerge as the
second-largest producer as well as consumer of steel in the world. As a matter of fact, India's per capita
steel consumption continues to be low at 46 kg as against the global average of 198 kg. Thus, India has the
potential for exponential growth in Steel consumption and be part of the new Steel World.

3.2. Comforting facts

India’s lower wages and favorable energy prices will continue to promise substantial cost advantages
compared to production facilities in (Western) Europe or the US. It is also expected that steel industry
will undergo a process of consolidation since industry players are engaged in an unfettered rush for scale.
The deployment of modern production systems is also enabling Indian steel companies to improve the
quality of their steel products and thus enhance their export prospects. High investment is expected in
steel consuming industries, including automotive, aerospace and marine, power, telecom and railways,
which will further boost up the Indian steel industry. Although India consumes less steel as compared to
other Asian countries, it was ranked fifth major crude steel producer in the world in 2008.

9
 3.3. India Demand & Supply
Particulars FY05 FY06 FY07 FY08 FY09 FY10E FY11E
Finished Steel 40.06 44.54 49.7 53.31 53.5 56.32 60.76
Production
Growth (%) 8.40 11.20 11.60 7.30 0.40 5.30 7.90
Imports 2.11 3.85 4.44 6.58 5.2 4.42 4.2
Exports 4.38 4.48 4.89 4.63 3.5 2.8 3.7
Interplant 3.39 4.73 4.91 5.84 6.5 6.5 6.5
transfer/Stock Chg
Fin. Steel 34.39 39.19 44.33 49.42 48.7 51.44 54.76
consumption
Growth (%) 10.30 13.90 13.10 11.50 -1.50 5.60 6.50

As a result of improved demand, domestic steel prices remained stronger versus the landed cost of
imports. Currently domestic prices are at a premium of around 30 percent to the landed cost of imports
from Russia and Ukraine. The prices from these regions are significantly lower than that from the US,
Europe and China, resulting in relatively higher imports from these regions.

The recovery in domestic demand has been mainly because of activities in construction and rural sectors.
Indian producers are targeting strong volume growth in FY10 from an expected 5-6% growth in domestic
demand in FY10-11 and better demand from rural and semi urban sectors, and from auto and consumer
durables. Domestic HRC prices are at ~Rs26-27,000/t. Producers state that hikes have been implemented
only on some products, with long prices generally firmer than flats. Imports have risen 6% YOY in April-
May 2009.

India’s steel demand may gain as much as 10 percent this fiscal year, almost double the pace previously
estimated, as the government spends more on infrastructure. Based on the economic factors, it will not be
a surprise to see a surge in consumption. Capacity is expected to increase to as much as 124 million metric
tons by 2012 or at least 100 million tons in the worst-case scenario.

10
4. Vishakhapatnam Steel Plant (VSP)
Vizag Steel, also known as Visakhapatnam Steel Plant, is a steel company based in the outskirts of
Visakhapatnam, India. Its main plant is located 26 kilometers from Visakhapatnam, Andhra Pradesh, it is
among India's premier steel mills. It has also been conferred the Mini Ratna status. Its vision is
Infrastructuring India.

The Visakhapatnam Steel Plant was designed way back in late 1960s but by the time its chief Consultants
- MN Dastur & Company's - report and revised reports were accepted in 1984 to start construction, it had
become the most expensive steel plant ever to be constructed, designed to produce about 3 million tons
(Mt) of processed steel per year.

4.1. Vizag Steel Plant production trends in 2008

Vizag Steel Plant had entered into contracts in the earlier part of 2008 for the raw materials to be supplied
in the latter half of 2008, because of which raw material cost was very high, while the sale price of steel
decreased due to which VSP suffered from huge losses. The data for the price and quantity of steel
supplied is given below:

Item Unit H1 H2 %Increase

Total production cost Rs/Tss 23294 30519 31.0

Net saleable steel Rs /Tss 36101 26931 -25.4

The table above shows that the production cost has increased from first half of 2008 to the second half
while the steel prices have fallen down, thus VSP had to incur huge losses in the second half of 2008.

