Scarcity and Saturation No8 2013

Scarcity and Saturation
Steel and the challenges of volatile raw

materials, flat margins, and overcapacities
McKinsey on Metals & Mining Number 08 Spring 2013

Mining in Africa Untapped Potential 1
Welcome ...
... to the eighth issue of McKinsey on Metals and Mining. This issue focuses entirely
on the steel industry. Its recent past is prologue. As in the last five years, the next five
will see uncertainties continuing to affect the steel value chain at all stages and for all
commodities. While steel demand has been growing globally, regional overcapacities
persist and further challenges have arisen: raw materials prices have increased and
been extremely volatile, and value-creation potential has shifted dramatically. Some
parts of the value chain have lost potential, while others mining, in particular have
made outstanding gains. For many companies, these changes have generated pressing
questions without easy answers.
As it is useful to reflect on the whole as well as the parts, we share our perspective
along the main steps of the steel value chain, starting with the raw material dynamics,
including the impact of recycling on current and future resources. Next, we turn the
spotlight on six major steel-producing countries or regions. Their largely divergent
demand profiles are splitting the steel landscape into a multispeed world. In this world,
successfully navigating the intersections between regional and global trade flows will
require greater foresight and agility than in the boom years that began a decade ago.
We then move downstream to outline some of the new opportunities and requirements
from end-customer perspectives, e.g., light-weighting in the automotive industry.
To conclude, we highlight the importance of preparing to be surprised, with an overview
of the implications of macroeconomic scenarios and their potential relevance for
industry players.
Our perspective is based on proprietary research by McKinsey & Company and is

intended to be a thought and conversation starter. We hope that our focus on steel will
also spark ideas for companies in other parts of the metals and mining sector, and we
would be happy to tailor a discussion to individual company requirements. Please feel
free to contact us or our local colleagues.
Benedikt Zeumer Frank Bekaert

Principal and leader of global knowledge Director and leader of
development for Metals & Mining, the Steel service line,
Dsseldorf Luxembourg
2 McKinsey on Metals & Mining Number 6
Executive summary
The steel industry has experienced considerable volatility and change in the last decade;
mining has become highly attractive following a long period of constrained supply, while
steel production has become less attractive, despite substantial underlying growth in
steel demand.
The steel value chain can be said to be slivering breaking into slices, each with
distinct characteristics. At the upstream end, the economics support the continued
attractiveness of mining. While supply levels are improving, factors such as increasing
mining cost and the geological challenges of reaching further ore bodies will contribute
to volatility. In the decade ahead, the industry can expect reduced scarcity in iron ore,
where these factors are unlikely to be so severe as to trigger the supply constraints
initially feared when the era of long-term contracts came to an abrupt end in 2009/2010.
In contrast, coking coal shows many signs of sustained tightness, especially over the next
3 to 5 years.
Steel production will continue to be challenged in many regions as overcapacities persist

and trade flows increase. Furthermore, global demand patterns are changing. Overall,
we see three regions to monitor: the mature world, which is likely to see low or no growth
in steel demand; China, which will see demand grow, albeit at a reduced rate, and whose
sheer size will shape the global demand and supply balance; and developing or emerging
economies like Brazil, India, and Russia, which are expected to define the industrys
future growth, but each of which is facing individual challenges for the local steel
industry. Moving downstream, greater demand for lightweight and resilient materials
and investment goods such as machine tools will change the patterns of steel use. In this
context, there is no common rule on how different countries will develop: steel producers
will need to adapt to a multispeed world.
For companies seeking a path to sustainable value creation, there is no one solution
rather, there are sets of considerations to weigh up, individually for every player in the
value chain, from mining companies to steel producers to customers. The industry will
have to cope with the complexities of the new world of steel: iron ore might have seen its
profitability peak; while persisting tightness in the coking coal market may sustain profit
levels into the medium term. Steel will have to contend with oversupply, distributed
unevenly across different regions; customers will try to leverage a wider range of supply
options; and financial markets will remain wary of funding rescue or recovery missions
for challenged companies.
Each player will need to tailor an agenda for moving ahead, including growth across new
markets and products, fresh focus on operational excellence, and potentially a round of
heavy consolidation. Saturation has slowed the industrys responsiveness new agility is
needed now.
Scarcity and Saturation

Steel and the challenges
of volatile raw materials, flat
margins, and overcapacities
The glory days of the steel boom before the 2008/2009 crisis are over, but what is the legacy? Are steel
producers, even in China, just taking a moment to catch their breath, or is the industry once again
on the brink of restructuring? Critics would say its high time to pay for the decisions made in the
second half of the past decade. Meanwhile, industry fundamentals have changed again and are not
yet reflected in companies business plans. Raw materials scarcity looks less troublesome than only
a few years ago and could soon be a thing of the past. The next step up for most steel companies will
be to increase productivity and the resource and energy efficiency of existing assets through better
processes and, beyond that, to invest selectively in advanced production assets and technologies.
This market environment raises fundamental questions for steel producers about how to keep assets
competitive, align capacities to demand, and manage raw materials. They must be prepared for three
broad trends that will define the competitive landscape over the coming decade:
The value shift upstream. The price of the raw materials basket for steel has moved to a
structurally higher level over the last decade combined with a higher rate of volatility. Raw
materials tightness may diminish, but cost curves are now much steeper, supporting the higher
price level and also increased volatility which means that the majority of the value has been and
will continue to be created upstream in the mines.
The multispeed world. Steel demand globally Analyses suggest several levers that steel
will continue to grow, and emerging regions producers can pull to achieve sustainable
will continue to define the global growth path value creation in this challenging new world.
for the industry. Some formerly lower-cost These include revisiting strategies for market
regions are seeing their competitiveness supply or sourcing, stepping up operations
erode. Brazil is a case in point: once effectiveness and technological innovation,
considered the future supply base for slabs, particularly for energy efficiency, and investing
its steel industry is now exposed to high rates in product innovation. However, some of the
of cost inflation and currency exchange that challenges cannot be resolved at the company
have hurt its competitiveness. level: in certain regions, the entire industry
landscape needs to change because demand is
The changing face of the customer. The smaller than the industry capacity. These cases
power and sophistication of steel buyers is call for policymakers and industry to work out
growing. They increasingly seek the lowest reframing actions and paths to migrate the
price anywhere in the world, resulting in steel industry to a new structure that
structurally higher steel trade flows. In restores competitiveness.
parallel, some seek technically advanced
solutions, particularly in automotive, where
body and chassis weight could fall by up to
40% over the next 20 years, requiring steel
makers to provide high-strength products
or lose out to lightweight materials. As
emerging economies like China move
from urbanization and building up their
infrastructure to becoming more affluent
societies that need more developed materials
and steel grades, the product mix can be
expected to shift accordingly to more
value added.
The raw materials

challenge continues
With high prices and
increased volatility, miners
hold the strongest hand
The outlook on raw materials will be tough for steel producers over the decade ahead. While the
phase of extremely high prices may have passed, price levels have settled in at a higher level over the
past decade and will remain there, with an increased level of volatility (Exhibit 1). Steel cost curves
have been flattening while raw materials cost curves have been steepening, and this has driven a
sustained shift in profit pools towards the owners of raw materials. The steel makers likely to be the
most successful in this new era of rising input prices are those that take a more integrated approach to
understanding how iron, coal, and scrap affect their margins, produce opportunities for innovation
and growth, and create new challenges for how they manage risk.
While structural scarcity was acute some years back, iron ore supply is now highly dependent on
whether new assets planned will really come on line and whether imports into China will continue
to increase at recent rates. Premium metallurgical coal is shorter than steel producers would hope
and it is as yet unclear whether this tightness will persist beyond the medium term. It will be highly
dependent on how long greenfield pricing can be sustained and on the ability to successfully develop
deposits in frontier countries, e.g., Mongolia, Indonesia, and Mozambique. Scrap is increasingly
available and popular and might be thought of as the "domestic mine" in developed markets and,
increasingly, in emerging markets, too.
It does not take much for iron ore to flip

from scarcity to surplus supply
These supply trends will create disruptions alone could be as large as the total demand
that have the potential to be real game- in Europe. Growth will continue in the other
changers for steel producers, especially in emerging markets, but not sufficiently fast to
combination with changes in energy prices compensate for any sudden drop in
shale gas is making energy significantly Chinese demand.
cheaper in the US, while the rest of the world
would be less affected. Below we consider, in turn, the outlook for iron
ore, metallurgical coal, and scrap.
China today represents about 60% of global
steel raw materials demand nearly double
its share a decade ago and has driven the raw Iron ore with prices high, supply will
materials cycle in the recent past. The global continue to expand
raw materials outlook will therefore largely
depend upon what is happening in China be In the short term, the iron ore industry faces
it tight markets or oversupply, price fly-ups or oversupply risks as projects are under way,
declines. While Chinese demand for steel and and despite some delays and cancellations,
steel raw materials is likely to grow overall, it is unlikely that the majority will be put on
the size of Chinese demand fluctuations hold. However, in the medium to long term,
Exhibit 1 Steel raw materials basket (iron ore, coke/met coal, scrap) in Western Europe
Input prices USD/metric tons, CIF Europe
have settled at
a higher level
600
500
400
300
200
100
0
January 2001 January 2006 December 2012
Source: McKinsey analysis

