Adam Smith Institute

The First International Conference on Commercial Opportunities in

 The Metal Sectors of Central & Eastern Europe

Restructuring of the Ferrous and Non-Ferrous

Metal Sectors of Central Europe

– a Review of the Progress Made

During the 1990s and of the Challenges Ahead

Andrew M Kotas & Roger F Price

Beddows & Company, Hatch Management and Technology Consulting

Vienna

1^st February 2000

Restructuring of the Ferrous and Non-Ferrous

 Metal Sectors of Central Europe

– A Review of the Progress Made

During the 1990s and of the Challenges Ahead

1.         INTRODUCTION

Mr Chairman, Ladies and Gentlemen.

We are honoured to be speaking here today about the restructuring of the ferrous and non-ferrous metal sectors of Central Europe. Transition of the region from a centrally planned economy to a free market system has, of course, not been easy over the last decade; and neither do we expect the coming years to be without their own difficulties. Yet with planning and perhaps a little foresight, maybe the process can be made a little more efficient and effective, or somewhat less painful. It is with this objective in mind that we present this paper today.

The ferrous and non-ferrous metal sectors share a number of similarities. Both are highly capital intensive industries. Both sectors are also subject to major swings through the economic cycle in terms of demand volume and market prices. At the same time the two are also different along one key dimension. Whilst at an average point in the cycle, aluminium, copper, and zinc prices are of the order of US $1,000 to $2,000 per tonne, carbon steel prices are closer to $200 to $500 per tonne. This price differential has the important consequence that, whilst refined non-ferrous metals can be transported to international markets some distance away, marketing of steel has a far more local flavour. Indeed, almost two thirds of steel that is produced today does not cross any borders at the first point of consumption.  In the non-ferrous metal sector, we estimate this figure as closer to 20-30%. As we shall later see, the issue of product ‘transportability’ is likely to have important consequences for the way in which the ferrous and non-ferrous metal sectors might evolve. At this point however it is perhaps instructive to review some of the progress made in restructuring during the 1990s.

2.         RESTRUCTURING PROGRESS

2.1       Ferrous Sector

In the ferrous sector, much progress has been made with ownership change, modernisation and investment, and indeed with organisational transformation.

• Government ownership of the steel industry has reduced in Bulgaria (Kremikovtsi), in the Czech Republic (Nova Hut, Trinec), in Hungary (DAM), in Poland (Batory, Buczek, Gliwice, Ferrum, Jednosc, Ostrowiec, Pokoj, Zabrze, Zawiercie and Zygmunt), in Romania (Artrom, Ductil, Laminorul Focsani, Silcotub, Otelinox Targoviste,  Tepro) and in Slovakia (VSZ Kosice, Podbrezova). Roughly 30 steel companies from a full list of approximately 60 in the region are now in private hands.
• Across the region, with investment in electric steelmaking, obsolete open-hearth furnace steelmaking has fallen from about 22% of the total in 1990 to just 1-2% today.
• At the same time, continuous casting has increased from less than 20% to over 66%.
• Reported employment has fallen from 580,000 to 270,000. This in large part has resulted from organisational transformations whereby non-core activities (e.g. power generation, maintenance activities, catering functions etc) have been spun off into new, legally distinct business units.
•  

Despite this apparent progress, much more restructuring remains to be done. There still exist  too few steelmakers with strong balance sheets which one could rate as world class. Many of the larger steel companies (some of which today hover on the brink of bankruptcy) have yet to be successfully privatised, and the cost of turning many of these larger businesses around could run into billions of dollars per company. Funding turnarounds on this scale is unlikely to be provided from either the public or private sectors; and the harsh reality is that several major steelmakers will undoubtedly be made bankrupt in coming years.

