RETURN TO THE OLD DAYS?

Mittal Steel's Effect on Domestic Steel Prices and Innovation

Posted by Mark Reutter 2/21/07

The following is the text of my keynote speech to the Fabricators & Manufacturers Association’s Toll Processing Conference in Orlando, Fla., on February 16, 2007. The two-day conference was devoted to mergers and consolidations in the steel industry, and I addressed the growing worry that Mittal’s concentrated control of steelmaking is resulting in a price squeeze for U.S. industrial users and fabricators.

I had expressed concern about the anticompetitive implications of Mittal’s takeover of International Steel Group (ISG) before the merger took place in op-ed articles. The organizers of the conference asked me to compare the recent consolidations to the past history of the industry.

As it happened, on February 20, 2007, the U.S. Department of Justice – which I have given poor marks for its antitrust review of the Mittal-ISG merger – announced that Mittal must sell the Sparrows Point, Md., mill to preserve competition in the tinplate market. DOJ said Mittal’s 2006 merger with Arcelor, owner of the Dofasco (Canada) tinplate-making facility, raised “anticompetitive effects” in the marketplace.

I was quoted in the AP article on the decision saying that the ruling underscores manufacturers’ frustration with Mittal Steel’s pricing and production policies. And their complaints go beyond tinplate – embracing the pricing of automotive steel and several other mill products.

DOJ’s action is a positive step, not only for the future of Sparrows Point, but also for American manufacturing that uses steel, for reasons explained in my speech. Further, it represents the first time that the business policies of Lakshmi Mittal have come under government scrutiny.

Here’s hoping that DOJ starts looking at the draconian production cutbacks (described below) at Mittal mills since 2005, apparently aimed at controlling downward swings in steel prices by denying lower-cost steel to customers.

“The problem as I see it,” said Gustave Koven, “is this: how can we keep the small and medium-size manufacturer from extinction?” Koven, who managed a steel-fabricating factory in Jersey City, N.J., was testifying back in 1950 before a Congressional committee studying the ownership and pricing policies of the U.S. steel industry.

The committee concluded that the industry was dangerously over-concentrated, with three companies, U.S. Steel, Bethlehem Steel, and Republic, operating a “tropoly” that kept prices under the control of a small group of executives.

Throughout the 1950s, the Truman and Eisenhower administrations pleaded with an industry that had been consolidated under trusts by J.P. Morgan, Charles Schwab, and Andrew Carnegie not to raise prices – after all, we were fighting the Cold War and, for a while, a hot war in Korea. But to little avail. When U.S. Steel raised its prices, so did Beth Steel, Republic, Jones & Laughlin, Youngstown Sheet & Tube, Armco, and Inland Steel – usually within the same 24-hour period.

The industry invented some choice vocabulary to justify its actions. “Meeting the competition” was steel talk for the matched prices that the top steel companies instituted nationwide. “Unfair competition” was anything that might undercut these uniform prices. “Inelastic demand” was the purported economic reason why steel was outside the laws of supply and demand, and why the trade could advance prices with impunity.

“Our salesmen don’t sell steel; they allocate it,” gloated one executive.

Thus, the “Big Steel” companies rolled over the likes of Gustave Koven – the heavy-metal, high-octane, chrome-tail-finned Buick Rivieras of U.S. business – until they crashed into President John F. Kennedy. On October 22, 1962, Kennedy opened a White House press conference with the following statement (slightly edited):

“Simultaneous and identical actions of U.S. Steel and other leading steel companies increasing steel prices by some $6 a ton constitute a wholly unjustifiable and irresponsible defiance of the public interest. In this serious hour in our nation’s history, when we are confronted with grave crises in Berlin and southeast Asia, when we are asking reservists to leave their homes and families for months on end and servicemen to risk their lives in Vietnam, when restraint and sacrifice are being asked of every citizen – the American people will find it hard, as I do, to accept a situation in which a tiny handful of steel executives can show such utter contempt for the interests of 185 million Americans.”

Kennedy continued: “If this rise in the cost of steel is imitated by the rest of the industry, instead of rescinded, it would increase the cost of homes, autos, appliances, and most other items for every American family. It would add, Secretary McNamara informed me this morning, an estimated $1 billion to the cost of our defenses. It would make it more difficult for American goods to compete in foreign markets and more difficult to withstand competition from foreign imports.”

