BRIC Spotlight

Iron & Steel Industry in Brazil: In a Sweet Spot

New growth drivers at home

Brazil has been a darling of the global investment community for several reasons — political stability, fiscal strength, a rapidly expanding middle class, rising incomes and consumption, the success of its poverty alleviation and social welfare programs, and the structural advantages of its economy, among other factors. Arguably, the only sore point in this compelling investment theme has been its poor infrastructure. While struggling to stabilize the economy through the 90s, successive governments consistently cut long-term investment to be able to fund current expenditures.

Those years of neglect reflect in the country’s congested ports, crowded airports, and underdeveloped railroads today. In fact, Brazil’s appallingly inadequate infrastructure spending also manifests in its per capita annual consumption of steel, a major raw material for the infrastructure sector. Until recently, the nation used on average only around 100 kilograms of steel per person per year while the comparable figures for China and South Korea were 300 kilograms and 1,200 kilograms, respectively.

But this is set to change. Having realized that its growth momentum might wilt if the infrastructure deficit is not bridged, Brazil has launched a sustained effort to build or improve ports, railroads, airports, and roads. The Soccer World Cup and the Olympics, which Brazil is slated to host in 2014 and 2016, respectively, are also adding to the sense of urgency. Eager to showcase the two mega sporting events to the world, Brazil’s federal government has already drawn the blueprint to build and upgrade stadiums and airports, as well as spruce up urban infrastructure. Riding on this infrastructure boom, the demand for steel in Brazil, already on the rise, is expected to increase manifold over the next few years. Clearly, the primary beneficiaries of this trend will be steelmakers based in the country.

It’s not just infrastructure though. The growth in the size of the middle class, which now makes up more than half of Brazil’s population, and the nearly 45% rise in wages over the past few years, have pushed up the demand for automobiles, appliances, furniture and everything else that requires steel as a raw material. In fact, driven by increased bank lending, tax breaks on cars, and historically low interest rates, the automobile sector, which is globally one of the biggest consumers of steel along with the infrastructure sector, saw sales increase more than 11% year-on-year in 2009 and is projected to see a revenue growth of 10% in 2010.

Thus, this happy union of sorts — the government’s newfound zeal to improve infrastructure, the two mega sporting events, and rising consumption of cars and appliances — guarantee an enormous rise in demand for steel in Brazil in the coming years. Of course, for the country’s iron and steel industry as a whole, these aren’t the only positives. If the steel segment of the industry is projected to benefit from new domestic drivers, the iron segment is expected to continue growing on the strength of Chinese steel mills’ appetite for iron ore.

Overseas growth drivers intact

Chinese steelmakers have been the primary driver of global iron ore demand for nearly a decade now. And, given the current outlook for steel consumption in the country, the trend may continue in the foreseeable future.

Every year, China inducts nearly 18 million people — which is slightly more than the entire population of The Netherlands — into its workforce and new houses, appliances, automobiles, buses, trains etc have to be produced for them. All of these things require steel. Therefore, China’s annual steel demand has been surging at double-digit percentages and the country now consumes a third of the world’s steel. Since nearly all of the iron ore produced in the world is used by steel mills, China’s share in the global seaborne (transported by ship) iron ore market has jumped from 16% in 2000 to around 70%. In line with this trend, Brazil, which has the second largest deposit of iron ore in the world, has been increasing its iron ore exports to China. Today, close to 25% of China’s ore imports come from Brazil and that figure can only increase in the coming years as the China juggernaut rolls on.

Other emerging economies will also remain a significant driver of demand for steel — and, therefore, of iron ore — over the next decade. The slowdown in the developed world notwithstanding, the world is presumably in the middle of a commodity super cycle now as hundreds of millions of hitherto low-income families from countries in South America, Asia, and Africa make a leap to the middle class. This global trend will continue to push up the consumption of everything from oil and food grains to ores and metals in the coming years.

Industry players

The major players in the industry include:

• A handful of large steel producers, some of which also have iron ore production units
• The global mining behemoth, Vale, and another relatively smaller mining firm

In fact, Vale, with total iron ore reserves of about 14 billion metric tons, is the largest iron ore producer in the world. A $150 billion diversified mining company, it has the capacity to produce about 400 million tons of iron ore a year and accounts for more than 80% of Brazil’s total iron ore exports. Although the firm is a mining giant — with nickel, coal, aluminum, copper and coal production as well as logistics units — iron ore mining is its largest business and generates more than 60% of its revenues. Vale’s chief rivals are the Australian diversified mining groups BHP Billiton and Rio Tinto. Together, the three giants control around 60% of the global iron ore market.

