Steel stocks may be down, steel prices may be going through the roof causing inflation to go up in India and allegations of cartelisation fill the air, but the country is poised to be the 3rd largest steel producer by 2013.

Strong local demand and global fundamentals will drive Indian steel output to 100 mn ton from 53 mn ton in 2007. Steel demand is expected to grow 4-5% over next four years despite recessionary conditions in the US due to rising share of emerging countries in global GDP.

According to Goldman Sachs, global steel supply will continue to remain tight in 2008. Investors can look forward to 2009 with hope as it will present a challenging operating environment for steel producers.

Indian steel consumption has accelerated from 3.4% in FY02 to 11% in FY07 and the momentum is likely to be maintained on the back of $ 540 bn infrastructure investment and $ 210 bn capital expenditure by various industries.

Among the factors that enable India to reach the third position include: higher domestic prices of finished steel due to strong local demand, lower iron ore costs due to trade surpluses, lower transportation costs due to proximity of mines, skilled manpower pool at low costs, and local coal availability, according to an assessment by Motilal Oswal Securities Ltd sent to its clients recently.

Strong local demand

There are only five producers of Hot Rolled Coil (HRC) currently that manage their sales such that there are no surpluses in the domestic market.

Thus, re-rollers have the option either to buy locally or import, thereby prices are based on import parity, which is generally higher due to factors such as: high sea freight, import duty of 5% and high inland transportation costs.

The prices for long products are marked up over the cost of import price of steel scrap. India is a net importer of steel scrap due to poor local generation and high consumption from a large number of mini mills. Therefore, long products too are priced higher.

Lower iron ore costs

India has rich iron ore reserves. The annual production of iron ore is above 160 million tons and 60% of this is exported. Total global trade of iron ore was 750 million tons in 2006 and Indian iron ore exports of 95 million tons were the third largest next only to Australia and Brazil.

The Indian iron ore industry being largely fragmented, miners are left with no choice but to sell at export parity prices. The high grade iron ore mines are located in Karnataka, Chhattisgarh, Orissa and Jharkhand.

Miners at these locations have to bear high inland transportation costs to send iron ore to the ports, about 400-600km away. Shortage of railways rake forces them to incur roadway transportation costs that are several times higher. Additionally, miners are liable for export duty of Rs 300/ton.

Therefore, prices of iron ore at the mine mouth are far lower than international prices. SAIL [Get Quote], Tata Steel [Get Quote], Jindal Steel Power have captive mines and are thereby insulated from input price risk.

Lower transportation costs

Indian steel producers are mostly located in iron ore rich belts and incur low costs despite high inland transportation costs.

Proximity to iron ore mine is more critical than the proximity to customers as the requirement is twice the volume of iron ore for every ton of saleable steel.

Essar Steel [Get Quote] and Ispat Industries [Get Quote] are few exceptions among the big mills. Global iron ore is located largely in Australia, Brazil, India, China, Russia and few pockets in Canada. Chinese and Russian ore is low grade.

Australia hardly produces steel while Brazil's production is lower than that of India. Most of steel production is concentrated in China, Japan, Korea, US, and Europe who have to depend upon imports incurring high transportation costs.

Low cost manpower

India has a rich pool of trained manpower due to overstaffing by two of its leading steel companies, SAIL and Tata Steel. Combined with lower salaries, the specific labor costs per ton of HRC produced is just $ 15-20/ton for players like JSW, Ispat and Essar Steel while the costs ranges from $ 50-150/ton in the Western world.

Local coal availabililty

India has 250 billion tons of coal reserves, the third largest in the world. Though Indian coal has high ash content and low calorific value, the cash cost of power generation is less than US cent 2/kWh.

Many of new generation steel plants have access to captive coal blocks or they are located in coal-rich belt of West Bengal, Jharkhand, Orissa, and Chhattisgarh.

Operating costs lower due to plenty of ancillaries

India has huge manpower base and has good ancillaries around most of the industrial locations, which supply spares, consumable, projects etc. at very reasonable prices compared to prices in the Western world.

Relatively lower specific capex costs

The cost of setting up an integrated greenfield steel plant in India is about $ 800- 1,000/ton depending on level of value addition on finished products, which is about 25% cheaper than the Western world. There has been little addition of blast furnace capacity in the West in the last 10 years.

Backward area incentives

Indian mineral rich states so far have remained poor and less industrialized due to low literacy etc. and a lack of political will. These states are now keen to attract investment to fuel economic growth and are bundling incentives such as allocation of iron ore and coal mines for captive consumption, land, and tax breaks.