2.2              Non-Ferrous Metals Sector

Total production of non-ferrous metals in Central Europe is much lower than that of steel.  The known mineral deposits of the area, with the exception of bauxite in Hungary and copper in Poland, are relatively small.  In many cases the deposits are uneconomic and therefore cannot be considered as reserves.  However, restructuring of the industry has taken place in many Central European countries and there have been attempts to make unprofitable operations in the non-ferrous metal sector viable. A few examples of the problems of the non-ferrous metals industry in Central Europe, the restructuring efforts and the ownership changes that have taken place over the last decade are given below.

Bulgaria

Bulgaria is not rich in mineral deposits and the grades of the ore deposits being exploited are about half that considered internationally as being economic. During the period of a centrally planned economy the state fixed prices and provided subsidies for the mining industry.  In addition, the state controlled all capital investment but since the early 1990s it has provided little in the way of investment for this industry. Overall the production costs are high and the non-ferrous metals industry has been one of the heaviest loss-making sectors of the Bulgarian economy.     

The problems of the metal mining industry were recognised at the start of the last decade and in 1992 a decision (Cabinet Regulation 140) was taken to reduce activities in this sector; a list was made of the operations to be closed and liquidated.  However, there has been some delay in the full implementation of this plan because of the social issues and the lack of funds for retraining programmes.

In November 1998 the State Ore Mining Council announced a new strategy to reduce losses in the mining industry.  This plan involved restructuring 16 loss making mining companies, closing down unprofitable operations, reducing labour levels, rapid privatisation of auxiliary services and offering concessions for the development of new deposits of non-ferrous minerals over the next 15 years. Under the plans proposed some 3,500 people in the mining sector would be laid off by the year 2000 and by 2015 the number of employees in mining would be reduced from the 1998 level of 16,500 to 9,000. 

Since 1992 a total of 55 pits have been closed at an approximate cost to the state of US $1.75 million  and in 1999 eight unprofitable parts of mines were liquidated at a cost of about $5 million.  The Bulgarian government planned to generate revenue of about $2.6 million per year from the concessions to be granted on some 40 undeveloped deposits.  It is reported that the investment needed to develop the 40 new deposits is of the order of $110 million and that both local and foreign companies have shown interest in eighteen of these deposits.

However, there continue to be many financial difficulties within the industry: these have been exacerbated by recent low metal prices.  Although an accurate estimate of the total debts of the state-owned mining companies is not available it is reported that while in 1997 the 16 state-owned companies owed some US $7.6 billion, this increased to $19.5 billion by the end of June 1998.  Furthermore about $118 million will need to be invested in a capital programme for exploration, mine development and replacement of mining equipment in a two-year period from the end of 1998.  In addition funds are needed for environmental restoration including revegetation of damaged areas, which a national programme has estimated will cost $23.5 million.

In Bulgaria environmental aspects of the non-ferrous metals sector are an issue and a cause for concern for potential investors.  Although, in February 1999, a law was passed which made the state liable for the prior environmental damage of enterprises after they have been privatised there are still difficulties in this area.

Despite the apparent problems of the non-ferrous metals sector in Bulgaria there have been a number of companies privatised during the last ten years, including the following.

• The purchase of 56% of the MDK Copper Smelter by the Belgium group Union Miniere in September 1997 followed by the purchase of local shares so that in January 1998 it owned 97.5%.
• In February 1999 the Bulgarian government approved the sale of 75% of Asarel Medet to the employee and management buy-out company Asarel-Invest .
• Similarly the management and employees of Kardjali lead and zinc plant acquired 57%  of the company jointly with a Bulgarian company Kardzhali Invest which holds 5% of the equity.
• The Irish based mining company Navan Resources Plc owns 98% of Bimak AD which operates the Chelopek copper mine and concentrator.

Hungary

In Hungary, aluminium is the principal industry within the non-ferrous metal sector and includes all stages of production from the mining of bauxite, alumina production, smelting and the production of semi-finished and finished aluminium products. Approximately one million tonnes of bauxite are mined annually in Hungary; although some bauxite is exported most is processed locally to alumina for the production of primary aluminium both in Hungary and in neighbouring countries. There is a small amount of primary aluminium production within the country; this is inadequate for the large tonnage of semi-finished and finished aluminium products manufactured and substantial quantities of aluminium are imported.