The raw materials challenge continues With high prices and increased volatility, miners hold the strongest hand 9
new investments (brown- and greenfield) will The recent roller-coaster development of
be needed in order to satisfy global iron ore iron ore prices indicates the instability of the
demand, also as a consequence of the depletion demand and supply ratio. It does not take
of existing mines. By 2020, about 800 million significant change in demand to flip from
metric tons (Mt) of new iron ore capacity scarcity to surplus supply (Exhibit 2). In 2012,
additions could be required to meet demand prices on the spot market fell constantly month
growth and depletion of existing mines. by month until September 2012. Prices stayed
at the floor level of USD 90 for 2 weeks, then
Even with these capacity additions, industry shot to USD 160 in December before falling
concentration will remain high on the back in mid-January 2013 to USD 140. The
seaborne market. The top three suppliers drop to USD 90 can be explained by a drop
will retain their strong positions despite the in Chinas steel production combined with
growth of new junior miners, especially as a destocking of iron ore, against a seaborne
result of international acquisitions by Chinese supply decrease resulting from the unusually
miners, and despite the vertical integration dry 2012 monsoon in India. Then on September
of major steel producers, which together 6, the Chinese government announced a RMB
account for around 25% of global iron 1 trillion stimulus that boosted steel demand
ore production. expectations and drove the price up.
Exhibit 2 Iron ore supply-demand balance Existing supply/capacities1 Base case demand
Recent iron ore price Million metric tons (rich ore equivalents) Capacity additions C1 and C2 Low case demand
changes indicate the High case demand
instability of the demand
and supply ratio
3,500
3,000
Potential
2,500 512 519 and likely
270
368 452 522 523 supply
levels
2,000
1,500
1,000
500
0
2005 06 07 08 09 2010 11 12 13 14 15 16 17 18 19 2020
1 2005-11 supply; 2012-20 capacities

Source: McKinsey Iron Ore Supply Model; McKinsey Steel Raw Materials Demand Model
Exhibit 3 Iron ore (seaborne) cost curve for 2002 and 2011 2011 cost curve 2002 cost curve
Todays iron ore cost FOB costs
curve steepness is a FOB cash cost
consequence of strong USD/ton1
cost inflation in mines 100
90
80
70
60
50
40
30
20
10
0 Volume
0 200 400 600 800 1,000 1,200 Million tons
1 Rich ore equivalent, real 2008 terms; seaborne operations shown at total production volume
Source: AME; McKinsey Flat Steel Cost Model; McKinsey Steel Demand Model; McKinsey Steel Raw Materials Demand Model
Exhibit 4 Profit pool distribution in the steel value chain 1 Trend line
Value creation in steel Percent
has shifted upstream
USD
billions 54 36 24 17 39 125 136 58 230 135 = 100%
8 12 12 12
21 17 18
11
12 13 39 42 Iron ore
18 10 46
18 22
24
Coking
81 32
28 coal
76 75 72
70 61 61
37 Steel
26 26 making
(HRC)
1995 97 99 2001 03 05 07 09 2011 2017e
1 Cumulated EBITDA from mill to hot rolled coil
Source: McKinsey Steel Model; McKinsey Mining Value Pools Model

Coking coal was a source of surprises in 2012

prices were significantly lower than expected
Since 2009, the surplus of iron ore mining clearly influence volatility in China is the
capacity has increased. As long as prices stay increasing monetization of iron ore through
high, it is likely that iron ore projects will derivatives/OTC contracts. An increasing share
continue to come on line. Significant capacities of volumes will flow through traders that are
have been or can be opened almost immediately disconnected from operational constraints (as
including overseas acquisitions by Chinese opposed to steel makers and miners).
or integrated steel producers to supply the
market. Thus, there is little reason to expect iron
ore to go short. Metallurgical coal clarifying the situation
still required
Chinas reliance upon the seaborne market
will increase. Domestic iron ore production Metallurgical coal was a source of surprises
is likely to decline by 2015 at the latest, driven in 2012 prices were significantly lower than
by depletion and closure of Chinas high-cost expected (Exhibit 5). Despite the widespread
mines. The rationale of the past that domestic belief that the market was short of coking coal,
mines carry cost advantages is likely to fade there was an excess supply.
as cost inflation takes its toll, making it very
probable that marginal mines will disappear Future demand for metallurgical coal will largely
from the scene. depend upon finished steel demand growth, scrap
availability, and the development of blast furnace
China has been the driving force in the market, operations including points in the focus of most
even beyond sheer supply/demand economics producers such as fuel rate reduction, greater use
as a case in point, the price set by CIF China of lower-quality coals, and increased pulverized
has established a new index and is also used carbon injection (PCI) as well as more flexible
for setting prices in Europe. Chinese steel operating practices. In the past decade, annual
demand, combined with shrinking domestic global demand for metallurgical coal doubled to
mine capacities, will continue to drive demand roughly 1,000 Mt in 2011 and is expected to reach
for seaborne iron ore. In parallel, however, the about 1,250 Mt by 2020, of which some 80% will
closure of Chinese mines will also affect the be coking coal. China, India, and Latin America
global cost curve. Taking out high-cost Chinese are expected to account for more than the
iron ore supply will prevent the global cost majority of the net growth in coking coal demand.
curve from getting much steeper as it did in
the past (Exhibit 3) despite significant cost By 2020, the available coking coal supply could
inflation of 6 to 8% p.a. on average for existing grow to 1,500 Mt, if all the projects in the pipeline
and new mines, as extraction depths increase were to come on line as announced. This would
and average metal content of the ore decreases. mean excess supply on the global coking coal
This will prevent a further shift of the value market and downward pressure on prices
chain profit pool toward iron ore arresting a and margins. However, from a mine-by-mine
trend that has been evident over the last decade. assessment of the likelihood that individual
(Exhibit 4). This is good news for steel makers projects will actually materialize, a supply of
as it suggests that iron ore prices will stay high 1,250 Mt for 2020 looks more realistic, with
but will not go through the roof, as some feared China, Australia, Russia/CIS, and North America
when the Chinese first broke away from the remaining the largest suppliers.
practice of long-term contracting for iron ore.
In 2010, demand for seaborne metallurgical coal
However, the steeper cost curve will continue jumped to 251 Mt, 211 Mt of which was coking
to contribute to high volatility, as will other coal as Chinese imports for coking coal soared
elements. For example, one factor that will to 50 Mt (from 7 Mt in 2008), but then stayed at
those levels in 2011 as China started shifting substantial ~ 10% to the demand balance and
its imports from seaborne Australian coking therefore likely to push the price up.
coal to Mongolian coking coal. Going forward,
seaborne coking coal demand, including China, Coking coal mining costs rose at a nominal rate
is expected to grow to 244 Mt by 2015, mainly of around 12% p.a. between 2002 and 2010,
driven by India and South America. a moderate increase compared with other
commodities such as iron ore or bauxite. Coking
Chinas impact on the seaborne market will coal mining costs are likely to continue increasing
depend on its ability to continue to increase its at this rate or even faster hence maintaining or
sourcing of coking coal from Mongolia and the even raising todays relatively low price floor for
quality of its domestic coking coal (currently coking coal. In the major mining regions, such as
50/50 hard coking coals/semi-soft coking Australia, cost inflation will remain high, keeping
coals). For example, over the next five years, coking coal in the spotlight.
Mongolian imports into China could grow to 70
Mt if rail infrastructure build-up allows cost- Globally, the shale gas boom in the US is
efficient delivery. But if Mongolia cannot meet having a significant impact on the coal business,
this demand from China, coking coal will have particularly in the US. Thermal coal is becoming
to come from the seaborne market, adding a less cost competitive with natural gas, leading to
Exhibit 5 Seaborne hard coking coal price development over time

Coking coal prices came USD/t FOB Australia1
down significantly in 330
2012, leaving them only 315
slightly above 90th 300
285
percentile cash cost level
235
225 225 225
209 210
200
170
125 129 90th

116 percentile
98 seaborne
cash cost
58
49 47
40 43
2000 01 02 03 04 05 06 07 08 2009 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2010 2011 2012
1 Annual benchmark contract prices are negotiated for the Japanese fiscal year (Apr - Apr)
Source: McCloskey; TEX report; press search; McKinsey Coking Coal Cost Model Q3/2012; McKinsey analysis
China is likely to become scrap self-

sufficient within the next decade
a significant drop in thermal coal demand and Scrap not yet tipping the market
declining prices. However, as a consequence,
the seaborne metallurgical coal market Rising raw materials prices are likely to make
emerged as an attractive alternative outlet for scrap increasingly attractive. However, on
US coal producers who have started exporting a global level, strong growth in the scrap
aggressively. They are selling cross-over semi- supply will be seen mainly after 2020 to a
soft grades of coking coal into the seaborne large degree driven by China (Exhibit 6). Only
market, where it acts as an additional swing then will return scrap levels be high enough
volume. They have also become the marginal to decrease the need for iron ore. While there
supplier given their high mining costs, is already equilibrium or even excess supply
significant inland freight charges, and quality in mature regions such as Europe, the US,
discounts. These swing capacities favor the and Japan, the change in supply in emerging
steel industry, as steel makers can order at regions, particularly China, will dramatically
almost a moments notice, thus reducing their shift the global scrap balance in the future.
risk of technical shortages. If the marginal
producers manage to stay in business, their China is likely to shift from being a net scrap
costs could provide an upper price shield for importer to self-sufficiency within the next
the seaborne market. decade, due to the increase in domestic returns
Exhibit 6 Scrap net trade 2010 2030