The other significant iron ore mining firms are MMX Mineracao e Metalicos S.A., which has an annual production capacity of 10.1 million tons, and Companhia Siderurgica Nacional (CSN), which has an annual capacity of 28 million tons. In fact, CSN is also Brazil’s biggest diversified steel producer with interests in mining, logistics, and cement, besides steelmaking. It controls more than 30% of the domestic market for steel and has the capacity to produce around 8 million tons of steel a year.

Brazil’s second largest steelmaker is Usinas Siderurgicas de Minas Gerais SA or Usiminas. Incidentally, the company — which controls a little more than 25% of the domestic market for steel and has an annual production capacity of 7 million tons — is Brazil’s largest maker of steel products for the auto and construction industry. Gerdau SA, the world’s 14th largest and Latin America’s largest steelmaker, is the third most prominent steel producer in Brazil. The multinational steel company, which has operations in 14 countries, controls about 20% of Brazil’s steel market. Other players in the steel market are Metalurgica Gerdau SA and the Brazilian subsidiary of ArcelorMittal, the world’s largest steel producer. All three of Brazil’s top steelmakers — CSN, Usiminas, and Gerdau — make steel products that are used extensively in the construction and infrastructure sectors.

Industry strengths and weaknesses

Steelmakers in Brazil enjoy a unique set of advantages:

• Most of them are vertically integrated, meaning they own and operate iron ore mines and do not need to purchase iron ore, their raw material, from mining firms such as Vale. No wonder then that Vale sells only about 10% of its iron ore output in its domestic market and exports the rest.
• Globally, power costs for steel producers have been found to be the lowest in Brazil, Russia, India, and the Ukraine.
• They have access to some of the lowest-cost and highest-grade coking coal and iron ore deposits in the world.

In fact, the high grade of iron ore deposits in Brazil is the biggest advantage for iron ore producers in the country. For instance, the reserves at Vale’s Carajás mines have an average iron content of 66%-67% while ore from Rio Tinto and BHP Billiton mines in Australia have an average iron content of 62%-63%. Superior ore quality translates to lower operating costs for miners. What’s more, each 1% increase in grade fetches Brazilian iron ore producers a premium of $3-$6 per ton of ore in the global market.

While superior ore quality is an advantage for Brazilian iron ore producers, the geographical proximity of Australia to China is a plus for Australian iron ore producers. The cost of shipping goods between Brazil and China is nearly twice as much as the cost of shipping on the Australia- China route. Therefore, despite the price premium for Brazilian iron ore, Australian miners tend to profit more from their exports to China than Brazilian miners do.

Industry trends

Predictably, industry trends reflect the favorable conditions Brazil’s steelmakers and iron ore producers face both at home and overseas. For instance, the Brazilian steelmakers who own iron ore mines have been trying to sell portions of their stakes in the mines to make the most of the overall optimism in the iron ore market across the globe. Usiminas has started the process to sell 30% of its stake in its iron ore mining unit, Mineracao Usiminas SA, to Japanese trading company Sumitomo Corp. and CSN is planning to spin off its mining unit through an IPO. However, the two firms have different objectives. While Usiminas is aiming to take advantage of the surge in iron ore prices over the past year and a half, CSN wants to raise money for acquisitions outside Brazil.

Steelmakers are also feverishly increasing capacity to take advantage of the expected demand surge. CSN, for instance, plans to spend $6.4 billion on new projects, which include a flat steel mill in the city of Congonhas.

However, given the capacity scale back and idling of blast furnaces in 2009, a supply crunch persists. In fact, despite a fall from the highs scaled in April 2010, steel prices in Brazil are considerably higher than they were in 2009. Worried that the trend may persist, the Brazilian federal government has been goading iron ore producer Vale to focus on steel-making as well. Afraid that the government may find ways, such as an increase in mining royalty, to force it to comply, Vale has started expanding its steel capacity. The mining behemoth, which had sold its various stakes in steel companies a few years back to concentrate only on iron ore production, now has steelmaking projects worth several billions of dollars in the pipeline.

But steelmaking is not the only business Vale is trying to boost. It has joined hands with Brazilian oil producer Petrobras to explore for natural gas and oil, a move to ensure energy supplies for its operations. The firm is also expanding its maritime fleet from 15 dry bulk carriers to 35. As well, Vale is building eight huge iron ore ships and a mammoth distribution center in Qingdao, China, to cut its shipping costs by 30% and offset some of the advantage Australian miners have in terms of their proximity to China.

Thus, clearly, Brazil’s iron and steel industry is in a sweet spot now — long-term overseas demand for the country’s iron ore exports will likely remain strong and steel consumption is projected to grow rapidly within the country. But, can industry players capitalize on the situation? They should, if they steel themselves against all the odds and put the pedal to the metal!

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