This chart shows the price of steel mill products relative to other producer prices over the last 60 years. Largely because of wartime price controls, steel prices dropped in the 1940s compared to all producer goods, then began rising at roughly double the rate of producer goods. Following President Kennedy’s intervention, steel-price hikes moderated over the 1960s, only to shoot upward again in the 1970s. Overall, the price of all producer goods roughly tripled between 1947 and 1979, while the price of steel-mill products rose by a factor of six – faster than any other metal product.

While rising prices had obvious short-term benefits for the steelmakers, the long-term consequences were disastrous. Aluminum, plastics, and concrete began replacing steel in markets that, 50 years earlier, steel had conquered from glass bottles, wood-framed cars, brick-and-mortar buildings, and wrought-iron machinery and tools. What was an all-steel kitchen in the days of June Allyson became by the 1990s a kitchen with aluminum and plastic, right down to plastic microwaveable food packaging (in place of tin cans) and aluminum instead of tin foil.

Inroads by competitive products and the lack of new steel markets – much more than rigid union work rules or imported steel – played havoc on the economic base of Big Steel. In the 1980s and 1990s, hundreds of thousands of jobs were lost in the cradle of the industry around Pittsburgh and Youngstown, and plant closures spread west to Chicago and east to Johnstown and Bethlehem, Pa. Then there was another factor. Mini-mills that used electric-arc furnaces, thin-slab casters, and motivated employees undercut Big Steel’s prices, delivery dates, and customer service.

After all the bloodshed, Big Steel was returning to what it had been before the “trust-building” movement of Morgan, Schwab, and Carnegie – a lean, competitive industry. Yes, LTV (former Republic Steel) and Bethlehem struggled, but U.S. Steel and Armco (re-named AK Steel) did an admirable job in restructuring their businesses.

The chart indicates how steel prices responded in the 1990s when competition was robust and no firm had significant control over the marketplace. Returning to levels that were very competitive, steel was making inroads against substitute products, gaining ground, for example, against lumber in the booming housing market.

But the dynamics of the U.S. – indeed, world – steel business has rapidly changed as a result of the aggressive business tactics of Lakshmi Mittal. Having succeeded last July in his hostile takeover of Arcelor Steel, the Mittal combine is by far the largest steelmaker on the globe, now employing 330,000 employees in more than 60 countries.

With a personal net worth reported at $25 billion, the Indian-born, London-based businessman has not been shy about advertising his wealth. He shelled out $125 million for a mansion next door to the royal family’s Kensington Palace in London. Comprising the former Russian and Egyptian embassies joined together, the house boasts a swimming pool inlaid with jewels, a grand ballroom, and a 20-car garage. 

Mittal also raised eyebrows for the lavish wedding of his daughter, Vanisha, 26, who sits on the Arcelor-Mittal board of directors. Invitations for the Hindu nuptials were 20-page thick, encased in silver, and contained jade necklaces or diamond watches for close family friends. Mittal chartered 12 Boeing jets to fly 1,500 guests from India for five days of festivities in France that included the rental of the Palace of Versailles.

As recently as five years ago, Mittal was mostly known for his oddball collection of steel mills in such countries as Kazakhstan, Trinidad, and Mexico. In 2002, Mittal survived the disclosure that British Prime Minister Tony Blair had intervened to help him purchase Romania’s Sidex Works shortly after the mogul had made a $235,000 donation to Blair’s Labor Party.

Since then, Mittal and his son Aditya – who works intimately with his father – have cultivated ties to politicians in the U.S. Father and son were photographed with our 41st and 42nd presidents after contributing to a Tsunami-victims fund. Last year, Mittal jetted Bill Clinton and New York Senator Hillary Clinton to a celebrity wedding in India in his private Gulfstream plane.

So what’s the secret to the success of Mr. Mittal, whose steel holdings have multiplied 252 times over the last 18 years? Forget about Internet innovation or creative-class convergence.  Mittal makes his money the old-fashioned way, accumulating strategic control over the same commodity that forged the fortunes of Schwab and Carnegie. Mittal is a serial acquirer, whose specialty has been scooping up distressed steel properties in remote corners of the world and making them profitable through tough management practices.