Strong growth in scrap Millon metric tons
supply is foreseeable Imports Exports
but after 2020 8
Europe
10
-19
MENA
-25
North 17
America 15
Developed 6
Asia 35
-6
China
0
-4
India
-5
Other -3
Asia -30
7
Other1
5
1 CIS, Africa, Latin America, and Oceania
Source: ISSB; WSA; McKinsey Integrated Steel Demand Model

after use. The first significant wave of scrap From around 2020, scrap could change the
increases in China should be expected around overall picture albeit slowly, with a big double
2020 as the first building boom of the 1990s squeeze: Chinas steel demand is expected
reaches end of life. Buildings from this period to peak at the same time as the start of end-
are already being replaced with new structures of-life scrap supplies from the construction
much faster than is seen historically in other boom of the 2000s (much bigger than the
countries (e.g., currently an estimated 30 years one of the 1990s), generating a massive scrap
in China versus more than 100 years in the US supply. At that point trade flows might change
or UK). The Chinese supply pipeline of scrap dramatically, and new dynamics, such as EAFs
will be increasing due to the countrys current in China making flat products for Europe, could
enormous demand. Currently, Chinas visible move into the spotlight. What is certain, though,
investments in electric arc furnaces (EAFs) is that the world of the future will see more scrap
continue to be mostly for special steels, and the than today, and export flows will be redirected
projected EAF base will not be able to handle to places where scrap can be processed.
the predicted scrap pipeline. Consequently,
further projects are needed to absorb the scrap
flow, and industry developments in Europe
and the US have taught that if steel mills do not
sufficiently anticipate this, the industry is likely
to experience another overcapacity blow that
will take a long time to overcome.
Europe will remain a net scrap exporter

because of returns from historical consumption
and limited growth in scrap consumption
and that could lead to structural changes in
processing. Europe, like the US, could add more
EAF steel and therefore develop towards better
leveraging its domestic mine. The NAFTA
countries will also continue to export in
particular, the US will remain a net exporter,
assuming that the EAF rate remains high, and
the availability of shale gas triggers direct-
reduced-iron (DRI)-based production for
higher-quality grades.
Global steel dynamics

Operating in a
multispeed world
Global steel demand has shown strong growth over the last decade, mainly driven by the rise of
China since the beginning of the century, and halted only very briefly with the economic crisis
when global demand fell by more than 5% from 2008 to 2009, the first global decline since
1998. However, by 2010, the industry had already recovered from this global drop.
In the aftermath of the crisis of 2008/09, high raw materials costs and volatile prices have
leveled margins on steel globally, with no sign of recovery in sight. Yet, high sunk costs in mills
and high exit barriers have kept old, inefficient sites in operation, even though new capacity
has come online (307 Mt in China alone since 2007).
These developments result in increasing surplus capacities an estimated 343 Mt worldwide

in 2012, with the largest surpluses in China (107 Mt) and Europe (71 Mt). The increasing
financial pressure on steel makers should eventually trigger industry restructuring, and
the shedding of excess capacity will reshape the steel value chain and its global footprint.
The prospect of structural upheaval is thus looming over the industry and raises strategic
questions for steel makers and their stakeholders.
At the regional level, the picture is much more differentiated. China, which will continue to
be the primary shaping force for the global steel industry, faces significant excess capacity
after a decade of extreme expansion. Russia has the potential to continue to grow its steel
exports, even while ramping up domestic sales whereas Brazil and India are both likely to
Surplus capacity is increasing globally,

raising the potential for structural upheaval
see their growth slow because of individual steel value chain in selected countries or regions,
domestic challenges. In Europe, steel demand grouped around China, emerging markets, and
is expected to remain some 5 to 10% below the mature markets:
long-term demand projections from the past,
saddling the industry with an overcapacity China gradual slowdown or sudden halt?
problem that will be solved only through
restructuring. In North America, continued Russia competitive exports, but turning
volatility is on the horizon. towards more profitable domestic customers
The steel industry will thus be operating in a Brazil caught by cost increases
multispeed world in the decade ahead, with
different markets exhibiting very different India high potential, but hobbled by
demand growth (Exhibit 7), value creation regulatory uncertainty and red tape
opportunities, core challenges, and options for
action by industry and policymakers. Europe restructuring ahead?
On the following pages, we offer portraits of North America favorable demographics

the current situation in the midstream of the and cheap energy.
Exhibit 7 Apparent demand for finished steel products (selected regions)

Steel is a multi- Million metric tons
speed world
814
141 98 132 167 154 186 585

+35% +21%
73
28 45 +62%
+40%
North America
Europe
CIS
132
China
131
28 63 +108%
India
131
41 65 +102%
Latin America
Source: World Steel Association (WSA); McKinsey Steel Demand Model

Global steel dynamics Operating in a multispeed world 17
China 3 to 5% look likely in coming years, in line with

scenarios published by official institutions
in China.2 Demand can be projected to reach
China gradual slowdown or
some 815 Mt in 2020. While construction will
sudden halt?
continue to be the largest end market, machinery
Over the past decade, steel demand in China will increase its share, which will influence
grew from approximately 160 Mt in 2001 the product mix (Exhibit 8). Depending on the
to 620 Mt in 2011, an average annual rate scenario, change in steel demand growth in China
of 14%, driven by rapid urbanization and could affect world demand growth negatively or
1
As of 2012, more than half
(53%) of Chinas population is
industrialization. During this period, nearly positively by as much as 20 to 22%.3
estimated to live in cities 200 million people moved into cities roughly
2
The 12th 5-year plan, published half the population of the EU1 and industrial The current steel production overcapacity will
by the Chinese Government
(Ministry of Industry and GDP per capita nearly tripled, contributing not ease up even in the medium term, which
Information Technology of
China) foresees a growth rate of roughly a third to the worlds GDP growth. is likely to keep the pressure on steel makers
4 to 5% in the base case. margins. Chinas crude steel capacity is already
3
McKinsey Global Institute:
Resource revolution: Meeting Following this decade of double-digit growth, about 850 Mtpa, translating into an industry
the worlds energy, materials, Chinas steel demand is now expected to slow average utilization of less than 80%. According
food, and water needs,
November 2011, p. 156 down considerably. Growth rates of around to the CISA statistics, China's major large and
Exhibit 8 Chinas finished steel demand, base case scenario, 2005 - 20

Chinas urbanization Million metric tons
CAGR
drives demand from
Percent
construction companies 2000 - 05 2005 - 20
and machinery
manufacturers 814
717 149 Residential building 12.4 0.9
142
585
179 Commercial building 11.0 3.8
128
148
103 171 Machinery 13.4 3.1

334 147
72 113
102 Public infrastructure 13.7 3.2
61 87
60 103
86 Transportation 21.2 2.1
77
54 65
25 116 127 Others 3.2 1.9
62 73
2005 10 15e 2020e
Source: China Steel Demand Model v 7.18

medium-sized iron and steel enterprises had a the industry: continue fostering consolidation to
total operating loss of RMB 5.2 billion (USD ~ gain efficiency, restrict growth of subscale mills,
820 million) from Jan. to Oct. 2012, compared avoid mills in structurally unattractive regions
with a year earlier (10-month) profit of RMB (e.g., noncoastal regions), promote EAF plants
84.9 billion (USD ~ 13.5 billion). Large state- and other technological levers, and push for
owned mills have been hurt much more than high-end products. During 2012, the Ministry
small and medium-sized private companies, of Industry and Information Technology
which are more flexible in response to market (MIIT) issued several policies to speed up
dynamics and have more cost-efficient, restructuring, including improving steel mill
flexible operations. energy efficiency by about 20% (February
2012) and continuing the shutdown of obsolete
Despite slower demand and overcapacity, capacity (July 2012).
China is unlikely to dump significant
quantities of steel on international markets To increase competitiveness and reduce/
in the near future. Exports are expected mitigate surplus capacity, the tasks for Chinese
to remain at or slightly above the current steel makers include the following actions:
level (net exports were about 40 Mt in 2012).
Chinese producers might target nearby Strategic change. A buildup of mega-
markets (East Asia now accounts for about players through domestic consolidation
50% of Chinas steel exports) or emerging and outbound M&A to gain access to certain
regions with high price levels and limited distressed overseas markets
import constraints, such as East Africa, if the
economics are attractive. The government Commercial capability building. A move
discourages companies from exporting away from distribution to a direct sales
products with low value added and high energy model in order to ensure control of the
consumption and, therefore, has limited total relationship with customers and capture a
exports to between 6 and 8%, as seen in larger share of value added. Achieving this,
the past. however, will require shorter lead times and
higher delivery reliability.
Overcapacity is expected to continue until
government actions laid out in the 12th five- Introducing operational excellence. An
year plan are implemented, especially the improvement in all upstream operations
ban on capacity expansion for small mills and particularly blast furnace operational
and the consolidation target of 60% for the excellence (e.g., energy efficiency, materials
top 10 producers by 2015. However, this limit loss reduction, larger furnace size), together
was already mandated in the 11th five-year with shifts in portfolios toward more value-
plan and did not materialize. Consolidation added products.
within provinces is now supported by local
governments and would seem to be one of the Taking a longer-term perspective, Chinas steel
options for small, privately-owned mills. demand is expected to peak between 2020 and
2030 at a per capita consumption level between
Driven by market forces and policy changes, heavy export economies (e.g., South Korea)
restructuring could speed up at both the and developed and diversified economies (e.g.,
industry and company levels. The 12th five- Germany) and probably much closer to the
year plan has laid out five major initiatives for latter. Post-2020, as a result of the massive
Driven by market forces and policy

changes, restructuring could speed up
urbanization and industrialization from 1990 to