Restructuring of the industry started during the mid 1990s with the initial splitting and privatisation of Hungalu RT  (the Hungarian Aluminium Corp.).  As a result of the privatisation a successful group, Magyar Aluminium RT (MAL), was established in the period 1995 to 1997.  Today this group controls about a third of the aluminium industry in Hungary and has holdings in companies involved in all stages of the process chain, including the only Hungarian primary aluminium smelter, Inota.  Since its inception MAL has made acquisitions and restructured its operations. In 1998 the group’s sales revenue was HUF 29.8 billion (approximately US $140 million), which is about 20%  higher than in 1997; approximately 70% of the group’s products are exported. Operating profits for 1998 are reported to be HUF 1.5 billion (about US $7 million).  The group is also making significant capital investments (with a present commitment of about  $10 million) in mining and plant expansions.

The American company Alcoa acquired a stake in the state-owned company Kofem in 1993 and became the full owner in 1996. Alcoa-Kofem produces hot-rolled and cold-rolled, semi-finished and finished aluminium products using imported aluminium ingot (mainly from Russia and the Ukraine). Alcoa is a strategic investor in Hungary and is one of the ten companies that account for 25% of Hungary’s total industrial exports. In the period from 1993 to 1998 Alcoa invested about US $250 million in Alcoa-Kofrem.

Other foreign companies have been active investors in plants producing aluminium components for the automobile industry.  Examples include the company Suoftec Kft, which is a 50-50 joint venture between the US’s Superior Industries and Otto Fuchs Metallwerke of Germany, that set up a plant producing aluminium wheels about two and a half years ago.  Recently plans were announced to increase the plant capacity from 2 million wheels per year to 2.5 million; all of this output is exported to Audi, BMW and Rover plants.  Another is the German aluminium processor Erbsloeh AG, which invested about US $6.5 million to set up a new facility to produce aluminium spare parts for BMW and Porsche.

Poland

The non-ferrous metal sector of industry is important economically for Poland: it creates about 2.5% of the total Polish industrial output, employs some 130,000 people in a total of 19 entities involved in mining and processing of the important non-ferrous metals.  Apart from the production of aluminium, which requires alumina imports, Poland is self-sufficient in non-ferrous metals, although the current known lead-zinc deposits are close to depletion.

Since about 1995 the non-ferrous metal sector has undergone technological and ownership changes; the latter through both privatisation and consolidation.  Most of the Polish non-ferrous metal companies are joint stock companies, some of which are listed on the Polish and foreign stock exchanges.  The two strongest groups in Poland are Impexmetal SA and KGHM Polska Miedz SA (KGHM). The non-ferrous metal sector is generally at an advanced state of privatisation with only four enterprises remaining state-owned.

Impexmetal today is an important industrial trading and holding company, and has nine subsidiaries and six associated companies.  Its strategy has been to invest in state-owned companies engaged in the metals industries. Impexmetal has acquired a majority shareholding in many important companies in the aluminium, copper, zinc and steel sectors.  When Impexmetal acquired a majority stake in Huta Aluminium Konin in 1995 it agreed to increase the share capital, implement an investment programme and maintain a number of employee guarantees.  In 1996 Impexmetal increased its holding in Konin to 80% and through this holding has a dominant position in the Polish aluminium market.

KGHM is a state-owned joint stock company with its shares quoted on the Warsaw and London stock exchanges.  As at 31 December 1998 the state treasury held 52.17% of the share capital (including the balance of shares [1.17%] held for employees and former employees), and Citibank NA held 16.45%. For the year ended 31 December 1998 KGHM made a net profit of PLN 178.75 million (approximately US $52 million).

There has also been some investment by foreign companies in the non-ferrous metal sector. The Norwegian company Hydro Aluminium Extrusion for example recently invested US $15 million in an aluminium stamping facility.  This produced about 8000 tonnes of aluminium sections in 1997 for use in the Polish construction, electrical, automotive and engineering industries.

