Steel Pricing in South Africa: Competition history and current concerns

Steel Pricing in South Africa:Competition history and currentconcernsSeptember 2010Towards a fair and efficient economy for all

ContentsHistory of Iscor/AMSAIssues leading up to the Harmony Mittal caseCompetition authorities decisions on the Harmony Mittal caseTests for excessive pricing and AMSA's likely defenseComments on the current situation

History of Iscor/AMSA1927: Government established Iscor1989: Iscor privatised with significant state shareholding remainingvia the IDC1996 – 1999: JV between Iscor and IDC to build Saldanha with taxincentives (S37E & S37H)2001: Unbundling of iron ore mining into Kumba and steel makinginto Iscor. Iscor was required to ensure the viability and costcompetitivenessof local steel production alongside a competitivepricing regime.

History of Iscor/AMSA (cont.)2001 – 2004: LNM introduced as an international partner,introduces efficiency improvements, and increases shareholding.2004: LNM acquires majority shareholding in Iscor.2006: After lengthy negotiations with DTI and in the context of theHarmony Mittal case, AMSA introduced a pricing system based onan international basket of prices.2009 – 2010: AMSA fails to convert its mineral rights resulting in adispute over iron ore prices to AMSA by Kumba. AMSA thenimplements a price surcharge to customers deposited into anescrow account should AMSA lose the dispute.

LNM acquisition of Iscor• LMN needed to notify the Competition Commission of a mergerwith Iscor in 2004 because it planned to increase itsshareholding in Iscor to above 50% (was 47.23%). The Tribunalapproved this unconditionally because it would not give rise toany substantial lessening of competition.• At this time the DTI had an agreement with LNM that it would:- Conclude a steel pricing agreement with the DTI that would replaceexisting import parity pricing (IPP) with a sustainable, developmentalpricing model that would raise the volumes of downstream steelbeneficiated in South Africa for both the export and domestic market incompliance with WTO (World Trade Organisation) Rules for the SouthAfrican Steel industry- Increase investment in liquid steel capacity from 6 million tons (Mt) to 9Mt(including expansion of Saldanha Steel capacity to 2Mt from 1.2Mt).

Market StructureFlat steel productsLong steel productsAMSA 80% 52%Highveld 20% (incl. imports) 15%Scaw 15%Cape Gate 12%Cisco 6%Scaw (Johannesburg)Highveld (Witbank)AMSA (Vanderbijlpark)AMSA (Newcastle)AMSA (Saldanha)Cape Gate (Cape Town)Cisco (Cape Town)


Issues• AMSA enjoys a monopoly position due to it being a former SoEand continued to enjoy preferential iron ore pricing (cost + 3%)- AMSA's monopoly position was not "earned" by being moreefficient than other competitors- AMSA is not in an innovative and dynamic market- There are significant barriers to entry• AMSA pricing at IPP to domestic customers and EPP to exportcustomers- EPP could be approximately 40% lower than IPP- South Africa is a net exporter of steel products- This was maintained through agreements with exporters notto resell their product back into SA

IPP pricing by AMSAIPP pricing by AMSA resulted in domestic customers paying farmore than what AMSA was able to receive on its exportsHot rolled coil steel prices – an example, US$/tSource: Iscor 2004 in DTI presentation to the Portfolio Committee of Trade & Industry, 24 Aug 2010Worldexport priceValue received on local salesAmount that localcustomers pay above whatMittal receives on exportsValue received on exports

IPP with surplus• Pricing at IPP is not itself a contravention of the Competition Act.The issue is whether or not a competitive market would result ina lower price than IPP.- If domestic producers do not have the capacity to satisfy thedomestic demand, then consumers will import the remainderof what they need and the market price will be IPP.- If domestic production is greater than domestic demand thena competitive market would lead to a domestic price close toEPP. If the market is not competitive then firms can increaseexports and increase the domestic price to IPP.• Situations where this distiction becomes critically important arewhere transport costs of importing are a large proportion of thevalue of the product.

SA export volumesExports are not incidental to AMSA’s strategy considering the largevolumes exported and the fact that AMSA has separate pricingstrategies for export and domestic sales.Steel sales: domestic sales, exports, imports andembodied in value-added exports, tons ‘000Source: DTI presentation to the Portfolio Committee of Trade & Industry, 24 Aug 2010


Prerequisites• Excessive pricing is tha abuse of a dominant position and thusthe firm has to be shown to be dominant.- The Act explicitly states that a firm with a market share ofmore than 45% can be presumed to be dominant.- The Tribunal argued that excessive pricing requires a greaterhurdle than a 45% market share. It is necessary to show thatthe company is super-dominant, a "near monopoly".• Barriers to entry that cannot be overcome by potential entrantsneed to be present.- These include high capital costs and cost advantages from asupply agreement

Tribunal decision• The Tribunal showed that Mittal was a super-dominant firm thatwas uncontested and in an incontestable market.• Mittal's ancillary conduct shows that it used its dominance toprice excessively in the South African market for flat steel. Theancillary conduct included:- Segmenting markets into domestic and export markets- Selective discounts in the domestic market to counter someconsumers ability to import, or to make steel a viable input inproduction of certain products where there are alternativeimputs.• In March 2007 the Tribunal thus found that Mittal hadcontravened Section 8(a) of the Act by charging an excessiveprice to the detriment of consumers.

Appeal of Tribunal decision• During the Tribunal hearing both parties put forward evidenceon price comparisons and profitability analysis.• The Tribunal did not use these arguments as such argumentswere informed by EC jurisprudence and the Tribunal did notwish to assume any price regulation responsibilities.• The Act however identifies that an excessive price be one whichbears no reasonable relation to the economic value of the goodand is indeed higher than this economic value.• These were the grounds that led to Mittal appealing the Tribunaldecision in which the CAC produced a general framework toidentify excessive pricing quantifiably.