2010, Chinas domestic scrap supply is expected
to pick up. The increase of available scrap will
lead to a fundamental change in the Chinese steel
industry. Assets to process scrap are required
and, by the end of this decade, these EAFs will
force noncompetitive BF/BOF sites to close.
Because of its size, China will continue to shape

the global steel industry. Beyond China, there are
a number of emerging economies that will also
grow each under its particular circumstances
especially Russia, Brazil, and India.
Russia available domestically. Given this economic

ceiling on production, the Russian steel industry
is continuing to move away from less profitable
Competitive exports, but turning towards
exports of semi-finished products and towards
more profitable domestic customers
more profitable domestic sales. The home
Russian steel makers inherited Soviet-era market generates healthy demand and margins,
production capacities that far exceed domestic and export volumes have been declining by
demand. With a crude steel production level of 4% annually since 2009. Producers success in
70 Mt in 2012, the domestic steel industry has locking in growing domestic demand will depend
managed to maintain utilization rates of upwards on tightly managing costs, boosting productivity,
of 80% in recent years, by exporting 35 to 45% of and getting the product and quality mix right.
its total steel production (over 60% of net exports
are semis), mainly to Europe, the Middle East, One source of the strength of Russian steel lies in
and North Africa. Despite having theoretically favorable factor costs for energy, raw materials, and
huge capacities, the realistic maximum total labor. However, Russias competitiveness on export
aggregate production volume for Russian steel markets is being undermined by rising energy
makers is currently limited to somewhat below prices and labor costs. Continuing productivity
100 Mtpa constrained by the cost of extracting improvements and strict cost management as well
the increasingly hard-to-access raw materials as further investments in energy efficiency are
Exhibit 9 Russia steel plant and raw materials Steel plant Iron ore existing mines Iron ore planned projects
As new coal and iron ore resource distribution Coal existing mines Coal planned projects
projects are increasingly
developed in the east, it is Karelsky Okatysh Olkon
(Severstal) (Severstal)
getting harder for Russian
steel mills to access them Vorkutaugol
Cherepovets
(Severstal) (Severstal)
Prioskolsky GOK Usinsky-3

(NLMK) Moscow
(NLMK)
NTMK Yakutugol Sivaglinskoye (Mechel)
(Evraz) (Mechel) Sutamskaya (Mechel)
NLMK VGOK, KGOK Pionerskoye (Mechel)
(Evraz)
Zhernovski
Gluboki NKMK/ZSMK
ChMK (NLMK) (Evraz)
MGOK, MMK (Mechel) Elga Coal
Evrazruda (Mechel)
LGOK UralSteel
(M-invest) (M-invest) Nikitinsky
(MMK)
Yuzhny
Kuzbass
Stoylensky OEMK (Mechel) Korshunov
GOK (M-invest) Raspadskaya, GOK (Mechel)
(NLMK) Yuzhkuz-
bassugol Tyva
(Evrazl) (Severstal) Mezhegey and Eastern
field (Evraz)
Source: Company information

Russias ability to increase steel exports is limited
still feasible and necessary if Russian steel is value-added products is what has encouraged
to maintain operational cost advantages both for Russian steel players to refocus on the domestic
exports and the home market. market. Current investments in product quality
and downstream integration might be followed
A further source of the cost competitiveness of by advanced materials research, eventually
Russian steel is especially a high level of vertical leading to the capabilities necessary to lock out
integration and an abundant supply of coal and imports of high value-added products and to
iron ore. The challenge is that newly tapped compete on global markets.
deposits are located in the far eastern regions
far from Russias steelmaking base in the west An important question, especially for the
(Exhibit 9). There are mines in the western European steel industry, is whether Russias
regions as well, and they are not depleted yet, but grip on its home market will strengthen and
they will require further investments to extend whether Russian steel could become even more
their lives. The profitability of building even competitive in exports. Much will depend on how
more steel capacity that relies on those mines is, local demand evolves. The majority of capacity
however, questionable. expansions currently in progress or planned
are, however, clearly aimed at serving
Additionally, the share of scrap required for both domestic markets.
integrated and electric steelmaking is heading
towards constraints. By 2015, companies could There are only two plausible but unlikely
face a scrap deficit and might be forced to change scenarios that could upset this stable situation:
the mix of metallics towards DRI pig iron, which a sharp economic downturn in Russia, which
would hurt their cost structure and threaten would impel domestic producers to sell their
further EAF expansion plans. Vertical integration excess production onto export markets; and
is thus a strength for a few steel producers, but not extensive investments by domestic players in
for all. new capacity along the entire value chain. Such
an investment could be profitable as long as
Integrated companies with steelmaking and it is in brownfield plants (a few Russian steel
mines have a significant advantage, which they producers have recently made these types of
can play to and strengthen by leveraging the investments). In this case, Russian steel makers
raw materials volumes they control. Further would have competitive assets that could
growth is limited to the product-quality track. directly target European markets. Greenfield
Players could target more value added and build plants are unlikely, since their economics differ
downstream capacity. Some leading Russian steel and would not be competitive, i.e., able to earn
makers are already going the route of value added adequate returns on invested capital.
products as well as maintaining self-sufficiency
in raw materials, which will most likely be the Finally, even if one of these two changes occurs,
continuing success formula for the CIS. the upper limit on domestic production of some
100 Mtpa still puts a ceiling on what Russia
The Russian steel industrys other source of could reasonably export to compete with steel
strength is market-based: the healthy growth of companies based in the EU. Analysis indicates
Russian manufacturing. Domestic steel demand that the domestic supply of raw materials is
has risen by 8% since 1998, reaching more than sufficient for exports to the Middle East and
40 Mt in 2011, and has already surpassed precrisis North Africa. To export beyond that level would
levels. Strong demand from Russias automotive, require importing raw materials, which would
machinery, and construction sectors for high not make sense economically.
Under current circumstances, there is no way

to build a steel mill profitably in Brazil
Other emerging markets costs, particularly in energy, labor, and logistics,

its cost position is now closer to average than to
first-quartile (Exhibit 10). As a result, its steel
Brazil caught by cost increases
imports have grown and now cover 10 to 15% of
Given its resources in raw materials (partic- steel demand up from 5% in the recent past.
ularly in iron ore), Brazil would seem to be an
ideal location for the steel industry, provided This has led to an erosion of price premiums and
the environment is cost-competitive. Although is hurting the sectors profitability. Brazilian steel
a decade ago this was commonly assumed to be makers, which posted EBITDA margins above
the case, it seems no longer true today. Instead, 30% between 2006 and 2008, are now facing
the country now faces the risks of becoming low double-digit margins and even single-digit
short of supply and seeing its competitive profitability. Not even the movement of most steel
position deteriorate. players into their own iron ore mines in recent
years has significantly boosted competitiveness
What happened is that just as Brazils domestic though in some cases it has created economic
steel consumption began to gain momentum value. As a result, the attractiveness of steel
on the back of a strengthening economy, Brazil investments has all but disappeared and investors
ceased to be a low-cost country. Driven by strong have to weigh investing in steel against
currency appreciation and rising domestic other options.
Exhibit 10 Development of factor costs in Brazil

The tables have Million metric tons
turned: Brazil is losing
competitiveness on Electricity cost Labor cost Supply chain cost
world markets USD/MWh USD/hour USD transport cost/t coking coal
180 12 17
+54%
11
+272%
+288%
3.2
46
2003 2012 2003 2012 2003 2012
Source: Ministrio das Minas e Energia; Aneel; Economist Intelligence Unit; James F. King
Brazils domestic market is growing. Infra- In the longer run, as production increases,
structure needs, major sports events, and growing Brazil will also have to solve the problems of
industrial production will drive this demand sourcing metallic scrap and scrap substitutes,
growth. Yet despite a healthy demand outlook and as availability is limited. In this context, making
good raw materials availability, Brazil needs to use of the growing supply of pellet feed fines,
be careful in its response: past price premiums pelletizing plants, and natural gas could lead to
for even standard products are gone and thus the development of a sturdy local DRI supply.
profitability of domestic steel production is
decreasing while high investment costs will Brazil has a huge upside perspective. Sales by
challenge further investment economics. It also Brazilian steel makers should be around 50 Mtpa
appears that there is no way to build steel mills by 2020, but could reach up to 80 Mtpa if the
domestically with attractive economics under country manages to increase competitiveness in
current conditions. The cost of mill construction both domestic and export markets. Constraints
in Brazil is around 1,800 USD/t of annual capacity on investments leading to high cost need to be
for an integrated flat steel mill far above the revised, and plant performance can reach world-
benchmark (roughly 25% more than global class levels if the mindset is ready for this and
average and far above the regions with low-cost initiatives are taken.
potential, such as China with 600 to 750 USD/t
per ton or India with 1,000 to 1,200 USD/t).
The steel industry will need to take a series

