Department Responses to input by Eskom and Steel Industry & outstanding issues

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Trade and Industry

24 August 2010
Chairperson: Ms J Fubbs (ANC)
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Meeting Summary

The Department briefed the Committee on the steel industry with reference to ArcelorMittal South Africa (AMSA) and Kumba. Explaining a series of graphs it showed that benefits in terms of job creation and added value per unit of investment increased the further one moved through the stages of beneficiation. Steel had been regarded as strategically important and benefited from government support. With the unbundling of Iscor, Iscor (later AMSA) was guaranteed low cost iron ore, with the intention that it would ensure the viability and cost competitiveness of local steel production on the one hand and support the development of downstream beneficiation. By 2004 the government was not the majority shareholder and the price of steel was pegged at around import price parity which did not stimulate local steel product beneficiation and consequently saw flat demand for steel domestically and job losses in the industry.

An Interdepartmental Task Team (ITT) had been created by the Ministers of Trade and Industry, Economic Development and Mineral Resources as a response to the current tiff between Kumba and AMSA over the price of iron ore, however, its focus would also be aimed at recalling the original intent of the 2001 Iscor unbundling agreement. Policy tools being looked at included the mineral rights regime, competition policy and legislation, trade policy and attracting further investment and competition in the steel sector.

Responding to Eskom’s presentations at public hearings, the Department in conjunction with the Department of Public Enterprises and Eskom wanted to formalise the interaction to meeting on a regular basis to take forward Eskom's capital expenditure programme and how it would be linked to local manufacture.

There were a number of policy processes that needed to be finalised by the Department of Energy and the National Energy Regulator of South Africa (NERSA) concerning renewable energy generation and demand side management. The Energy Department’s integrated resource plan needed to be finalised, purchase agreements with independent renewable energy generators were dependent on NERSA’s REFIT pricing model. The DTI was looking overseas for supplementary resource funding for the REFIT model. The greater the funding, the greater the percentage power generated from renewable sources. This was encompassed in the South African renewable energy initiative to secure global funding and to secure local manufacturing of equipment and materials

Members agreed with the strategy adopted by the Department. Members asked what the actual price of steel was. How could AMSA’s price structure incentivise exports instead of Government? What was the time frame of the task team? Members said the AMSA incident showed the significance of strategic products to industrial development and that industry should support government programmes. Members wanted it confirmed that the government still thought the iron and steel industry strategically important and if so, why LNM was allowed to become the majority shareholder in Iscor. Members asked what power the ITT had to stop the looting of South African resources to benefit other countries and not South Africa, and what power did it have to redress what had happened. Members said there should be broad consultation amongst Departments, focusing on IPAP (Industrial Policy Action Plan) and Iron and Steel and what impact the pricing of steel and the actions of Kumba and AMSA had had on undermining IPAP2.

It was agreed to defer the submission of nominations for the Lotteries Board to the meeting on Tuesday 31 August.

Meeting report

Mr Nimrod Zalk, Deputy Director General, Industrial Development Corporation (IDC), outlined the iron ore, steel and steel products value chains as having four stages. In stage one there was market concentration with AMSA having 80% of the market. He said that when one looked at the price of steel as it was being beneficiated in comparison with employment opportunities and investment required in the different stages, it was apparent that the benefit derived increased as one moved up the stages. He then turned to look at the evolution of the industrial policy on steel. Steel had always been regarded as strategically important and had benefited from government support in the form of cheap electricity and tariff protection.

Steel Industry Policy and Developments
In 2001 Iscor had been unbundled into Kumba (Iron ore mining) and Iscor (Steel manufacturing) with Iscor getting iron ore at cost plus 3%, with the intention of ensuring the viability and cost competitiveness of local steel production and to support the development of the beneficiation process in downstream industries. LNM had been introduced to Iscor as an international business partner to introduce efficiencies in exchange for generous fees and the right to raise its shareholding. LNM raised its shareholding in the ensuing years and by 2004, in an agreement with the DTI, held a majority stake. The agreement called for a steel price that would replace the import parity price (IPP) aiming to raise the volume of downstream beneficiation in the South African economy for the domestic and export markets. The agreement also called for an increased investment in the liquid steel capacity from 1.2 mt/a to 2 mt/a.