Most of his conquests through 2004 involved purchasing state-owned mills in countries such as Mexico and Kazakhstan whose governments had shed their Socialist ways and were being running by privatizers, or, in the case of many ex-Soviet states, former Communist bosses posing as privatizers.

In the U.S., however, Mittal’s dominance came about not through a deal with government apparatchiks, but from a deal with a smart and well-regarded ex-Rothschild banker nicknamed the “king of bankruptcy.” Between 2002 and 2004, Wilbur Louis Ross bought in bankruptcy court five independent steel companies – LTV, Acme, Bethlehem Steel, Weirton, and Georgetown Steel. By far the largest of this group was Beth Steel. After shedding retiree and widow’s health benefits and letting the government-run Pension Benefit Guaranty Corp. take over the companies’ underfunded pension funds, Ross combined these companies into the nation’s largest steelmaker, International Steel Group or ISG.

Ross won the applause of the business press in post-9/11 America by announcing that he was a patriotic businessman seeking to “save” a troubled industry and keep steelmaking in America. How fascinating it therefore was to see our patriotic banker turn around and announce the sale of five former independent steel companies to Lakshmi Mittal in a $4.5 billion deal in October 2004. The man who said he wouldn’t flip U.S. mills flipped them.

Ross’ motivation to pack up his bags was apparent – he pocketed $267 million from the sale of ISG. And the reason why Mittal purchased the plants followed his tried-and-true business model of owning the majority of steel mills within any given country.  Bearing in mind that Mittal-owned Ispat Steel already owned Chicago-based Inland Steel, his acquisition of ISG has had enormous economic ramifications.

The acquisitions moved nearly 25 million tons of capacity from independent operation into a single combination. Mittal Steel currently owns six major steel mills, nine finishing mills, and fully 40 percent of U.S. flat-rolled steel capacity.

A year ago, members of Congress complained loudly about the sale of U.S. port facilities to the Middle East’s Dubai Ports, citing post-9/11 security. How ironic that these same statesmen did not raise national security alarms when our steelmaking capacity was sold to a little-known London businessman. Mittal’s takeover of ISG raced through the Bush Administration’s Committee on Foreign Investments in the U.S. as well as the antitrust division of the Department of Justice.

Washington was asleep at the switch.

Now in the wake of Mittal’s takeover of Arcelor, DOJ wants Mittal to divest of either Sparrows Point or Weirton, saying that the company otherwise will have too much pricing power in the domestic tinplate market. Since Mittal already owns four of the five integrated mills on the Great Lakes, such divestment – while welcome – is like closing the barn door after most of the animals have escaped.

And how has the London industrialist treated the mills that he purchased from Mr. Ross? “Squeezing more toothpaste out of the tube” is how I have characterized the Mittal way. For example, after paying $4.5 billion to Ross and associates and simultaneously paying himself a $2-billion dividend to form Mittal Steel, Mittal has kept capital expenditures at the mills to a bare minimum.

In 2005, the Mittal board of directors took away $40 million in capex previously planned by ISG. Overall, Mittal Steel USA spent no more than $385 million for capex in 2005. This compares to $475 million capex, or 23 percent more spending, by U.S. Steel, a smaller integrated steelmaker, in 2005.

Other key findings are described in detail on my website. But to summarize: There is little long-term planning. Sophisticated rolling equipment is operated to achieve short-term profit targets with little provision for adequate maintenance or renewal.

A cult-like conformity characterizes the corporate culture, especially at the upper ranks. Any mill manager who pushes for more resources than allotted from London is no longer – and I quote – “an effective manager.”

Last summer, Sparrows Point’s single remaining blast furnace (once there were 11) stopped running when the furnace froze. No hot metal was produced for many weeks. Eight months earlier, in November 2005, Mittal permanently closed the blast furnace and steelmaking operations at the Weirton plant, permanently eliminating 800 jobs and 3 million tons of annual steel capacity.

Since the Mittal takeover, management has been a merry-go-round. Rodney Mott, the respected CEO of ISG and CEO-designate of Mittal USA, resigned one day before the merger. Mott was replaced by Louis Schorsch, a Mittal loyalist from Inland Steel, who in turn was kicked upstairs and replaced by Mike Rippey. Most senior ISG executives left immediately after the merger. And the exodus continues with the resignation or retirement of many department managers.