of actions to restore its competitiveness and
financial performance. Local steel makers will
need to develop an entirely new set of capabilities
to address the efficiency gap in industrial
operations. Brazils perceived labor cost
advantage no longer applies and qualified labor
comes at comparable costs to those in Europe.
Optimizing the raw materials mix is another
essential lever, with options such as increasing
the use of PCI and using pellet feed. Steel mills
will also need to increase labor, energy, and
operational efficiencies throughout the chain,
assessing opportunities in heat recovery, process
automation, and maintenance effectiveness, for
example. On a broader level, steel makers can
also enhance the coordination of logistics along
the value chain, seek opportunities for upstream
and downstream integration, and develop new
capabilities in marketing and sales.
India huge potential, but hobbled by 85 to 90 Mt in 2015. From this low base,
regulatory uncertainty and red tape India will not become another China in the
foreseeable future.
In relative terms, demand for steel in India has
been very strong over the past decade, with There are a number of reasons for this
growth rates averaging 11% per year from 2000 slowdown in growth. Uncertainties about
to 2011. Comparing Indias steel demand today policies and regulation that affect end-user
with international benchmarks shows that it markets, such as construction, are expected
still has enormous growth potential (Exhibit 11). to continue, potentially until 2014. The
Indias per capita steel consumption is around uncertainty has brought investment in
60 kg, which indicates a potential for domestic infrastructure projects to a near standstill and
demand to grow to between four and six times lowered private investment (in automobiles and
current levels. Compared with other regions, real estate, for example). Also, policy-driven
such as China, India has not pushed and is not restrictions on access to domestic coking coal
pushing steel-intensive infrastructure and iron ore are limiting factors for the
and urbanization. local industry.
Yet despite the vast potential that exists, Indias Taking a long-term perspective, the growth
steel demand is expected to grow by only 5 to 6% fundamentals for Indian steel will remain
per year in the near future, to reach a level of intact and a revival in demand growth is
Exhibit 11 There is still significant potential for demand growth in developing countries
There is still significant
potential for steel demand
growth in developing Steel demand1
countries kg/capita
1,000
900
800
700 China
(1970 -
600 2011)
500 Russia
(1984 - EU-15 (1948 - 2011)
400 2011) USA (1900 - 2011)
300
200
Brazil (1970 - 2011)
100
India (1970 - 2011) Real GDP
0 (2000)
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 USD/capita
1 Crude steel equivalent
Source: WSA; Global Insight; IMF; McKinsey analysis

Mining ban for iron ore challenges

Indias steel producers
expected after 2015. By 2020, the potential In iron ore, the situation is different. In terms
demand could be 125 to 150 Mt. of reserves, India has sufficient quality-grade
iron ore available domestically, but mining is
Capacity growth in India will remain moderate. exposed to multiple hurdles. From the regulatory
Indias steel industry will effectively add side, iron ore capacity additions are hampered
some 34 Mtpa of capacity between 2010 and by increasing regulations and the governments
2015 to reach 107 Mt, with the majority of efforts to discourage merchant mining. Also,
the capacity expansion being undertaken by bans on iron mining in Goa and Karnataka to
the large local steel companies. Some 70% of curb illegal mining are expected to lead to a 35%
the upcoming capacity is blast furnace based drop in iron ore production and a 60% decline in
and largely brownfield. Adding greenfield exports, or even more.
capacity will remain constrained by structural
deficiencies, such as land acquisition issues and Furthermore, iron ore availability for domestic
increasing rehabilitation costs. Consequently, steel players might become an issue if the mining
steel production growth might be slower than ban continues in Goa and Karnataka, and is
demand and India may remain a marginal extended to Orissa. While most of the iron ore
importer of steel to 2020 and beyond. from Goa and Karnataka is meant for export,
Orissas production is largely consumed by the
Raw materials supply faces similar conditions, domestic steel industry due to its good quality,
being constrained partially due to unavailable such as high-grade lump ore. Some domestic steel
domestic resources and the need to import players have resorted to importing iron ore from
premium raw materials. India will remain a South Africa and Brazil.
major importer of coking coal, with the gap
between demand and supply expected to Overall, the outlook for Indias steel industry
increase to 55 Mt by 2020. While India has shows huge untapped potential waiting to
an abundant supply of coal, it lacks domestic be implemented. To change this situation,
reserves of prime coking coal. To remedy this, constraining factors need to be removed, such as
the government has formulated a master plan policy uncertainties to promote the demand side
to resettle the existing population in Jharia, and regulatory constraints to unlock the potential
the only known basin of prime coking coal in of raw materials. As a result, India may follow
the country. Because of the long lead time of an industrialization path that has a low steel
a megaproject like this, it is unlikely to bear intensity. Moreover, Indias chosen dependency
fruit before 2025. Although domestic supply on seaborne market imports will promote higher
is expected to nearly double between now and global prices for raw materials and make steel in
2020, it will not be sufficient. Therefore, Indian India a costly good.
steel mills are looking to acquire coking coal
assets abroad in order to secure supply.
Mature regions The future remains challenging, as the demand

outlook is not favorable for a number of end-
Europe restructuring ahead? customer industries, including construction,
which mainly drives the demand for long steel
Emerging economies such as Russia, Brazil, and products, and automotive, an important source of
India were not the only ones that experienced demand for flat steel. Historically, construction
a steel boom up until 2008. Europes steel accounted for approximately 35 to 40% of
makers also enjoyed both high utilization levels European steel demand, being the largest end-
and high margins. Following the boom, which user segment. After 2008, the Western European
did not reflect sustainable conditions, the housing index plummeted to levels 50% below
market started changing dramatically. In most the precrisis level, with Spain showing declines
European countries, demand has recovered of more than 80%, clearly foreshadowing the
very slowly following the sharp drop in 2009, current and future fragile demand. While there
resulting in low production and utilization rates. are sharp regional differences, the European
Europes overall weak cost position in steel construction industry as a whole will likely
compared with those of other regions, combined remain below precrisis levels beyond 2020.
with high and volatile raw materials costs and In many Southern European countries, the
volatile steel prices, has resulted in sharply construction bubble created a supply significantly
declining margins for steel makers. above fundamental demand (Exhibit 12).
Exhibit 12 European housing index (2003 - 13e)

Negative demand
development in end- 140
user markets with
significant impact
on steel demand 120
development of
the housing market ...
100
80
UK
60 Western Europe
Italy
40
20 Spain
0
2003 05 07 09 11 2013
Source: Euroconstruct Data Base

In the automotive sector, after a pronounced of 175 to 180 Mtpa was previously the norm,
double-dip leading to an 18% decline in sales extrapolation of demand drivers indicates that
between 2008 and 2012, the bottom will be levels of 165 Mtpa could be the new equilibrium,
reached in 2013 (Exhibit 13). Thereafter, sales given the probability that Europes steel-
should be uniformly positive and return to higher consuming industries will lower their steel
levels, but they will not regain their precrisis intensity. For example, the shipbuilding market
levels in the next few years. Given that automotive despite having enjoyed a high level of demand
accounts for only about 10% of the total finished at the end of the last decade is declining. At
steel demand and since European producers tend the same time, as mentioned, construction in
to build export capabilities outside of the EU (e.g., southern Europe is likely to remain low.
in North America where premium OEMs build
SUVs for Europe), it is doubtful that this positive This constellation will bring about structural
trend will create a turnaround in the European change. For long steel producers, the limited
steel industry. logistics radius of long products means that
their production in Europe will continue even
European steel demand has therefore remained during periods of low demand. Therefore, key
below precrisis levels since 2010 and will producers in Europe can expect to deal with
likely remain 5 to 10% below previous long- low utilization levels for years to come. In this
term demand projections. While a demand environment, they have the following options:
Exhibit 13 Million units

... and the
European1 domestic car production European1 cars net export
automotive market
Historical Forecast Historical Forecast
22 1.0
20 0.5
18 2000 2010 2020e

