Big steel on the ropes

Consolidation looms for a troubled industry

By Lincoln Brunner

June 18, 2001

Integrated steel mills in the U.S. are feeling the heat of foreign competition, pricing problems, and bankruptcies. How long will it be before consolidations start narrowing the field?

The story of the U.S. steel industry as of late reads a lot like the book of Job, whose misfortunes at the hands of the devil made his name synonymous with pain and suffering.

Indeed, Chapter 11 might be an appropriate place to start reading, because that's where many of Big Steel's main characters-notably, LTV Corp. and Republic Technologies—are anyway.

Four steelmakers-Trico, CSC, Gulf States, and Qualitech-representing 3,800 workers have announced plans to cease operations or have gone out of business entirely since 1999. The rest of the companies on the industry's list of recent bankruptcies continue to operate but face what many call the worst uphill battle for the industry in decades.

Opinions on how the industry got into its current morass differ as widely as I beams and BMWs. Mismanagement, the negative sting of the strong U.S. dollar on sales, foreign steel dumping and resulting price drops, worldwide overcapacity, and monstrous retiree benefit costs all have been blamed, at least in part, for the crisis.

So what's the fix?

President George W. Bush recently directed U.S. Trade Representative Robert Zoellick to request the International Trade Commission (ITC) to investigate possible serious injury to domestic steelmakers from foreign imports under Section 201 of the Trade Act of 1974.

Though any action on that initiative is months away, applause for the move has sounded from several steelmakers and the United Steelworkers of America (USWA). The president's directive coincides with the Steel Revitalization Act of 2001 (H.R. 808), which is intended to pull the industry out of the mire with, among other measures, quotas on steel imports and a surcharge earmarked for a steelworker retiree benefit fund. The measure this week gained its 219th co-sponsor, giving it a majority of House votes.

Steel Revitalization Act: Saving Grace or Big Mistake?

To counter what they view as unfair foreign competition on American soil and the steel industry's sinking fortunes, federal lawmakers-led by Rep. Pete Visclosky, D-Ind.—have proposed H.R. 808.

The act offers four remedies for what ails the steel mills that touch on the main issues facing the industry right now:

1. Limit imported steel of all kinds to the average level of market penetration that occurred in the three years prior to late 1997.
2. Create a program, funded by a 1.5 percent surcharge on steel sold in the U.S., that is meant to guarantee continued health coverage for steel mill retirees and their families.
3. Modify the existing loan guarantee program, whereby the federal government would guarantee 95 percent of the loans from private institutions to steel mills rather than the current 85 percent.
4. Provide financing for domestic steel producers that want to consolidate. Visclosky said the point of this measure is not to reduce capacity, but to assist those companies that want to join together and feel they would be more viable as a larger firm.

While H.R. 808 has drawn huge support from the integrated mills and their workers, it doesn't sit well with industry professionals who believe government support of the steel industry can't end soon enough.

"It falls into the category of doing the same thing and expecting a different result," says David Phelps, president of the American Institute for International Steel, a trade group that supports importers and exporters of steel. "H.R. 808, without debating the individual portions of the bill, simply will not solve the problems of the steel industry. It will merely pass them on to the customer. Fabricators are being asked to pick up the tab for plate producers and beam producers. From a policy perspective, it's plain stupidity."

USWA spokesman John Duray, a union veteran with deep family history in the steel and coal industries, says he has yet to see any verifiable facts that back up talk, such as Phelps' comments, about the fabrication industry "taking it in the shorts" from a possible surcharge.

"All of this is done in esoteric computer programs that no one can verify," Duray says.

If people are concerned about surcharges, they ought to compare what a ton of hot-rolled steel would cost with a health care fund surcharge to what prices were in July 1997, Duray says. Based on the average April 2001 price ($230) quoted by the USWA, a 1.5 percent surcharge would add $3.45 to the price of a ton of hot-rolled carbon steel. That same ton of steel cost $350 four years ago.