Romania

Romania is not a large producer of non-ferrous metals but does have deposits of bauxite, manganese and smaller quantities of gold, zinc, copper and tin.  It is the aim of the Romanian government to exploit domestic resources rather than to import non-ferrous metals, where it can, even if the costs of production are high.  Formerly the mines were under exclusive  control of the state and dominated by eight specialist companies (Regia).  In 1998 the World Bank carried out a survey of the country’s existing mines and although details were not widely released, many of the operations were considered not to be viable.  In general, the mines tend to be small, low grade and high cost operations with a limited reserve base.

In 1998 Romania started to restructure the mining sector and offered financial incentives for voluntary redundancy; this was taken up by some 20,000 miners but new employment proved difficult to find.  In an attempt to overcome some of these problems the government declared many mining zones disadvantaged areas and offered fiscal incentives to investors. In October 1999 the World Bank and Romania also signed an accord for a US $44.5 million credit to finance the closure of loss-making mines and provide assistance in the economically depressed areas. Some $26.5 million was to be used to close down 29 unprofitable mines, and $13.8 million was to help to establish other industries, for re-training and job creation. The balance of funds was to upgrade and strengthen the administrative structure of the National Agency for Mineral Resources.

The Romanian aluminium industry is an important part of the non-ferrous metal sector and the Romanian government started to re-organise this industry in 1996.  The main purposes of the reorganisation were to streamline production and to improve the direction for investment.  Essentially a new holding entity was established to control the five state-owned plants, which cover all phases of aluminium production including semi-finished products.  There are two alumina refineries, a primary smelter, a rolling mill and a cable maker in the holding entity.  The primary aluminium smelter SC Alro Slatina is a relatively large operation (design capacity of 265,000 tonnes per annum) that has been upgraded in recent years and there are contracts in place for further improvements.  Plans are well advanced for the privatisation of the primary aluminium smelter and the rolling mill and interest has been shown by several western companies.

To date, two primary smelters in Romania have been privatised and some foreign companies have established joint ventures locally to exploit gold deposits in the Baia Mare area:

• In 1998 Allied Deals Plc, a London based company, acquired 69.99% of Phoenix SA, a primary copper smelter and refinery located near the town of Baia Mare; and in February 1999 took 50.89% stake in Elcond, the copper wire rod plant.  Current production of Phoenix SA is relatively low but Allied Deals has announced plans to increase output, in stages, to 100,000 tonnes per annum by the year 2004.  Similarly Allied Deals is planning to increase production of copper wire rod to about 90,000 tonnes per annum within 5 years.
• In early 1999 a Greek company Mytilineous Holdings acquired 60% of the State Ownership Funds shares in Sometra Copsa Mica the primary lead zinc smelting operation for the sum of about US $20 million.

Other

Other areas within Central Europe not mentioned in detail include the Czech Republic, Slovakia and the former Yugoslavia. These countries have a relatively small non-ferrous metal industry and are attempting to revitalise what there is: restructuring is following a similar pattern involving mainly privatisation.  

3.         THE MATTER OF COMPETITIVE & COMPARATIVE ADVANTAGE

Whilst historic legacies - principally evident in the form of Central European ferrous and non-ferrous metals businesses currently having very large debt burdens – may account for some businesses shortly going bankrupt, looking further to the future an equally important issue is whether these sectors have any form of competitive advantage in the international context to allow them to compete and survive.

3.1       Ferrous Sector

We have referred already to the fact that almost two thirds of the steel that is produced does not cross borders. Indeed, despite everything that we may read about trade disputes, just 15% or so of steel production is shipped between the world’s main trading regions. We consider this to be the consequence of the price level of steel in relation to the cost of transporting this product, an argument which applies to the bulk of the steel that is produced. With typical transport costs at say 15-20% of product cost for billet and slab, or perhaps 10% for galvanised coil or tinplate, industry economics dictate that proximity to customers cannot be ignored. For this reason, if Central European companies can produce steel with the appropriate product quality and offer local consumers the right level of customer service, they should be able to enjoy significant competitive advantage relative to other producers around the world. This is especially the case whilst Central European labour costs per tonne (despite differences in productivity) still remain low in relation to labour costs in Western Europe or North America. 