0
16
-0.5
14
-1.0
12
10 -1.5
8 -2.0
2000 2010 2020e
1 Western and Central Europe
Source: IHS Automotive Light Vehicle Sales Forecast, November 2012; McKinsey analysis
restructure the production base, reduce costs, Most likely, only a few large companies will
convert to the mini-mill concept, merge with be able to make the necessary changes and
others and consolidate capacities, and/or they will be the producers with multiple
expand home markets. production routes or sites serving Europe. They
can reduce capacities structurally and close
The situation is different for flat steel producers. the fixed-cost-heavy steps of the value chain.
Already today, the fourth-quartile players of the For smaller companies, closure means exiting
cost curve in Europe find it hard to compete on certain markets or giving up certain products.
cost in commodity grades, especially compared As this is an unattractive prospect for owners,
with steel coming from Russia, Ukraine, or Europe is likely to see small companies seeking
other low-cost regions. All new capacity in options to act jointly, which will require further
these regions will cost much less than European consolidation. An alternative operating model
capacity, even including transportation costs. could be broad in design: it could lead to shared
The way the aluminum industry reacted to hot end facilities, e.g., joint steelmaking to supply
a similar challenge was to move demand to slabs or even in combination with hot rolling
specific grades for high-end applications, supplying hot-rolled coil. Such sites already exist
improve services to create more value added, and have proved their viability, as seen in steel
and provide other services that importers are in Germany or in aluminum hot-rolling across
unable to provide. Around 70% of European Europe, for example. As was the case in the 1980s,
production is devoted to high value-added public and political support will likely be required
products and competition and local demand to enable the transition.
are expected to push this share even higher.
The loss of competitiveness could lead to a drop

in sales of European flat steel by 10 to 15 Mtpa.
Consequently, sites are and will be up for
closure, reducing capacity in Europe by up to
15 to 20 Mtpa, in addition to the 10 Mtpa already
permanently closed down after the 2008 to
2009 crisis. Site types expected to close are
small and outdated inland sites that handle a
relatively high share of commodity products.
North America favorable Additionally, existing steel producers can

demographics and cheap energy start restructuring and reinvesting in the
industry in North America. Many assets
Over the past decade, demand in North are no longer state-of-the-art and some are
America has been uncertain. Finished steel even obsolete, making a critical asset review
demand has been volatile and varied between essential for many players. But there are
68 (2009) and 142 (2006) Mt. With a per capita also changes ahead that steel producers can
consumption of 300 - 400 kg/person, North potentially leverage. The impact of shale gas
America is less steel-intensive than other could improve the position of the US in the
developed economies on average, the US has steel industry by stimulating a new generation
a roughly 10% lower demand per capita than of investment, which should include the
does Western Europe. This, combined with DRI/scrap/EAF route. While some of the
continued population growth, should lead to limitations regarding quality need to be
increased demand for steel. overcome, indications are that even high
automotive quality can be cost-efficiently
In recent years, steel makers in North America delivered via this route. Then as recently
have struggled to achieve competitiveness, built assets show US steel makers with low
particularly at integrated sites. Given that steel conversion costs and high-quality steel can be
produced in the US costs more than imports, competitive challengers.
steel makers need to differentiate themselves
through processing capabilities. For example, It is worth highlighting Mexicos role as
in the flat steel value chain, some companies potentially the largest source of demand
have succeeded in significantly reducing costs growth in North America in this decade. The
by increasing direct sales to end customers. In countrys current steel intensity is below 200
tubes, the quality of machining and coating are kg per capita lower than its level of economic
differentiating factors that reduce exposure development would suggest. Manufacturing
to imports. is a key contributor to steels strong potential:
Mexico has over 40 automotive OEM and
A further opportunity is linked to the resources supplier facilities as well as a large number of
available in the region. North America is self- white goods plants. Steel demand in Mexico
sufficient in raw materials and does not depend could very well grow to above 25 Mtpa in the
on global markets for coal, iron ore, or scrap. next decade, against production of about 18 Mt
Two main factors determine whether this raw of crude steel in 2012. Imports and exports are
materials advantage can be turned into export currently quite balanced overall, but with big
opportunities. The first is the level of the global differences by product type and grade. This
seaborne price. Higher global prices provide US would indicate that investments in additional
steel producers with a price shield, making local capacity can be expected.
steel production more competitive in North
America. The second factor is the exchange rate
(a strong US dollar makes the US steel industry
less competitive). If export countries such as
Brazil continue to experience rising costs and
pass these costs through (and do the same with
the iron ore price), this favors North America.
The steel industry in the US could increase
production by substituting imports and provide
more supply to local OEMs or start exporting.
Steel users changing

requirements
New challenges,
new opportunities
While the environment for steel producers is challenging, ongoing changes in the global
economy continue to open up new and different opportunities. Whether these are in new
products, new applications or new regions, the key will be to identify them early and
respond appropriately.
In the aggregate, regional trends need to be reflected. The development of China and India,
the two leading emerging economies, is proceeding at roughly ten times the economic
acceleration of the Industrial Revolution, on 100 times the scale resulting in an economic
force that is over 1,000 times as large. Although the growth of these giants has slowed from
the highs in the mid-2000s, the primary source of demand growth for steel makers will
continue to be urbanization, which is undergoing a seismic shift to emerging economies.
Emerging market cities about 440 of them are expected to contribute nearly 50% of global
growth from 2007 to 2025.
Furthermore, in the next twenty years, up to 3 billion more people are expected to cross the
threshold into the middle class defined as a disposable income of USD 10 per day, measured
at purchasing power parity compared with 1.8 billion people at or above this level today.
About 90% of these new consumers will be in developing economies. As a consequence, by
2025, annual consumption in emerging markets is projected to reach USD 30 trillion the
biggest growth opportunity in history. This new middle class will drive up demand. As just
Steel users changing requirements New challenges, new opportunities 31
one example, the worlds new consumers reduction standards will also require the help
are expected to double the global car fleet of electrified powertrains and lightweight
to 1.7 billion by 2030, and their needs will materials. Their role is the second factor,
also boost demand for a range of resources as both engine-efficiency measures and
including inputs for urban construction, electrification will increase car weight and
infrastructure, and transportation, which, system costs, which in turn will trigger
by some estimates, could increase steel additional demand for lightweight solutions
demand by as much as 80% between 2010 to reduce overall vehicle weight, to reduce the
and 2030. associated system and battery weight, and to
improve driving dynamics.
In addition to sheer volume growth,
changing customer requirements offer steel The use of lightweight materials in cars is
makers opportunities to de-commoditize therefore expected to increase from 30%
and sell more value-added offerings. (2010) to an estimated 70% by 20304, thereby
Examples include lightweight applications, creating a lightweight materials market with
a requirement that continues to grow projected sales in 2030 of more than EUR 300
and increase in urgency, while offshore billion, up from EUR 70 billion today. Because
applications for energy will require lightweight materials come with a higher price
different plate grades, and the demand tag, a diverse landscape of material mixes
for corrosion-resistant alloy (CRA) tubes will emerge. Traditional steel will be replaced
will also increase. As demand patterns to a large extent by high-strength steel
change, competition between metals will (especially in the mass market) and to a lesser
increase, making product innovation a more extent by aluminum. To be sure, carbon fiber
important source of differentiation is growing the fastest at nearly 20% a year,
than ever. albeit from a small base. Plastics and all kinds
of sandwich materials are also bound to
play an increasingly important role in
Automotive lightweight downstream an
certain applications.
example of major impact on steel markets
In automotive engineering, the use of Nevertheless, high-strength steel will be one
lightweight materials has been a constant focus of the lightweight winners. A recent McKinsey
and is now reaching a new inflection point due analysis indicates that small and medium-
to tighter regulations on energy and engine sized cars with conventional or hybrid
efficiency. Aluminum has already taken a powertrains are likely to mainly increase their
strong position in the premium class segment, share of high-strength steel due to the good
in chassis and powertrains as well as in body weight saving to cost ratio. The remaining
structures. Recently, carbon fiber has been one-third of the car market upper- and
making headlines as a new material to replace medium-class vehicles and battery-powered
some of the steel used for the support structures electric vehicles (BEVs) is expected to
of electric vehicles. use a higher share of lightweight materials,
including aluminum, magnesium, high-
Two main factors are driving changes in the strength steel, and (to a limited extent) carbon
4
Lightweight, Heavy Impact - material mix in cars: First, the CO2 reduction fiber. Only niche luxury and extreme premium
How Carbon Fiber and Other
Lightweight Materials Will targets for 2025 under discussion in Europe BEV cars (less than 1% of all cars) will use
Develop Across Industries and are not attainable through engine-efficiency carbon fiber to a great extent. In the premium
Specifically in Auto (McKinsey
Brochure), February 2012 measures alone. Fulfilling European emissions segment, material choices are motivated not
The use of lightweight materials in

cars will increase significantly
only by the need to save weight, but also to exploit applications and aluminum panels. Example
new degrees of freedom in car design and the calculations have shown that the cost of saving
opportunity for further differentiation. 1 kg in panels is in the order of EUR 0.50 and 1.10.
For steel, the implications are already fairly Overall, high-strength steel represents a sales
clear: high-strength steel applications will growth opportunity for steel companies and offers
grow, albeit at the expense of other types of steel large potential savings. A modest increase in the
(Exhibit 14). Steel producers serving automotive penetration of high-strength steel could save
customers will have to focus on high-strength 105 Mt of steel in 2030, a reduction of 9%. One
steels, while competition in commodity-like major barrier to adoption is a lack of awareness
segments or low-strength exposure will make among the many buyers of construction and
serving such customers less attractive. Using standard engineering steels in emerging markets,
high-strength steel would reduce the weight of and the increased need for technical expertise
steel columns and steel beams by about 32% and of the sales force further promotion is needed
19%, respectively. This could result in a greater outside of the automotive industry. But changes
share of high-strength steels being used all over to the landscape are already occurring in other
the car. Panels and outer bodies are likely to see prominent places for example, builders of the
fierce competition between steel and aluminum. Shanghai World Financial Center and Dubais
In D1/D2 cars, modern concepts could also lead to Emirates Towers have incorporated high-strength
alternatives that provide space for high-strength steel into these structures.
Exhibit 14 Material mix in automotive

High-strength steel Percent
is likely to be one of
the winners
100% 0 0,5 Carbon fiber

9 12 Plastics
0 5
5 Magnesium
Lightweight 15 12 Aluminum
share1 29% Body and chassis weight
decreased by ~ 40%
38 HSS2 Weight of powertrain