The other factors which affected plant productivity:

Total power failure on 3rd may ,2008 and its cascading effects
Correction in production plan in the last quarter in view of the slump in the markets
VSP had gone for expansion of plant capacity so as to meet the huge demand in the earlier half of
2008 but with the recession looming in, inventory remaining was very high.

In order to arrest the trend, the following steps were taken:

Various technological up gradation projects were taken up such as combined blowing, CCM
modernization ,replacement of L&T housing
Capital repairs carried out
Original suppliers of the equipment such as M/s Azovmash were called for inspecting the
converter failures.

11
 1600
1350
1400
1200
1200
1000
800 steel output(000
800 tonnes)
600 Linear (steel
400 output(000 tonnes))
200
0
2001 2006 2007

The above data shows the world steel output from 2001 to 2007which increased at a compounded annual
growth rate of 6.8% per annum.

140
120 120
120 110 110 110
100 100 100
100 90
85
80 80
80

60

40

20

output (000tonnes )

As can be seen above, the world steel output has started decreasing from June and has fallen by about
33% till December as a response to the contraction in the demand for steel. Most of the steel plants had
gone for capacity expansion anticipating that the price of the steel would rise, but the slump hit them
hard resulting in excess inventory which was difficult to sell.

12
 4.2. Micro –Economic Outlook
We can look at the above phenomena with respect to micro –economics .Initially , as the demand for steel
was increasing pre 2008,the price of steel started rising and to extract greater profits ,the steel plants all
over the world went for huge capacity expansion, the supply of steel increased in the anticipation of
greater demand and as the recession set in the European countries and Chinese infrastructure demand
came to halt ,inventory levels rose ,steel prices went for a tailspin and the pseudo profits turned into
gargantuan losses .

The graphs below explain the supply demand dynamics in the pre-July2008 and post July 2008 of the
steel industry:

Demand curve of steel pre July 2008

As we can see in the graph drawn above , the demand for steel shifts towards the right mainly driven by
infrastructure expansion in China and India .As a result ,the price of steel increased and so did the
demand for its raw materials namely , iron ore and coking coal .

13
Post July 2008, the demand for steel drastically decreased because of global economic meltdown as is
illustrated by the demand curve shifting to the left (D1 to D2). On the other hand, VSP went for a capacity
expansion taking a cue from increasing demand for steel in first half of 2008. This led to increase in the
inventory levels (supply) as demonstrated by the supply curves shifting from S1 to S2. This caused the
price of steel to plummet.

4.3. Graphical representation of collected data

420 402.8
400
380
360 345.4
Series1
340
320
300
March 09 March 08

Above chart shows the volume growth of steel produced by VSP in 000 tons .On further analysis we can
break the individual volume sales into domestic as well as exports .The table shown below gives the
export domestic sales breakup of steel produced by RINL the months March2008 and March 2009:

Exports (000 tons) Domestic sales (000tons)

March 2008 322.9 322.6
March 2009 0 402.8

Thus ,we can see from the above data that the world external demand having dried up, the exports had
vanished in the year 2009.Further ,further outlays by the government on infra spending projects such as

14
Bharat Nirman ,JNNURM(Jawaharlal Nehru National Urban Renewal Mission ) led the way for the
domestic steel prices being higher than the global steel prices .Thus the profit margins played an
important role in the shifting of the sales inward .

8000 7359.3
7000
6000
5000
4000
2902.6 Series1
3000
1740.5
2000
1000
0
SAIL RINL TISCO

The above graph shows the volume of finished steel produced by the major steel producing behemoths
in India .during the period April 2008 to March 2009.

5000 4618.4
4500
4000
3500
3000
2500
2000 1753.4 Series1
1500
1000
500 0
0
SAIL RINL TISCO

The chart above illustrates the flat products produced by the major steel plants across India .VSP does
not produce flat steel which is mainly used in automobiles, appliances and magnetic cores .As is
illustrated in the graph shown above, SAIL has a dominant market share in this category.