Phelps says the federal government should proffer some sort of legacy cost assistance to the industry rather than having the burden default to the Pension Benefit Guaranty Corp., a federal agency funded by insurance premiums paid by sponsors of defined benefits plans, assets from pension plans trusteed by the agency, and other nontax sources. The difference would be that Uncle Sam could offer its assistance with a stipulation that companies close inefficient mills. Done the other way, taxpayers still foot the bill, but with no action to close poorly producing mills, Phelps says.

Veteran industry analyst Charles Bradford says he would rather not see the U.S. government decide who survives in the steel game, because Uncle Sam would invariably choose to save mills that employ a lot of people but operate inefficiently.

"I don't want government to decide who would close or merge," Bradford says. "If they would make those decisions, they would do it wrong.

"It's a very, very major mistake to have government decide who's going to be the winners or losers. Since 1969, the government has constantly help the industry in return for promises that they'll be more efficient and consolidate, and it's never happened."

Imports. Imports of steel into the U.S. have decreased from the level they were at three years ago, according to the U.S. Census Bureau. Preliminary figures for March show that the U.S. received 2,311,065 tons of imported steel across the product spectrum. This is down from the 2,435,473 tons of imports that entered the U.S. market in March 1998.

Weirton Steel President and CEO John Walker said in a recent release that recent import figures are not the issue, but rather the collapsing price cycle that imports have created.

"Illegally priced imports have forced prices downward," Walker says. "Prices are so low that many foreign producers are no longer finding our markets attractive. In addition, the demand for steel is slow, which inflates the problem. However, when demand increases and prices rise, foreign producers will return to our markets with their cutthroat pricing, keeping the cycle alive."

Walker's medicine: a 201 investigation, which Bush has preliminarily set in motion, along with negotiations with overseas trading partners over inefficient capacity.

However, import figures don't help the industry in its case against imports, unless somehow it can persuade the government to use numbers from 1995 to 1997 instead of the latest totals in its Section 201 investigation, Bradford says.

In addition, if Congress sets up import quotas, the industry has trouble, Bradford says. Why? Because setting quotas affects volume, but not one of the real problems, which has been contract prices with big customers such as automakers, Bradford says.

"Import quotas have zero impact [on auto companies]," Bradford says. "It's meaningless to car prices."

Another conundrum for steel that relates to imports and prices is the strong U.S. dollar, which feeds the import problem by making imports cheaper. However, a strong dollar also is a cornerstone of U.S. economic policy and is not likely to be abandoned as such anytime soon.

"This is a chronic problem," Bradford says. "A strong dollar is extraordinarily important to the U.S. economy as a whole, but it's bad for basic industry. I don't know how you solve the major underlying problem."

One way, according to the USWA and Visclosky, would be to give the integrated mills help with their so-called legacy costs.

Legacy Costs. Integrated mills carry about $13 billion of retiree health benefit obligations, according to the USWA. H.R. 808 would spread those costs out across the industry by creating a pool of money funded by a surcharge on all steel sold in the U.S.

While he supports what President Bush is doing on behalf of steel, he and 80 percent of the industry are against setting up a fund for legacy costs, Nucor Steel President Dan DiMicco says.

"It's a business management decision," says DiMicco, whose company employs nonunion workers. "If their costs are out of control because of that, the U.S. taxpayer should not be asked to bail them out of that. They should compete with the rest of the industry without having any benefit of the U.S. taxpayer on those items."

Duray submits that the problem of legacy costs is unique to U.S. steelmakers, mainly because foreign competitors enjoy some sort of socialized medicine. Spreading the costs over the industry would put domestic steel producers on a more level playing field, he says.

A surcharge could help with some of the industry's liquidity problems. That is, if the market would accept such a surcharge, which it won't, Bradford says.