52 and electric components
increased due to the
67% electrification of the
13 Steel (< 550 MPa) powertrain
19 20 Other nonlightweight3
2010 2030e
1 HSS, aluminum, magnesium, plastics, carbon fiber

2 High-strength steel (> 550 MPa)
3 Mainly other metals, glass, fluids, interior parts
Source: McKinsey Lightweight, heavy impact, 2012

Steel users changing requirements New challenges, new opportunities 33
Distribution an irreversible change from Customer relations are changing too: for the
local to networks majors in this sector, direct customer interaction
is becoming less relevant, and managing logistics
The market environment for steel distributors more important. This will lead to new customer
has changed significantly since 2008. Quantities interaction models, establishing key account
and prices have become much more volatile and structures for core customers while minor
the pace of change more rapid. The industrys customers are served through a standard process
cyclical behavior of the past has become less with reduced service attention. These service
reliable as a predictor of the future. Customer models need to be explicitly developed, company
requirements are also changing lead times, by company: in future, the service model will be
customer service, and processing have become the differentiating factor for distributors.
solid competitive arguments.
In this situation, distributors need to adapt and

start steering product spectrums and quantities
more strategically, and develop capabilities
to mitigate risks from larger price drops.
Operational capabilities will need to improve
significantly in order to cope with current market
needs, which include managing working capital
by steering stock turnover rates and reducing
stock-keeping volumes, managing prices
consistently over multiregional organizations,
and redirecting the sales force to address
changing market segments. Currently, only a few
major players have such capabilities and those
that do not need to establish them quickly in
order to stay competitive.
From the supply side, distributers need to follow

the trend to negotiate contracts with different
conditions regarding duration, volume, and
payment terms in order to optimize both their
position and their value proposition. Moreover,
they can no longer carry the risks that volatility
presents, as they have done in the past. On the
other hand, distribution should leverage global
market trends. Distributors need to embrace
global sourcing opportunities to leverage their
price potential, thereby building positions
different from the regionally focused ones of
the past. Consequently, most distributors need
to build a second leg encompassing global
sourcing and managing global flows. One
dimension is no longer sufficient.
Initiatives needed now

Getting the fundamentals
right again forging a
successful future for steel
While the challenges facing steel industry are significant, they also offer opportunities. At the
level of the individual company, the top priority is getting the fundamentals right again. The
initiatives most urgently needed now are: to find and close profit and efficiency leaks and to
develop and market value to customers. While there are always strategy issues to address, it is
now the operational improvements that are the musts. Without making basic improvements to
operations, work on strategic issues such as consolidation or acquisitions will not yield the full
underlying impact.
Operational excellence a core task for most companies

What will it take to secure a competitive positioning in the new world of steel? A few key areas of
focus stand out:
Profitable pricing high margins are better than high volumes. Profitability still depends
primarily on steel prices. Despite current pressures, this powerful lever can still be moved to
a companys advantage and faster than the other major elements of operational excellence.
Companies need to strengthen strategic pricing in two main ways: by setting and enforcing
prices that will provide healthy conditions and by closing the leaks where prices do not yet
Initiatives needed now Getting the fundamentals right again forging a successful future for steel 35
reflect the true value-in-use of products and that can cope with increasingly extreme
contracts for the customer. In the current applications, most notably for lighter-
climate and for the foreseeable future, weight vehicles and more resilient offshore
maintaining steel prices to preserve or equipment. As in the past, many steel
restore profitable margins should generally companies in developed countries can
always take priority over market succeed by focusing on the high-value
share growth. products with higher margins than for
commodity steel. To do so, however, it is
Operations effectiveness the art no longer enough to invest in top-notch
of managing assets as a portfolio. technical research and innovation.
Comparisons of leaders and followers reveal Steel makers need to communicate
that room for improvement continues to more effectively with customers about
exist for most companies. Outperforming new products, and both development
competitors will take more than just classic and marketing must be backed by more
productivity improvement, such as labor sophisticated market coverage.
productivity or cost cutting on supplies. It
will be crucial to leverage scalable assets Hedging strategies learning from non-
and better utilize those assets by improving ferrous commodities. While widely used
equipment effectiveness.5 Stepping up in North America, hedging strategies offer
productivity thus also and importantly steel makers in Europe a new set of solutions.
implies site and cross-site optimization, Managers in the copper and aluminum
including closing uncompetitive or industries have successfully shown how
unused assets. hedging options or, as a starting point,
price benchmarking against indexes for
Technological process innovation taking exchange-traded products can protect
performance to the next level. Product a company against extreme swings in the
innovation will remain important, but the market. As steel makers are not necessarily
sharpest attention now should be paid to the best owners of the risk, volatility will
making steel processing more efficient. This force them to come up with a response.6
is a major savings lever, and our estimates The World Steel Association is currently
show that, across the global steel industry, reviewing its opposition to derivatives
the potential to cut energy consumption, from steelmaking raw materials, and has
for example, exceeds 12%. Targets to pursue announced a report on the subject in 2013.7
could include using PCI to reduce emissions
and developing the next stage of integrated These are the handful of levers that most steel
hot band production, including thin slab players will have to pull in combinations
casting and immediate rolling. In the specific to their circumstances in order to
medium term, it will be crucial to produce improve and protect margins against volatility
5
For example, OEE (overall
equipment effectiveness) or
steel at much lower CO2 levels. and uncertain changes in demand patterns.
overall utilization of individual However, like studying company assets for ways
equipment units in the plant
6
See Replacing the Crystal Ball,
Product innovation finding the next to optimize them across the group, rethinking
McKinsey on Metals & Mining, applications where steel makes the the structure of the industry as a whole will
No. 5, Autumn 2009
difference. Changing customer requirements indeed, must be the other important source of
7
Steel Business Briefing,
October 12, 2012 are fueling demand for steel with properties further improvement.
Exhibit 15 Western Europe HRC margin over raw materials

Margins are too low to USD/metric ton1
sustain current industry
structures Price-margin-squeeze China boom Crisis
700
600
500
400 Glory days
300 Crisis level
200
100
0
1998 99 2000 01 02 03 04 05 06 07 08 09 10 11 2012
1 In real 2005 prices
Exhibit 16 X% Percentage of the companies Steel only Some mining

Leverage ratios for in the sample A lot of mining Minor mining
many companies are Leverage (proxy for financial health)
Net debt/EBITDA, 2012, Q21
unsustainable
8.5
Troubled with no easy way out Troubled for now
7.5 45% 8%
6.5
5.5
4.5
3.5
2.5
1.5
0.5 18% 29%

Solid, but frozen Ready to grow
-0.5
0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 2.4 2.5
Market-to-book (proxy for future perspectives)
Current market cap/book value, 2012, Q21
1 Or last available
Source: CPAT; Bloomberg; McKinsey analysis

A further major lever lies in rethinking the

structure of the industry as a whole
Getting the structure right the core While there is no easy escape route, action must
task for the industry, with little or no be taken, and consolidation moves are one likely
outside help response. A healthier industry structure would
consist of larger operations that are better able
Following several years of good performance, to respond to underutilization, deal with market
steel players earnings plummeted as of 2008, volatility, and push innovation. The financial
and today the financial position of many predicament is especially severe for companies
companies, and the industry as a whole, in Europe and North America, but it also affects
is unsustainable. Recently, margins have steel makers in China and Brazil. For Europe,
deteriorated again to crisis levels, creating consolidation would provide some options and
unsustainable leverage ratios for many players should result in selective, but significant capacity
(Exhibits 15 and 16). Today, more than half of a reduction. The most likely candidates for closure
sample of 38 steel companies globally have a net are undersized and outdated assets, or assets with
debt to EBITDA ratio greater than 3.0, and more high revamp needs. In the US, similar retirements
than 60% have a market-to-book ratio of less of old and uncompetitive assets are required.
than 1.0; the median leverage for the industry Given the industry structure, producers will
is 3.1, and the median market-to-book ratio is have to merge before closing assets, as individual
0.8. Many companies are even operating with players that take this road are putting their
negative cash flows. businesses at risk.
Given these unattractive financials, external

help is unlikely, and getting access to new
equity will thus be another challenge. For
M&A activities, it will be hard to find financial
resources even under the current regime of
low interest rates. Profit recovery to the extent
required to change the game seems likely to
remain elusive.
Last word demand growth, supply will change dramatically

in favor of recycling and scrap: demand is no
longer increasing at historic growth rates, but the
Be prepared for uncertainty
rate of end-of-life scrap return is rising briskly. In
In a multispeed world, the steel industry needs to this scenario, the steel industry value chain would
anticipate multiple scenarios. Significant shifts shift away from iron ore to production based on
in demand alone have the potential to change the recycling and the EAF route. As a consequence,
steel landscape radically, with direct and indirect raw materials could flip 180 degrees from
implications, and interdependencies. Demand being scarce to being superfluous, shifting
growth losses can change investment behavior, value creation from mines back to processing.
impact the amount of production based on Currently less-competitive assets based on EAFs
primary ore versus scrap, and trigger regionally might become attractive again. This scenario
divergent trends. A look at the extremes can offer could even give nonintegrated steel mills a new
insights into possible surprises. lease on life, strengthening their position, at least
after 2020 when scrap will be more abundant.
A market saturation scenario, in which steel
demand stops growing significantly, would likely Such thoughts can build on a few assumptions
result in fundamentally new patterns for supply, about steel demand growth until 2030: in
pricing, and profitability. In the absence of strong the developed world (Western Europe, North
Exhibit 17
Scenario Scarcity Steady growth Saturation
Impact on raw materials
demand strongly varies Chinas
by scenario steel
80% higher than today, same 30% higher than today, i.e., 10% higher than today in 2030;
as South Korea between developed Asia and US peaks 2015 - 20; then slowly
intensity or Europe declines
Role of
other
Very strong growth in other Moderate growth in other Global steel demand growth
emerging markets emerging markets after 2020 is driven entirely by
regions
Latin America, MENA, and India Latin America, MENA, and India other emerging economies
become leading steel makers continue on current growth path
Steel 1,385 1,940 2,620 1,385 1,810 2,210 1,385 1,790 2,060
produc-
tion
3,380
Million
metric
tons 2,690 2,630
2,440
2,400 2,350
1,926 1,926 1,926
Global
iron ore
demand
Million
metric
tons
2011 2020e 2030e 2012 2020e 2030e 2012 2020e 2030e