15
 3000
2614.6
2500

2000 1740.5

1500
Series1
1000

500

0
SAIL RINL TISCO

The chart above illustrates the long products produced by the major steel plants across India. We can
deduce that although SAIL occupies a dominant position in the market as far as long products are
concerned, RINL being single entity is giving tough competition to SAIL .The long products are mainly
used in structural parts of buildings ,roads ,bridges ,railroad tracks and supports in reinforced concrete .

The raw material price trends:

300 280

250

200

150
120 Series1
100
100 90

40 45
50 30 35

0
2001 2002 2003 2004 2005 2006 2007 2008

We can thus observe from the bar graph drawn between raw material international coking coal prices
($/t)and the years from 2001 and 2008 ,that in the period from 2007to 2008 the price of coking coal has
more than tripled due the demand for steel and it is thus a complementary product .

16
 90 82
80
70
60
50
50 45
38
40 Series1
25 27
30 22
20
20
10
0
2001 2002 2003 2004 2005 2006 2007 2008

The above bar graph shows the relationship between international iron ore prices ($ per ton) between the
years 2001 to 2008, we can observe that the iron-ore prices have increased by over 1.6 times from 2007 to
2008.

Excel files of data collected:

% ful. wrt to sust

PRODUCT SUST TARGET Mar-09 Mar-08 % growth wrt last year target
DOM EXP TOT DOM EXP TOT DOM EXP TOT DOM EXP TOT
Volume : 000T
PIG IRON 22.2 23 45.2 2.4 2.4 16.9 25 41.9 -86 -100 -94 5
IRON SCRAP 1.8 1.8 1 1 94 94
BLOOMS 9.5 9.5 15.2 15.2 7.1 7.1 115 115 160
BILLETS 6.9 6.9 14.7 14.7 12.4 12.4 19 19 213
WRM 122.5 122.5 140.4 140.4 94 10 103.9 49 -100 35 115
LMMM 100 100 121.1 121.1 98.4 98.4 23 23 121
MMSM 122.8 122.8 111.4 111.4 110.7 12.9 123.6 1 -100 -10 91
END CUTTINGS 2 2 0 0 -100 -100

TOTAL STEEL 363.7 363.7 402.8 402.8 322.6 22.9 345.4 25 -100 17 111

Value : Rs . Crs.
IRON 65.1 57.2 122.3 6.9 6.9 50.7 52 102.8 -86 -100 -93 6
STEEL 1508 1508 1201.7 1201.7 1362.7 63.4 1426.1 -12 -100 -16 80
BY-PRODUCTS 37.9 37.9 18.5 18.5 17.9 17.9 3 3 49

TOTAL VALUE 1611 57.2 1668.2 1227 1227 1431.3 115.5 1546.7 -14 -100 -21 74

17
 Domestic sale of main producers Domestic sales of secondary producers Total domestic consumption
Categories SAIL Plant Sales RINL TISCO Total Main Producers Mini Steel Plants Re Rollers Imports(All India) Cumulative 2007-08
A. Pig iron 123 0.8 178.3 0 302.1 3414 7.6 3723.7 5592.8

B.Saleable Steel
1. Re-Rollables 647.3 315 101.5 95.2 1159 15475 353.6 16987.6 21829.9

2.Finished steel

Bars and rods 1333.9 22.4 15585.5 1149.2 4064 13390 378.6 17832.6 21399.7
Structurals 551.5 21.3 182 754.8 3751 45.1 4550.9 5615.3
Rly Matrls. 729.2 52.7 781.9 120 23.4 925.3 1062.9
Total Long Prod. 2614.6 96.4 1740.5 1149.2 5600.7 0 17261 447 23308.7 28077.9

