Greybull or grey clouds? Why these are temporary solutions to structural problems in UK steel
Tata Steel's decision to sell the firm's UK steel assets follows the wider divestment and mothballing trend playing out in the country's steel sector.
Most recently, Tata Steel put the firm's Port Talbot and Scunthorpe mills up for sale, following a suit of competitors in the UK market, such as Sahaviriya Steel Industries and Caparo.
On 11 April, Greybull Capital acquired Tata's Scunthorpe long products business, which makes products for the construction, energy and automotive sector.
Although the deal will prevent the closure of the plant and loss of jobs, for now, it will not resolve the long-term structural issues that will plague the country's steel sector. For instance, Greybull's turnaround plan is focused on dramatically improving earnings from the plant's rail products, which account for only 25 per cent of the plant's overall long products.
This is a long shot for a division that made a $100m loss last year, from total revenues of $1.6bn.
As such, I don't believe the turnaround can be successful without significant long-term government financial assistance. This could be done via subsidies, for example, or stipulating that all government infrastructure projects can only use UK steel, which will indirectly subsidise labour wages.
Structural issues persist
There are two other structural issues that will continue to curb the sector's competitiveness and prevent it from recovering over the coming years.
Firstly, low steel prices due to a persistently oversupplied global market will continue to erode producers' profit margins. To provide some context, China, which consumes nearly half of the world's steel each year, has seen demand steadily falling on the back of the country's economic slowdown and shift towards a consumer-oriented economy.
As the country's steel mills have maintained production, this has resulted in a persistently oversupplied market, leading Chinese producers to ship excess steel capacity overseas, pushing prices down globally. Put in context, in 2015, China exported over 110m tonnes of steel, which is more than the United States produces as a whole.
Average prices have fallen by over 35 per cent in the last four years. While the Chinese government announced in early March that it intends to scale down domestic steel capacity by 150m tonnes over the next two to three years, this will not be enough for prices to rise rapidly. For instance, BMI Research forecasts that the global market will only post a 6.6m tonnes deficit by 2020, which is minimal, compared to global production totalling 1.6bn tonnes that same year.
Low iron ore prices will continue to support high-cost steel producer margins, despite falling prices. This in turn will slow the closure of high-cost steel producers necessary to rebalance the steel market.
Secondly, domestic regulations will ensure UK steel production remains uncompetitive.
The country's high power costs, primarily due to an expensive carbon tax, will be the key driver behind elevated production costs. In 2010, The UK implemented a £18.1/tonne carbon dioxide tax, on top of the EU's £5.3/tonne carbon tax, increasing the rate paid by carbon emitters in the UK to double the level in Germany or France.
A UK steel plant pays around €68.0 per megawatt hour (mWh), while a German competitor pays only €24.0/mWh.
Taking all of these factors together, it is a stretch to say the UK steel sector has any chance of staying competitive.