America, developed Asia, Oceania), growth In such a scenario, nonintegrated steel companies
will be, at most, very moderate until 2030. The will continue to struggle under heavy margin
future of global steel demand growth will be pressures, as they will be caught between mining
determined by the developing economies companies with selling power and demanding
India, the Middle East and North Africa, customers who refuse to accept full cost
Latin America, Russia and the other Eastern pass-throughs.
European and CIS countries, and developing
Asia. Demand growth in China will add to this. While all of the twentieth century saw falling
(Under different plausible assumptions about costs for inputs, competitive dynamics in the
Chinas demand growth, global steel demand new era will be shaped by higher and increasing
could vary by around 20%.) The different growth prices for raw materials. Where management
rates will have a significant impact, not only could previously focus mainly on capital and
on demand for steel, but also for raw materials labor productivity, a more joined-up approach
(Exhibit 17 ). is now needed to understand how input prices
and volatility will affect profits and growth,
The input scarcity scenario discussed in the potentially creating opportunities for disruptive
introduction would hit raw material demand innovation, but also new sources of supply
the hardest, resulting in outcomes ranging from risk, competitive asymmetries, and regulatory
iron ore scarcity to scrap-focused processing. In changes. The world of steel will continue to
addition to higher costs for extraction as high- change in the next 10 to 20 years, offering many
quality grades are depleted, mining companies opportunities for steel companies. Much of their
face an array of pressures that could discourage fate depends on how global demand plays out, and
investment in new reserves, such as difficulties volatility will make their path a bumpy one. Those
in obtaining permits in developed countries steel makers that strengthen their operating
and, in less regulated developing countries, high performance and develop much greater agility in
public expectations for profit sharing. Pressure assessing and seizing opportunities will be better
is also increasing to put a price on carbon and equipped to adjust their strategies to the slope of
water, previously unpriced externalities. A the demand curve as it evolves.
carbon price would affect coal directly, but
would also increase the cost of doing business ***
for iron ore mines through higher energy prices.
Analysis indicates that if water is priced at its Moving ahead in the steel industry without a
shadow cost the economic value of its next major recalibration of activities will not work
best use, the combined impact of the estimated neither for mining companies nor for steel
carbon and water prices for some operators in producers. Both productivity and profitability
water-scarce regions could be a cost increase of will need to be driven much more systematically
16%. If, under these sorts of pressures, mining throughout the steel value chain from mining
companies then do not invest in expanding operations to the end customers.
capacity despite depletion of existing resources,
raw materials will go short faster, setting off
further price increases.
McKinsey & Companys Metals & Mining Practice

McKinseys global Metals & Mining Practice serves clients around the world on issues relevant to
the top management of companies in the metals and mining industries. As in its work in every other
industry, McKinseys goal is to help its metals and mining clients make positive, lasting, and substantial
improvements in their performance. Our staff consists of individuals who combine professional
experience in these industries with functional expertise in a broad range of related disciplines and
comprehensive training in business, economics, engineering, or the natural sciences. If you are
interested in further information on McKinseys Metals & Mining Practice or have specific questions
regarding the topics raised in this issue, please contact us. We would also appreciate your feedback and
comments on any of the important issues in metals and mining.
McKinsey on Metals & Mining is also available in Chinese.
Dr.-Ing. Benedikt Zeumer Thomas Luedi

Kennedydamm 24 17F Platinum, No. 233
40027 Dsseldorf Tai Cang Road, 200020 Shanghai
Germany Peoples Republic of China
Phone: +49 (211) 136-4142 Phone: +86 (21) 6122-3296
benedikt_zeumer@mckinsey.com thomas_luedi@mckinsey.com
Copyright 2013 McKinsey & Company, Inc.

The material in this publication is intended to give our view of value creation in the metals and mining
industries. It should not be construed as a recommendation to trade in shares of any of the companies
mentioned, and McKinsey & Company, Inc., shall not be responsible for losses incurred by such trade.
The analysis is based on information that we consider reliable, but we do not represent that it is accurate
or complete, and it should not be relied upon as such. No part of this publication may be copied or
redistributed in any form without the prior written consent of McKinsey & Company.
Authors and contributors:

Frank Bekaert (Luxembourg), Rajat Bhargava (Delhi), Avetik Chalabyan (Moscow), Karel Eloot
(Shanghai), Deepak Garg (Delhi), Joo Guillaumon (So Paulo), Wieland Gurlit (So Paulo), Toralf
Hagenbruch (Berlin), Ruth Heu (Berlin), Bruno Iared (So Paulo), Laurent Kinet (Shanghai),
Alessandro Mady (So Paulo), Eduardo Mencarini (So Paulo), Tom Niemann (Hamburg), Oliver
Ramsbottom (Shanghai), Stefan Rehbach (Dsseldorf), Antonio Sun (Hong Kong), Diedrik Tas
(Louvain-la-Neuve), Steven Vercammen (Louvain-la-Neuve), Benedikt Zeumer (Dsseldorf)
Picture credits:
Voestalpine (background pictures cover, p. 5 , and p. 15, background and front pictures p.30),
BHP Billiton (front pictures cover and p. 5, background and front pictures p. 7),
ArcelorMittal (front pictures p. 15 and p. 34),
Stahl-Zentrum/ThyssenKrupp Steel (background picture p. 34)
Editing/translation:
Vernon Donkers, Colin Douglas, Terry Gilman
Design and layout:

Marc-Daniel Kress/www.metamorphosis7.de
Metals & Mining Practice
Spring 2013
Copyright 2013 McKinsey & Company, Inc.

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Scarcity and Saturation

Steel and the challenges of volatile raw

McKinsey on Metals & Mining Number 08 Spring 2013

Our perspective is based on proprietary research by McKinsey & Company and is

Benedikt Zeumer Frank Bekaert

Steel production will continue to be challenged in many regions as overcapacities persist

Scarcity and Saturation

The raw materials

It does not take much for iron ore to flip

Source: McKinsey analysis

1 2005-11 supply; 2012-20 capacities

1995 97 99 2001 03 05 07 09 2011 2017e

1 Cumulated EBITDA from mill to hot rolled coil

Source: McKinsey Steel Model; McKinsey Mining Value Pools Model

Coking coal was a source of surprises in 2012

Exhibit 5 Seaborne hard coking coal price development over time

125 129 90th

China is likely to become scrap self-

Exhibit 6 Scrap net trade 2010 2030

1 CIS, Africa, Latin America, and Oceania

Source: ISSB; WSA; McKinsey Integrated Steel Demand Model

Europe will remain a net scrap exporter

Global steel dynamics

These developments result in increasing surplus capacities an estimated 343 Mt worldwide

Surplus capacity is increasing globally,

On the following pages, we offer portraits of North America favorable demographics

Exhibit 7 Apparent demand for finished steel products (selected regions)

141 98 132 167 154 186 585

Source: World Steel Association (WSA); McKinsey Steel Demand Model

China 3 to 5% look likely in coming years, in line with

Exhibit 8 Chinas finished steel demand, base case scenario, 2005 - 20

717 149 Residential building 12.4 0.9

103 171 Machinery 13.4 3.1

2005 10 15e 2020e

Source: China Steel Demand Model v 7.18

Driven by market forces and policy

urbanization and industrialization from 1990 to

Because of its size, China will continue to shape

Russia available domestically. Given this economic

Prioskolsky GOK Usinsky-3

Source: Company information

Russias ability to increase steel exports is limited

Under current circumstances, there is no way

Other emerging markets costs, particularly in energy, labor, and logistics,

Exhibit 10 Development of factor costs in Brazil

2003 2012 2003 2012 2003 2012

The steel industry will need to take a series

1 Crude steel equivalent

Source: WSA; Global Insight; IMF; McKinsey analysis

Mining ban for iron ore challenges

Mature regions The future remains challenging, as the demand

Exhibit 12 European housing index (2003 - 13e)

Source: Euroconstruct Data Base

Exhibit 13 Million units

Historical Forecast Historical Forecast

18 2000 2010 2020e

1 Western and Central Europe

The loss of competitiveness could lead to a drop

North America favorable Additionally, existing steel producers can

Steel users changing

The use of lightweight materials in

Exhibit 14 Material mix in automotive

100% 0 0,5 Carbon fiber

38 HSS2 Weight of powertrain