CAC excessive pricing test• In the Harmony Mittal appeal the CAC outlined the followingapproach to identify excessive pricing:i. The determination of the actual price at issue;ii.iii.iv.The determination of the ‘economic value’, expressed asan amount of money, of the good or service;A comparison of the actual price and the economic value,and a subsequent value judgement regarding thereasonableness or not of the relationship between the two;and,A value judgement on whether or not the charging of anexcessive price is to the detriment of consumers or not.

CAC decision• While the CAC set the Tribunal decision aside in September2009, it was not because the facts of the case did not supportthe decision, but rather that there was no effort to assess thecredibility of the defense that AMSA was not earning excessprofits.• Indeed the CAC agreed with the Tribunal that AMSA's superdominance,together with the ancillary conduct, did constituteprima facie evidence of excessive pricing:"In summary, the dominance of Mittal read together with itscase in answer to respondent’s case, as pleaded, raised aprima facie presumption of a contravention of s 8(a)."-CAC decision, para 81


Comparator pricing• Comparing AMSA prices and costs with those in other coutriesgives an indication of whether or not AMSA charges more than"economic value" for steel in South Africa- It is this margin (price less the cost) that is the comparatorand not the price alone- These must be on an equal quality basis• This adresses the first three steps of the CAC framework:- The actual prices charged by AMSA is step i- The comparator price is the economic value in step ii- Comparing these two values is step iii• Another method is to compare prices charged it two differentmarkets where one market is more competitive than the other.

Comparator pricingSouth African prices have, for the most part, been on par withthose charged in the high price countries such as the US, Canadaand the EU. Costs in SA are, however, likely to be far lower than inthe these countries and closer to those in the lower price countries.Hot rolled coil prices, US$/t 2004 - 2010Source: DTI presentation to the Portfolio Committee of Trade & Industry, 24 Aug 2010

AMSA input cost advantages• The agreement with Kumba was for iron ore on a cost plus 3%basis (approximately $35 per ton).• Even if AMSA receives iron ore from Kumba on a market basisthe price would be below the export price (approximately $147)because Kumba has export bottlenecks. This is reflected in therecent offer by Kumba of a price to Saldanha of $50 and a priceto Vanderbijlpark and Newcastle of $80 (negotiated down to$70) per ton.• AMSA also enjoys cheaper electricity input costs than othermajor steel producing countries. This holds even after electricityprice increases.

AMSA price-cost cost analysis• The cost advantages, together with a high domestic price resultin large profits being earned by AMSA• Domestic prices in SA in 2004/05 were $613 with average costsof production of $335 resulting in an gross margin of 45%.• The expansions are expected to have led to cost reductions of$51 per tonne, thus increasing the gross margin to 54%.

AMSA expansions• 2006 AMSA strategy documents indicate plans to expand outputby 1Mtpa by the end of 2007 and another 1.5 Mtpa by 2012.These expansions were anticipated to result in cost reductions:- A quantified target of a 20% reduction in HRC/billet cashcosts by 2007 was stated• In 2008 AMSA had increased their expansion target to 10mt• In AMSA's 2009 annual report they stated that they hadexpanded capacity to 8mt, but that the schedule of expansion to10mt had to be reviewed in light of market conditions. Theyremained "confident [in] the long-term growth potential of the[region]" and intent on expanding capacity further.

“AMSA is not profitable”• Mittal has used profitability analysis to show that Mittal was notearing excess profits. The theory behind this is that:- Mittal has exceptionally high fixed costs based on Mittal'svaluation of their plants,- which results in substantial economies of scale,- and export sales making a partial contribution to fixed costsbut not to profits.- "Mittal's dual-pricing system is a business imperative"– Mittal claim as reported in Engineering News, 15 March 2006• This practical application by AMSA was disputed in the case,however never resolved. AMSA maintains that its plants are nothighly profitable.

AMSA profitability• Profits slumped in 2009 but have begun recovering at the endof 2009 and into 2010AMSA Quarterly Headline Earnings, 2005 – Q2 2010Source: AMSA interim results 20102009 losses were partially due toimports of steel slabs during theexpansions to keep the rolling millrunning. As these expansions comeonline profits recover.


AMSA’s s basket pricing• AMSA implemented a basket pricing approach in March 2006which is based in theory on comparator prices.- AMSA's basket is a simple average of 6 countries, 3 of whichare higher cost than SA (US, Europe, Russia) and 3 of whichare lower costs than SA (China and 2 developing countries)- AMSA may also manually modify the basket price frommonth to month based on demand and supply conditions• Ultimately it not clear whether or not the basket pricingimplemented by AMSA has resulted in pricing in line witheconomic value. Furthermore, facts presented to DTI by AMSAmay not be fully reflective of the actual pricing framework giventhat they were even "prepared to blatantly mislead the Tribunalon [the implimentation of basket pricing by AMSA]."(Harmony Mittal Tribunal decision, para 46)

The AMSA surcharge• During the dispute with Kumba AMSA applied a surcharge ontop of the basket price to customers- The basket would have included the iron ore costs ofsuplliers in the foreign countries. AMSA applying a surchargeto the basket may be interpreted as partially double countingiron ore input costs?• The theory on excessive pricing requires that a firm charge anexcessive price in the long term. The surcharge was, however,only imposed for a few months.• The ability to unilaterally impose a surcharge on goods doeshowever give good insight into the degree of AMSA's dominance

Current steel cases at the CCAbuseCartelInvolvingMittalNotinvolvingMittal

Steel Pricing in South Africa: Competition history and current concerns

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