He then explained that IPP was the local price of steel, calculated as if it was purchased and shipped from overseas. The DTI had extensive negotiations with AMSA since 2004 over price and a proposal to have export price parity had been rejected. A second proposal to calculate the price based on a basket of prices weighted equally between a) where the price in South Africa matched steel prices in markets where South Africa’s main steel fabricators’ imports came from and b) the average price of steel in the last quartile of global steel producers in the world, where AMSA was placed as far as costs of production was concerned. This was because iron ore was being supplied at cost plus 3% and AMSA should factor in and pass on the low cost of the iron ore. AMSA rejected this too and was unwilling to link the steel price with the cost of production.

AMSA, in 2006, introduced an international basket price model taking into account steel prices in four countries, the USA, Germany (high cost countries) and China and Russia (low cost countries) but  incorporated any domestic adaptations it wanted to apply. When the DTI tried to replicate this price calculation it bore no resemblance to the prices arrived at by AMSA, whose prices were significantly higher.

In 2009, AMSA departed from this price model unilaterally and also failed to convert its mining rights, leading to the current dispute with Kumba. In an interim agreement reached while the dispute was being sorted out, Kumba raised its iron ore price to AMSA. It, in turn, introduced an iron ore surcharge to its prices and then subsequently subsumed this into the base price of steel. The DTI felt that this was a contradiction to its previous position as AMSA now sought to link the steel price to the cost of production.

Cost and Pricing
Ms Thandi Pele, Chief Director Metal Fabrication, Capital and Transport Equipment of the Industrial Development Division of the DTI, then looked at the cost and pricing of steel, noting that the fact that it received their iron ore at cost plus 3% gave them a major cost advantage, placing them in the lowest quartile of producers from a cost perspective, but that this was not passed on to downstream beneficiators. Since 2004 their prices had always been above average and always been in the highest price group. Its prices had not reflected even the basket of prices of the four countries chosen by AMSA. AMSA did have rebates for export beneficiation and special discounts but these were solely at the discretion of AMSA.

The iron ore industry meanwhile in the period 1991 to 2008 showed a growing divergence between the domestic and export markets. The domestic market remained flat while exports doubled in this period. This reflected the fact that there was no growth in the beneficiation of steel domestically and that jobs had been lost in the 90’s which could have been mitigated had the low production costs been passed on to downstream beneficiation, because the price of steel was the single biggest cost factor in downstream development projects.

Mr Zalk said that an Interdepartmental Task Team (ITT) had been created by the Ministers of Trade and Industry, Economic Development and Mineral Resources as a response to one element of the Iscor unbundling, the mineral rights and pricing supply arrangements to AMSA. However, its focus was also aimed at recalling the original intent of the 2001 unbundling agreement. The concessional supply agreement had been made with the intent that not only would it make Iscor a viable, competitive international supplier of steel, but that it would pass on those savings to downstream beneficiators.

The focus of the ITT would not be on the price of iron ore paid by AMSA to Kumba, but rather on how the cost advantage is given effect throughout the value chain to benefit beneficiation. The ITT ‘s mandate was to make recommendations on appropriate policy tools to ensure that public developmental obligations of the 2001 unbundling was effected and enhanced the viability of the domestic steel industry with competitive steel prices to expand value added manufactured production . The policy tools being looked at included the mineral rights regime, competition policy and legislation, trade policy and attracting further investment and competition in the steel sector. The ITT would make recommendations to the Ministers and brief the respective portfolio committees.

Discussion
Mr B Turok (ANC) said it was correct that the focus should be on the strengthening of the domestic industry rather than the price of the iron ore supplied to AMSA and that the ITT be given a time frame to report back and that it adopt a vigorous approach, not the feeble one of the last ten years. He said he would like the former Ministers of Trade and Industry and Public Enterprises to be called to explain what they had done as they had been taken for a ride by AMSA, the consequences of which had been de-industrialisation and job losses in the nineties.

Mr S Marais (DA) said that the DTI was investing enormous amounts of money in the automotive production industry but that car manufacturers were still importing cheap metal for car bodies. Why was local beneficiated products not looked at? What was an acceptable profit margin for AMSA? How could AMSA’s price structure incentivise exports instead of Government?

Ms C Kotsi (COPE) asked if there were time frames to turn around the current state of affairs. How were the ITT’s recommendations going to be enforced?

Ms C September (ANC) said that the Committee should not lose its focus; the objective was to create labour intensive industries and beneficiation opportunities. She proposed that the Committee as part of their oversight should map an independent programme to reach the objectives the Committee wanted, with legislative changes if and where necessary. What other options had the department explored regarding the price apart from the two mentioned above? She said there had to be a dispensation in the pricing model to benefit downstream beneficiation. How was the value chain being taken into consideration in the recommendations the ITT was formulating?

