Tata's Port Talbot Problems Are Not The End Of The European Steel Industry

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Includes: SLX
by: Tim Worstall

Summary

Tata Steel is having horrible problems with its Port Talbot plant; essentially, it's bust.

This is not the end of the European steel industry.

It's, instead, the end, or near end, of one particular technology in that industry.

It's possible to see the flailing around in Britain over the problems at Port Talbot as being a message to run for the hills from the steel industry. That's a message that we shouldn't, as investors, hear. Rather, view that as being a result of the political smokescreen that is being thrown up around what is a much more boring and simple technological story. The steel industry isn't going away, it is not all crumbling under Chinese competition or dumping. Rather, we're just one more step on that long road away from 19th century steel technology toward the 21st century.

The point to understand from a technical point of view is that there are two parts to the steel industry. There's the production of the basic steel itself and then there's the processing of it into something that people actually want to use. Akin to the oil business if you like, upstream and downstream, oil exploration and production and then refineries. In steel, the traditional method of that primary production, that upstream business, is by using a blast furnace. Add coking coal, iron ore and limestone and get rivers of crude steel. Almost fun and essentially a 19th century technology.

Downstream is things like rolling mills and so on that turn this into the sheets that people actually use to make, say, cars. Or various other specialist plants use to make certain alloys and so on.

What's actually happening in the steel industry, and this has been going on for decades, is that the upstream business is being disrupted by technology. Instead of those blast furnaces, we now recycle much more of the older steel we have already lying around. We do this using arc furnaces. This is, again, very similar to the oil industry. Instead of going looking for mega reservoirs of oil, we now increasingly look for shales and tight oils that can be extracted using advanced techniques and on a very much smaller scale. Shale wells cost under $10 million, while big fields cost billions upon billions. Blast furnaces hundreds of millions, arc furnaces a few millions.

It is not thus the steel industry itself that is falling apart. It is just the blast furnaces that are being made surplus to requirements by our increasing use of alternative technologies. This was true of the ArcelorMittal (NYSE:MT) decision at Florange four years ago. The blast furnace needed to close: the rolling mill was viable being fed from a scrap fed arc furnace.

This is what is happening to the British steel industry now. Redcar and Scunthorpe, which closed earlier, were blast furnace sites. Port Talbot, where all the fuss is now, is one too. It is that specific technology which is being marginalized, not steel itself.

One interesting proof of this is what is being said by a potential rescuer of the business:

The founder of commodities firm Liberty House will tomorrow night fly into the UK ready to meet Government officials and Tata to gauge their support for a proposal to keep Britain's largest steel plant open. The entrepreneur, who has saved a number of British steel plants and mills from the industry's unfolding crisis, has submitted preliminary proposals to the Government to replace Port Talbot's traditional blast furnaces with modern electric arc furnaces, used to produce raw steel by melting scrap.

Further:

Last week, Liberty House agreed to buy two Lanarkshire mills from Tata. It has also taken control of some operations of Caparo Industries, which collapsed in October. The company, which Mr Gupta started while a student at Cambridge University, initially said it was interested in some of Tata's downstream assets, not Port Talbot. Mr Gupta, who tomorrow returns from a business trip in Dubai, now believes a rescue that does not involve the South Wales plant would be too unpalatable. "The downstream assets I'm interested in anyway, with or without the Government," he said. "But I don't think that's the solution the country's looking for." Replacing the blast furnaces at Port Talbot would require "a lot of investment", Mr Gupta warned. "I've put concepts to the Government for what I think is required, and I'm asking them what are they prepared to do."

Of course, that last is code for "how much will the government pay me to do what I don't really want to do?"

From an investment point of view, here the idea to grasp is that it is not the steel industry tumbling down into the abyss. It's the death of one particular technology within that industry. Companies in the downstream part of the industry might be suffering under the Chinese dumping and so on, but that's going to be a passing phase. Companies that own blast furnaces are going to have a very hard time indeed whatever happens to those more minor trade issues.

Just as the world still wants oil so too does Europe and the US both desire steel and also continue to have a steel industry. It just won't be the making of that virgin steel that we no longer need to do in quite such volume. Depending on who you believe on this point and whose numbers, various estimates are that currently 75% to 90% of Europe's steel consumption comes from recycled, through arc furnaces, production methods. And that can be very profitable; of course, if the price of steel drops, then so does the price of scrap, preserving the processors' margins.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.