But if there has been turmoil within the ranks, there has also been the steady, determined vision of Mr. Mittal. “I want to be the Ford of steel,” he proclaimed to the London Sunday Times, which means not just being the emperor of world steel, but siring a dynastic line. This kind of imperial longing fits in with the most expensive house in London and a wedding staged in the palace of Louis XIV, known as Le Roi Soleil, or The Sun King.

What satisfied Mittal just four years ago – ownership of 20 million tons of raw steel capacity – jumped to 70 million with the acquisition of ISG. Now with Arcelor inside his corporate kingdom, Mittal says he will only settle for 200 or 300 million tons, arguing that the steel industry remains globally fragmented and can achieve lasting prosperity only through consolidation into two or three worldwide companies – led by Mittal and his children and, I suppose, the children of their children.

For those in the audience who do not seek to be steel deities – who wish to grow their steel-fabricating business steadily and serve their customers and employees well – what we’ve seen from two years of the “Mittal effect” is worrisome. Currently, people like you are squeezed between high prices and surcharges for tightly controlled domestic steel production and “dumped” finished steel goods from overseas.

I would like to cite two recent examples of the production/pricing squeeze:

First, regarding production. As the price of HRC (hot-rolled coil) dropped in the last quarter of 2006, an interesting thing happened at Mittal’s Sparrows Point mill. Typically, the mill runs 21 eight-hour turns per week. But early last November, as HRC prices dropped to $500 per ton, Mittal Steel reduced to 18 the number of turns for the final six weeks of 2006.

In other words, 108 of 126 turns were eliminated, which is an 85 percent reduction in potential production. Or stated differently, Mittal was using only 15 percent of HRC capacity at Sparrows Point in late November-December 2006.

But a few weeks later, in January 2007, as HRC prices swung back up toward the $550 range, the company was scheduling as many as 15 weekly turns, or up to 70 percent of capacity.

I don't know the answers, but I know that these are questions that a vigorous DOJ anti-trust department should be looking at, if only because a very similar pattern took place in the summer and fall of 2005 when steel prices dropped steeply from record highs earlier in the year. Production was throttled back by Mittal at the Cleveland and Indiana Harbor works – and, as noted, iron- and steelmaking were permanently shut at Weirton. Excess inventory was thereby “worked off” from steel supply centers, and HRC prices began rising, from a low of $400 per ton in the fourth quarter of 2005 to $600 a ton last spring.

On the other end of the spectrum, I’d like to quote from a letter I received recently from a company dependent on domestic steel. It might strike a chord among many of you in the audience:

I am a principal in a manufacturing company that uses cold-rolled steel to fabricate drawer slides for kitchen and bathroom cabinets. The rising costs of steel have taken every penny of profit from our company, while imports (primarily from China) continue to be sold at less that what we are paying for steel. The price we pay for cold rolled has increased from $24 CWT [price per 100 weight] in 2001 to over $44 CWT last year. We are currently paying $36-$38 CWT and obviously the steel companies are not satisfied and want the price back up in the $40-$44 CWT range.

Recently, it was reported that blast furnaces were being idled in Northern Indiana due to lack of demand for steel. This is totally untrue, the mills are being idled to reduce supply so prices will remain high. We are having a problem finding enough steel for our business, unless we want to pay $44 CWT.

Small companies like ours that use steel as a primary raw material are struggling to survive, while Ross and Mittal make millions off the monopoly that has been created. Since we cannot increase the price of our product (the imports dictate our selling price), we have been forced to cut costs, reduce employee benefits, reduce salaried positions, and, unfortunately, eliminate capital investments.

Protectionism or fear of foreign ownership – that’s not the issue being raised here. The issue is about guaranteeing a minimum level of investment and a reasonable level of competition in domestic steel to ensure that our – America’s – industrial infrastructure is kept strong.
It is also about fairness to customers and employees in times of rapid change, and about the obligation of globe-trotting businessmen to return value to the local communities whose good will and hard work they depend on.

Mr. And Mrs. Steel Fabricator: The trend-lines are clear, and, unfortunately, there is no JFK around asking pointed questions to a tiny handful of executives. You’re going to have to do political lobbying yourselves – and, perhaps, some legal kickboxing – to assert your legitimate claims, if you want to keep America’s “small and medium-size manufacturer from extinction.” 

Thanks for listening.