Plates 1738 26.3 117.9 1882.2 1582 806.8 4271 5598

HR coils/skelps 2133 4.5 549.5 2687 4489 1960.3 9136.3 12261
HR sheets 125 21.7 146.7 330 47.6 524.3 767.8
CR coils/sheets 465.9 48.1 783.6 1297.6 2315 619.8 4232.4 5047.4
GP/GC sheets/coils 156.5 6.3 280.7 443.5 1536 252 2231.5 2283.1
Total flat prod. 4618.4 85.2 0 1753.4 6457 0 10252 3686.5 20395.5 25957.3

Elec steel sheets 54 2.6 56.6 64 195.1 315.7 427.1

Tin Plates 14.2 14.2 89 151 254.2 305.5
Pipes 58.1 58.1 810 38.7 906.8 1622.1
Total pet prod. 126.3 2.6 0 0 128.9 0 963 384.8 1476.7 2354.7
Total finished steel 7359.3 184.2 1740.5 2902.6 12186.6 0 28476 4518.3 45180.9 56389.9

Less Double
counting for FP 3900 5600
Total Consumption 41280.9 50789.9

18
 4.4. Projected Outlook for the year 2009-10
With the forecasts of further slowdown in the growth of the steel industry for the year 2009-10, the main
objective of VSP is to keep costs down by maximizing production and arrive at a judicious market and
product mix to maximize profitability.

To keep the costs down, it is necessary produce at its peak potential and hence the year 2009-10 has been
recognized as the “THE YEAR OF PRODUCTION”.

Although the price of international coking coal is expected to fall by 57%in 2009-10, the cost of production
would be high due to the coal contracted in the previous years.

The expected net sales revenue for the year 2009 -10 is listed in the table given below:

Product Most likely Most optimistic % change

Pl 16000 16800 5

Blooms 21446 22646 5.6

Billets 21885 23175 5.8

Bar products 27000 28558 5.7

Wire rods 27250 28933 6.1

Saleable steel 26144 26558 5.4

Interest earnings will be less as the capital expenditure for the expansion would peak in view of
scheduled supplies for the erection and commissioning activities during the year.

5. Future outlook of the competitors

Ratan Tata has announced that the company would raise its annual production from 80% capacity from
the current 50 % capacity at the Tata steel annual general meeting .The demand is picking up in the west
and the trade fall in Europe and the US has bottomed out. The per capita consumption of steel
estimated at 44 kg in 2008-09is projected to reach 54 kg by end of 2011-12

The Indian steel industry output rose 3.4% in the first quarter of fiscal 2009-10in comparison to first
quarter of 2008-09, while the steel consumption was up by 5.3%.India was ranked the 3rd largest producer
of steel after China and Japan between January –May 2009.

SAIL: It has recorded a growth of 14 %growth in the steel output in July which was 1.08 mt , while the
sales have improved by 25% .The resurgence is mainly being led by strong domestic demand and
infrastructure sector’s revival .

19
Tata Steel: Tata Steel has recorded an 18% growth in domestic sales producing 0.48 mt of steel in July.

JSW Steel: JSW Steel has reported a 51 % jump in in crude steel output .it crossed 0.5 mt in July.

Steel industry scenario and company performance in 2008-09

Intensification of the global meltdown starting from the second half 0f 2008saw the steel prices fall by 72
% in a span of 5 months starting from July 2008 to Nov 2008 .The very same steel prices rose compounded
annually by 36%from 2001 to 2007.

800 Total
600

400
Total
200

0
2001 2006 2007

The above graph depicts the steel prices in dollars per ton on the y-axis and the years in the x-axis.

1400

1200

1000

800

600
Series1
400

200

The chart above depicts the steel prices (dollars per ton) in the y-axis and the months in 2007
which shows the fact that from July 2008 , the prices fell down rapidly as an after effect of the financial

20
crisis .The high price of steel was driven by the tremendous demand from Chinese Olympics because of
which even the primary raw materials such as coking coal and iron ore prices reached an all time high
.But then once in the US and European countries demand dried out and recession set in ,the prices fell
down like a pack of cards.

21