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The $10 billion question for steel

The American steel industry today stands at a crossroads. The decisions it makes in the near future will determine the course of the industry over the next decade and possibly even longer. Confronted with these crucial decisions, the industry is vacillating. The prime example of this is the postponement by U.S. STeel of its $2.5 billion Lake Erie facility, the industry's first new integrated plant in almost two decades.

This indecision in the corporate boardroom is understandable, for the decision to expand steel production in the United States is a complex one. It can only be understood in the context of recent developments in the world supply and demand for steel.

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World steel production broke a record in 1978. In the past, record-breaking opeations were associated with near capacity operations. This was not the case in 1978. Average capacity utilization in the world and the US was only 87 percent. Furthermore, the regional distribution of this capacity utilization was not uniform. Western Europe and Japan's capacity utilization was only in the 70-75 percent range, which left a large floating supply of steel in world markets and kept a heavy lid on steel prices, a situation which still prevails.

Against this near-term situation of oversupply looms a longer-term threat of a steel shortage. There is general consensus that the world demand for steel in 1985 will lie in the 900-950 million metric ton range even after allowance is made for smaller cars and higher net yields of finished steel. Projected world demand for 1985 compares with a current steelmaking capacity of approximately 810 million metric tons, indicating the need to construct over 100 million tons of additional world capacity in the next five years.

Given this outlook, one would think steel executives around the world would be vying with one another with their plans to increase output. Wrong. There are few or no plans in the developed countries of the world to increase capacity. Most investment currently planned will go for replacement and modernization expenditures including pollution control devices. On the basis of present plans, many of them vague, there will only be an additional 36 million tons of world steel capacity added by 1985, according to Peter Marcus, a leading steel analyst. Most of this will occur in less developed countries.

In order for the American steel industry to maintain its share of the domestic market in 1985, it would need annual capacity to increase by approximately 25 million tons. At present, only one-quarter of this needed increment is reasonably ensured.

What happens if Big Steel balks at making the big plunge into new capacity and takes its money elsewhere as it has been doing in recent years? The scenario might run something like this. World market prices of steel which are most sensitive to supply and demand conditions will rise more than domestic prices. This rise in prices will by itself increase domestic capacity somewhat. Past history has shown that during periods of high steel prices there is a delay in the retirement of overage equipment and newer equipment is pushed harder.

The share of imports will rise dramatically. In the short run a large portion of this will come from third-world countries, which have been the only countries building new capacity lately. In the longer run, the share of Japan in the US market will rise. The Japanese claim they can build a steel mill in two years which, if true, is the shortest lead time in the world. In the US a lead time of five or more years is required, a large part of which is spent in obtaining environmental clearances.

Eventually we shall witness a new wave of investment by American steel producers but not before there has been a considerable loss of the domestic market, part of which will be permanent if past history is any guide.

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At this point the US cannot avoid the problems that a steel shortage will create; it can only mitigate them. Several changes in government policy, however, can encourage a faster rate of growth in steelmaking capacity.

Perhaps the single most important structural reform would be the allowance of the more rapid depreciation of steel facilities for tax purposes.One could argue for this as a general policy for all of industry to stimulate growth, but it affects the steel industry particularly strongly because of the large amount of long-lived equipment employed in the steelmaking process. Depreciation rates in Europe and Japan vary from 5 to 11 years compared to an effective rate of 15 years in the US.

In the future a more consistent steel price policy must be pursued by the government. The de facto control of domestic steel prices and the advocacy of free trade in steel of recent years is one of the worst possible policy mixes that could have been chosen. It has led to a perverse price behavior by the industry, with domestic prices rising less than foreign prices in boom periods and rising more than foreign prices in slack periods as the companies attempt to restore normal relative price relationships. If direct or indirect price controls are to be maintained over the industry, it would be advisable to give the industry some measure of protection in periods of slack demand.

A more desirable alternative, if one believes in competitive markets, would be for the government to let steel prices respond to market forces. The American steel companies' domination of the domestic market is a thing of the past. One can place increased reliance on foreign competition to maintain price discipline. The result in the short run may be wider price fluctuations. In the longer run, however, there will be smoother growth in capacity and more stable prices.

The Environmental Protection Agency can facilitate the adaptation of the steel industry to the new environmental standard by timing its enforcement policies a little more with an eye on the business cycle. Companies' attitudes of what is possible change a great deal when there is a strong demand for their product. Indiscriminate application of current pollution standards could cause the closing of obsolete steel plants before new ones are available to replace them. It is up to the industry to come forth with a realistic program to replace its obsolete equipment and conform with the new environmental standards. The current hard line taken by both parties will only aggravate the future problems the industry faces.

The US steel industry is technologically sound. The projected increase in demand gives the industry a rare opportunity to regain some of its former market position. It is now up to the industry to come forth with a well-thought-out program to achieve this goal.

If strong action is not taken now, it is conceivable that US dependence on foreign steel will equal its dependence on oil before the end of the century.