Steel prices spell trouble for Gulf construction

It's as simple as the law of supply and demand. The current construction boom in the Gulf has led to greatly increased demand for materials - especially steel and cement - and that, in turn, has caused prices to skyrocket.

Between November 2003 and April 2004, for instance, UAE steel prices doubled to nearly $540 per ton; during the same period, prices for cement rose by 50 per cent. That's obviously good news for producers, at least for the immediate future, but rising prices could spell disaster for regional construction firms.

The steel industry, in particular, must now strike a fine balance between short-term profitability and long-term sustainability. Global and regional demand has risen to such an extent that steel shortages are now delaying construction projects.

According to MEPS, a consultancy operating in the steel sector worldwide, a severe steel shortage has compelled Middle East manufacturers and marine construction companies to reschedule project delivery. In addition, steel mills may show a preference for Chinese and US clients at the expense of the Middle East and other smaller markets.

The squeeze on steel supplies is likely to be maintained for some years, given major pipeline construction activity throughout the world. According to MEPS, proposed pipeline projects alone may consume up to half of available steel worldwide.

The oil pipeline that runs from the Caspian Sea to the oil port of Novorossiisk in northern Russia is made with 1.6-meter diameter steel pipe and runs for 1,500 kilometers. That project alone will have a marked impact on prices.

'The Middle East is home to one of the most vibrant and fastest growing steel industries in the world,' according to Metal Bulletin Research. At 12.9 million tons in 2003, steel production in the Middle East is modest for an emerging market, but enjoying healthy growth. The region's steel output is up 10.5 per cent for the year to date, and production of 14.5 million tons is forecast to year-end.

While many countries in the region produce steel, the major players are Iran, Saudi Arabia, Turkey and Egypt. 'Iran and Saudi Arabia are particularly large, each producing both long and flat products,' says Brian Levich, senior steel analyst at Metal Bulletin Research.

There are many small steel manufacturers in the region, but the main players are Hadeed in Saudi Arabia, Qasco in Qatar, NISCO in Iran and Al Ezz Steel in Egypt. Qasco and Hadeed are among the producers planning to expand. Levich says the region has some good steel mills, including Al Ezz Steel. He credits the company's relationship with its customers and the calibre of its clients.

The latest addition to Al Ezz Steel is Al Ezz Flat Steel, a state-of-the-art hot strip mini-mill with a 1.2 million ton per year capacity of hot rolled coils. A mini-mill is a steel production facility that feeds recycled steel into an electric arc furnace to reprocess the material into finished steel for new applications. Hot rolled coils are particularly sought after in automotive applications.

Italian steel technology supplier Danieli built the plant, and retains a stake in the business. This is a rare example, however; foreign investment in the region's steel industry is minimal. Any foreign investment in Middle East steel is usually on a joint-venture basis. 'Some steel shareholdings are still with the government, so the notion of majority foreign investor remains politically awkward,' says Levich.

One notable exception is Ispat Algeria, which is a foreign- owned steel mill. Karel Costenoble of MEsteel.com, a regional B2B steel portal, adds that in Turkey, major players like Arcelor are investing in joint ventures, but in the Gulf there are no foreign investors in the steel makers.

The Middle East region is a cost-competitive producer of steel. Levich attributes this primarily to low gas prices. However, the region is not immune to other variables. Steel producers have to import raw materials to produce the steel, which includes iron ore, direct reduced iron (DRI) and ferrous scrap. DRI is processed iron ore that is iron-rich enough to be used as a scrap substitute in electric furnace steelmaking.

'The Middle East industry is not completely isolated from events in the international market,' says Levich, who points out that raw material costs have increased due to strong demand. There is room for performance gains, though.

'There should be more investment in some companies; some do not produce as much steel as they should,' says Levich. However, this investment should come from the private sector, he says.

Quantity and cost are not the only issues. Steel is not a single commodity: there are currently more than 3,500 different grades of steel with many different properties - physical, chemical and environmental. According to the International Iron and Steel Institute, 75 per cent of these have only been developed in the last 20 years.

'The driver of quality increases is the consumer, who is happy to have average steel, as most goes to the construction market,' says Levich. In the medium to long term, however, it is risky to rely on basic steel products for construction alone. The demand climate at the moment provides the region's producers with a generous window during which they can improve quality and develop more valued-added products.

Added value. Karel Costenoble of MEsteel.com says steel mills in the region already produce a good variety of products, and are investing where needed, in value-added products. But he says that there is a limit to the possibilities with highly specialized steel products because local consumption is insufficient to support regional players.

Not surprisingly, there is a high degree of state involvement in the region's steel industry. For instance, most of Iran's industry is in government hands; Hadeed is part of Sabic, again government-related; and part of the Egyptian and Pakistani steel industry is state-owned, says Costenoble.

'Prices are driven by worldwide supply and demand,' he says. 'A limited duty protection - for example, five per cent in the Gulf - should offer enough protection. Higher duties will overprotect the local industry and kill competitiveness in the long term.' Industry alliances could enable players to benefit from synergies, he adds.

For regional construction firms, mergers may also soon prove necessary. Small firms in smaller Gulf markets - such as Oman - are already facing a serious cash crunch and may have to choose between selling out or going bust.

Today, any slowdown in government spending on new projects will drive these companies right out of business. For the regional steel industry, that could prove disastrous: construction would slow, competitiveness decrease, and both demand and prices drop. It's a delicate balance, and one that may not hold for long.