"They think the customer will pay, but in reality, the mill will pay," Bradford says. The situation is very tricky, because even if mills could jettison pension liability, the USWA still would demand that pensioners' health care coverage remain intact, and outside of nationalized health care-which won't see the light of day anytime soon-he doesn't see a quick solution to the health care liability issue, Bradford says.

"That's one of the big factors inhibiting consolidation," Bradford adds.

Loan Guarantees. Capital investment has become so difficult for steel companies to find that the federal government must step in to attract capital by bumping up guarantees on loans from private institutions from the current 85 percent to 95 percent, the USWA says.

It's hard to argue, based on many companies' numbers. A recent snapshot of current Big Steel stock prices reveals National Steel trading at $2.11, near its 52-week low of $1.12. Olympic Steel is trading at $3.57 a share after hitting a 52-week low of $1.62. Bethlehem Steel, which has traded as low as $1.62 a share in the past year, is trading at around $3.42. Those companies had 52-week highs of $5.06, $4.58, and $4.75, respectively.

Other companies such as USX-U.S. Steel and AK Steel have fared better, with both trading well above their respective 52-week lows of $12.68 and $7.50 a share but below highs of $22 and $15, respectively.

The USWA calls for a $10 billion loan guarantee program with 15-year guarantees on loans.

"Wall Street has abandoned the steel industry and even with import restraints the industry cannot raise the money it needs at reasonable cost," the union says in a recently produced presentation. "Therefore, we need a $10 billion loan fund, with the money used to revitalize the industry. The existing steel loan guarantee program is a good idea with problems that, in practice, made it close to useless."

As one of the parties urging that not another dime go to the industry, Phelps says the industry is the product of 30 years of government coddling and that the industry must be turned over to the forces of a capitalist economy.

"Protectionism is an addiction the industry has fallen prey to," Phelps said. "They expect government to bail them out whenever the market turns. For lack of a better term, it's corporate welfare."

Of course, there's always consolidation.

Consolidation: Easier Said Than Done. On paper, the logical step for companies carrying out-of-control costs in a poor market is to consolidate, reduce costs, close unprofitable facilities, and create a world-class company that is competitive in both foreign and domestic markets, right?

Guess again, Pollyanna. Union resistance to the inevitable labor consequences of consolidation, fear of big-customer retaliation, and big players' skepticism of each other all are likely to stymie wide-scale consolidation, according to some industry watchers. On the other hand, the need for consolidation has gained a lot of voice.

"It's inevitable because it's a necessity," said Nucor's DiMicco. "We're dealing with a global market."

Indeed, some moves to consolidate domestically already have been made. Republic merged with USS/Kobe Steel Co. in 1999, and integrated mill stalwart Bethlehem Steel joined with plate producer Lukens, Inc., in 1998. Though they hale from opposite sides of the industry, none other than Bethlehem's current chief is echoing DiMicco's call for synergy.

"If the North American steel industry is to survive by becoming truly competitive on an international basis, then consolidation should and must occur," Bethlehem Chairman Duane R. Dunham said in a recent release. "It won't be an easy road to travel, but we have to reinvent ourselves if we want to survive."

Indeed, paring the field to just a few giant players might be impossible, according to Bradford. For one, Bradford points out, steel mills want nothing to do with the health care and pension liabilities of potential merger partners.

"They are saying, 'We don't want to jeopardize ourselves,'" Bradford says. In addition, the USWA will demand that health benefits remain intact through any merger, he notes.

Second, mills are afraid that their major customers-notably, the major automakers might retaliate, perhpas by buying their steel elsewhere.

"The auto companies really like the idea of a fractured supplier base," because it keeps their prices down, Bradford says. However, he thinks that's a short-sided and incorrect outlook.

"It makes no sense to me for two or three auto companies to be buying steel from nine companies," Bradford says. "If you had three or four steel companies negotiating with three auto companies, you'd have much more balanced negotiations. I recognize full well that's easier said than done."

