Steel Pricing in South Africa: Competition history and current concerns

1. Steel Pricing in South Africa: Competition history and current concerns September 2010

2. Contents History of Iscor/AMSA Issues leading up to the Harmony Mittal case Competition authorities decisions on the Harmony Mittal case Tests for excessive pricing and AMSA's likely defense Comments on the current situation

3. History of Iscor/AMSA 1927: Government established Iscor 1989: Iscor privatised with significant state shareholding remaining via the IDC 1996 – 1999: JV between Iscor and IDC to build Saldanha with tax incentives (S37E & S37H) 2001: Unbundling of iron ore mining into Kumba and steel making into Iscor. Iscor was required to ensure the viability and cost-competitiveness of local steel production alongside a competitive pricing regime.

4. 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 the Harmony Mittal case, AMSA introduced a pricing system based on an international basket of prices. 2009 – 2010: AMSA fails to convert its mineral rights resulting in a dispute over iron ore prices to AMSA by Kumba. AMSA then implements a price surcharge to customers deposited into an escrow account should AMSA lose the dispute.

5. LNM acquisition of Iscor • LMN needed to notify the Competition Commission of a merger with Iscor in 2004 because it planned to increase its shareholding in Iscor to above 50% (was 47.23%). The Tribunal approved this unconditionally because it would not give rise to any 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 replace existing import parity pricing (IPP) with a sustainable, developmental pricing model that would raise the volumes of downstream steel beneficiated in South Africa for both the export and domestic market in compliance with WTO (World Trade Organisation) Rules for the South African 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).

6. Market Structure Highveld (Witbank) Scaw (Johannesburg) AMSA (Vanderbijlpark) AMSA (Newcastle) AMSA (Saldanha) Cape Gate (Cape Town) Cisco (Cape Town)

7. Contents History of Iscor/AMSA Issues leading up to the Harmony Mittal case Competition authorities decisions on the Harmony Mittal case Tests for excessive pricing and AMSA's likely defense Comments on the current situation

8. Issues • AMSA enjoys a monopoly position due to it being a former SoE and continued to enjoy preferential iron ore pricing (cost + 3%) • AMSA's monopoly position was not "earned" by being more efficient 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 export customers • EPP could be approximately 40% lower than IPP • South Africa is a net exporter of steel products • This was maintained through agreements with exporters not to resell their product back into SA

9. IPP pricing by AMSA IPP pricing by AMSA resulted in domestic customers paying far more than what AMSA was able to receive on its exports Hot rolled coil steel prices – an example, US$/t Source: Iscor 2004 in DTI presentation to the Portfolio Committee of Trade & Industry, 24 Aug 2010 Value received on local sales Amount that local customers pay above what Mittal receives on exports World export price Value received on exports

10. 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 in a lower price than IPP. • If domestic producers do not have the capacity to satisfy the domestic demand, then consumers will import the remainder of what they need and the market price will be IPP. • If domestic production is greater than domestic demand then a competitive market would lead to a domestic price close to EPP. If the market is not competitive then firms can increase exports and increase the domestic price to IPP. • Situations where this distiction becomes critically important are where transport costs of importing are a large proportion of the value of the product.

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

12. Contents History of Iscor/AMSA Issues leading up to the Harmony Mittal case Competition authorities decisions on the Harmony Mittal case Tests for excessive pricing and AMSA's likely defense Comments on the current situation

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

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

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

16. CAC excessive pricing test • In the Harmony Mittal appeal the CAC outlined the following approach to identify excessive pricing: • The determination of the actual price at issue; • The determination of the ‘economic value’, expressed as an amount of money, of the good or service; • A comparison of the actual price and the economic value, and a subsequent value judgement regarding the reasonableness or not of the relationship between the two; and, • A value judgement on whether or not the charging of an excessive price is to the detriment of consumers or not.

17. CAC decision • While the CAC set the Tribunal decision aside in September 2009, it was not because the facts of the case did not support the decision, but rather that there was no effort to assess the credibility of the defense that AMSA was not earning excess profits. • Indeed the CAC agreed with the Tribunal that AMSA's super-dominance, together with the ancillary conduct, did constitute prima facie evidence of excessive pricing: "In summary, the dominance of Mittal read together with its case in answer to respondent’s case, as pleaded, raised a prima facie presumption of a contravention of s 8(a)." -CAC decision, para 81

18. Contents History of Iscor/AMSA Issues leading up to the Harmony Mittal case Competition authorities decisions on the Harmony Mittal case Tests for excessive pricing and AMSA's likely defense Comments on the current situation

19. Comparator pricing • Comparing AMSA prices and costs with those in other coutries gives 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 comparator and 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 different markets where one market is more competitive than the other.

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

21. 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 basis the price would be below the export price (approximately $147) because Kumba has export bottlenecks. This is reflected in the recent offer by Kumba of a price to Saldanha of $50 and a price to Vanderbijlpark and Newcastle of $80 (negotiated down to $70) per ton. • AMSA also enjoys cheaper electricity input costs than other major steel producing countries. This holds even after electricity price increases.

22. AMSA price-cost analysis • The cost advantages, together with a high domestic price result in large profits being earned by AMSA • Domestic prices in SA in 2004/05 were $613 with average costs of 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%.

23. AMSA expansions • 2006 AMSA strategy documents indicate plans to expand output by 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 cash costs by 2007 was stated • In 2008 AMSA had increased their expansion target to 10mt • In AMSA's 2009 annual report they stated that they had expanded capacity to 8mt, but that the schedule of expansion to 10mt had to be reviewed in light of market conditions. They remained "confident [in] the long-term growth potential of the [region]" and intent on expanding capacity further.

24. “AMSA is not profitable” • Mittal has used profitability analysis to show that Mittal was not earing excess profits. The theory behind this is that: • Mittal has exceptionally high fixed costs based on Mittal's valuation of their plants, • which results in substantial economies of scale, • and export sales making a partial contribution to fixed costs but 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 not highly profitable.

25. AMSA profitability • Profits slumped in 2009 but have begun recovering at the end of 2009 and into 2010 AMSA Quarterly Headline Earnings, 2005 – Q2 2010 Source: AMSA interim results 2010 2009 losses were partially due to imports of steel slabs during the expansions to keep the rolling mill running. As these expansions come online profits recover.

26. Contents History of Iscor/AMSA Issues leading up to the Harmony Mittal case Competition authorities decisions on the Harmony Mittal case Tests for excessive pricing and AMSA's likely defense Comments on the current situation

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

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

29. Current steel cases at the CC Abuse Cartel Involving Mittal Not involving Mittal