Mr S Njikelana (ANC) said that it showed the significance of strategic products to industrial development and that industry should support government programmes. He wanted it confirmed that the government still thought the iron and steel industry strategically important and if so, why was LNM allowed to become the majority shareholder in Iscor.

The Chairperson with regard to the interim price mechanism, asked what power the ITT had to stop the looting of South African resources to benefit other countries and not South Africa and what power did it have to redress what had happened. He said he concurred with Mr Turok in requesting the previous Ministers, or functionaries within the Departments, to explain the memorandum of understanding it had entered into.

Mr Zalk replied that the mandate of the ITT was to make recommendations to ministers on changes, even of legislation. The ministers had not set a deadline but the work was to be expedited and completed within one to two months. He said it was important to see the value chain from both an economic and a policy point of view. He said the DTI’s second proposal captured the upper limit on what a developmental price for steel would be. He said that there should be a passing on of the benefit of lower cost iron ore supply whilst a lower limit would see the price pegged at export parity. Regarding enforcement, he said the Department had conveyed in detail and at length the rationale for a passing on of benefits derived from low cost iron ore and it was apparent that moral persuasion was not sufficient to move AMSA as this had been tried over a long period of time. The passing on of the low cost iron ore benefit was important as downstream beneficiation was where the biggest gains in added value and job creation occurred for the lowest unit cost of investment. The cost of steel was also the biggest cost factor in downstream beneficiation. With regard to the automotive industry he said that incentives were structured such that it encouraged local manufacture of parts so there would be no advantage to import car panels. He acknowledged that certain specialised steels were imported.

Mr Van Der Westhuizen (DA) asked if AMSA’s price was competitive in the world market.

Mr Njikelana said the Committee should embark on a monitoring, evaluation and review process with all strategic industries and projects and the DTI should help to identify and update them in this area. There was a need to explore incentives for the beneficiation programme. Because of the country‘s re-industrialisation drive, could the DTI not fully or partially explore regulations? He wanted to know more on the iron and steel pricing, what the original intent on the unbundling of ISCOR was and to be kept informed on the ITT progress. He said there should be broad consultation amongst Departments focussing on IPAP and Iron and Steel and what impact the pricing of steel and the actions of Kumba and AMSA had on undermining IPAP2.

In response to the question that if Saldanha Steel was at the low end of the production cost curve in 2008 why was it now suddenly under threat of not being a viable business, Mr Zalk said that given the low price of the iron ore it could only be for operational reasons that there had been a rapid decline in competitiveness and that most of its output was exported so its prices were lower because exports were more price sensitive and logistical costs had to be added to this too.

With regard to the domestic price of steel and IPP, he said other markets, like Europe, had regional competition while South Africa was relatively under industrialised and did not have competing plants regionally. Actual prices had fluctuated in the region of the IPP.

Asked by the Chairperson to comment on Eskom's presentations during the public hearing process, he said there were two presentations. The first dealt with Eskom’s capital expenditure and its link with local procurement. Transnet also made a presentation on localising train purchases. The DTI felt it had made more progress in discussions with Transnet than with Eskom. In conjunction with the Department of Public Enterprises and Eskom, the DTI want to formalise the interaction to meeting on a regular basis.

In Eskom’s second presentation on climate change, he said there were a number of policy processes that needed to be finalised by the Department of Energy and the National Energy Regulator (NERSA) concerning renewable energy generation and demand side management. The Energy Departments integrated resource plan needed to be finalised, purchase agreements with independent renewable energy generators was dependent on NERSA’s REFIT pricing model. The DTI was looking at the international scene to supplement resource funding for the REFIT model. The greater the funding, the greater the percentage power generated from renewable sources. This was encompassed in the South African renewable energy initiative to secure global funding and to secure local manufacturing of equipment and materials.

National Lotteries Board Position
The Chairperson asked for input from the Committee regarding the Minister’s request for recommendations for a position on the National Lotteries Board to be drawn from the short list drawn up during the previous nomination process as there was an urgent need to fill the post to allow the Lotteries Board fulfil its quorum requirements

The Committee agreed that the request be deferred till Tuesday 31 August allowing them time to go over the shortlist of candidates of the previous process.

The meeting was adjourned.



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