Phelps weighed in with his endorsement of domestic consolidation, based mainly on following the lead of foreign competitors such as French steelmaker Usinor, which is looking to complete a merger with Spain's Aceralia and Luxembourg's Arbed that would create an industry behemoth with 46 million metric tons of annual production capacity. The three companies hope to complete the deal by this autumn.

"It has to happen," Phelps says. "Around the world, consolidations are going at a tremendous pace. European companies are in their second wave of mergers. The U.S. has yet to begin its first. From an economic perspective, it's either merge or disappear."

Mergers and Jobs

The USWA is not the stalwart opponent of mergers that some people may believe it is.

"We have been in favor of consolidation; that really is not a question," Duray says. "The question would be the effects of consolidation on jobs and domestic steelmaking capacity. We're obviously in favor of the preservation and expansion of both. It would depend on which companies consolidated and how their facilities complement each other."

While many believe that the U.S. has too much capacity, Duray and the USWA assert that the U.S. has only 94 percent of the capacity it needs to fill domestic demand. The issue that pops up in many discussions over mergers and possible closures is inefficient capacity, for which Duray contends there is no clear-cut definition.

"If you look at productivity and efficiency of mills across the spectrum, across the world, American mills are the most productive," Duray says, quoting an average U.S. 1999 productivity rate of 2.61 labor-hours per ton. "We're overly downsized compared with most steel industries in the world. In that sense, there's really no excess capacity in the United States."

Though American steel mills increased their efficiency 174 percent between 1980 and 1999, according to the USWA, it still hasn't been enough to make the industry competitive worldwide, which is a sad thing, Bradford says.

According to Visclosky, more consolidation should happen, but not if it means a ton of job cuts—Visclosky's district in northwest Indiana produces more steel than any other state in the country, he says.

"Under a best-case scenario, in five years we'll see fewer companies in the domestic market," Visclosky says.

However, reducing the number of companies in the market does not mean necessarily a cut in jobs or capacity, according to Visclosky.

"I draw a very clear line of distinction between consolidation and reduction in capacity," Visclosky says. "Consolidation, from my perspective, is the joining of financial institutions and companies to be able to produce tonnage in a more efficient fashion."

"I don't think anyone is under the illusion that it will not mean a reduction of jobs," Visclosky says. The question then is how best to secure the jobs that remain.

A total of 18 U.S. steel companies, most notable LTV Corp., have filed for bankruptcy since December 1997. LTV, which intended to close its 900-employee Cleveland West facility, has put that move on hold. The steelmaking giant employs 18,000 people and filed for Ch. 11 protection in December.

The rest of the list, including filing dates and number of employees:

1. Republic Technologies (April, 4,600 employees)
2. Trico Steel (March, 320 employees)
3. GS Industries, Inc. (February, 1,750 employees)
4. Heartland Steel (January, 175 employees)
5. CSC, Ltd. (January, 1,225 employees, has since ceased operations)
6. Erie Forge & Steel (December, 300 employees)
7. Northwestern Steel & Wire (December, 1,600 employees)
8. Wheeling-Pitt (November, 4,800 employees)
9. Vision Metals, Inc. (November, 610 employees)
10. J&L Structural Steel, Inc. (June 2000, 275 employees)
11. Gulf States Steel (July 1999, 1,900 employees, has since ceased operations)
12. Qualitech Steel SBQ LLC (March 1999, 350 employees, ceased operations in January)
13. Worldclass Processing, Inc. (March 1999, 80 employees, since has emerged from bankruptcy)
14. Geneva Steel Co. (February 1999. 2,600 employees, since has emerged from bankruptcy)
15. Laclede Steel Co. (November 1998, 1,475 employees, since has emerged from bankruptcy)
16. Acme Metals (September 1998, 1,700 employees)
17. Al Tech Specialty Steel Corp. (December 1997, 790 employees, since has emerged from bankruptcy as Empire Specialty Steel, Inc.)

List courtesy of the United Steel Workers of America