The important point to recognise, therefore, is that because of transport costs, there is no fundamental reason why Central European steel makers should be competitively disadvantaged to other producers around the globe in serving the Central European customer base. No producer can sell below cost for protracted periods of time and for the purpose of this argument we assume that rational economic behaviour (particularly of producers in Russia and the Ukraine) prevails. If this is correct, then the challenge in the steel sector is to continue with restructuring, to make further progress in privatisation, to continue the pursuit of viability  (particularly balance sheet strength) and the emphasis on improvement of product quality and service.

3.2       Non-Ferrous Metals Sector

Since non-ferrous refined metals in general have higher unit prices than steel – that is, non-ferrous metals comprise products that can be transported some distance so that trade is more important – the matter of comparative advantage is more important with non-ferrous refined metals than it is for ferrous products. Competitive advantage in the non-ferrous metal sector is possibly best thought of by distinguishing between the three different production steps:

• Mining and concentration;
• Smelting and refining;
• Processing.

If we reflect upon the most important sources of competitive advantage for each of these steps, we might conclude that these are as shown in Chart 1.

 
Chart 1:  Competitive Advantage in the Non-Ferrous Metals Sector

Thus for mining, we consider that ore quality and longevity of reserves, and in the case of concentrators relative proximity to the mines, are fundamental sources of competitive advantage. For smelters and refiners, port access and (especially for magnesium, aluminium, and to a lesser extent zinc) availability of cheap power are important. In the case of processing, closeness to customers (e.g. for just-in-time delivery) is perhaps the more prominent factor. Different sources of competitive advantage are nevertheless evident as one moves down the production process chain.

Looking at the Central European non-ferrous metal sector in this light, it is hard to avoid the question: where indeed might this sector (especially the mines, concentrators, smelters and refiners) derive competitive advantage from, and in which production stage will producers have most comparative advantage in order to benefit from trade ?

• Certainly, as far as mines or concentrators are concerned, there are ample reserves of good quality raw material for the production of copper in Poland while in Hungary (and to a lesser extent Romania) there are significant reserves of bauxite. However, reserves of lead and zinc are soon to be depleted in Central Europe; and in countries such as Bulgaria, the Czech Republic or Slovakia, there are essentially few non-ferrous reserves that might merit commercial exploitation.
• As far as the smelters and refiners are concerned, and after the increases in energy costs of recent years, there are now no countries in the region with especially cheap power. It is also of course just Bulgaria and Romania that have access to the Black Sea, with Poland accessible also through the Baltic.

The foregoing suggests to us that in the Central European non-ferrous metals sector, there are actually therefore rather few country/metal specialisations where, even if we ignore existing debt burdens, refined metal production is able to succeed. Yet we see a number of restructuring initiatives underway, despite the very evident absence of competitive advantage in these examples. Reiterating two of the examples made above:

• In Bulgaria, which is not rich in metals, and where the local ores’ metal content is approximately half that of leading mines around the world, government plans to develop 40 new deposits of gold, copper, lead, zinc and manganese at a total cost that is estimated at $110 million.
• In Romania, government’s plans in the non-ferrous metal sector are to exploit domestic resources rather than to rely on imports. Romania’s mines however are known to be high cost, low grade, and with a limited reserve base; and in many cases are thought to be non-viable.
  

In neither case, considering the theory of comparative advantage, can we understand why it is these rather than the more downstream sectors into which resources are being directed for restructuring. A central thesis of this paper is that Central Europe is more likely to have comparative advantage in processing of non-ferrous metals than in the production of the metals themselves. A string of recent investments supports this view:

• In the Czech Republic, Hutni Zavody Bridlicna – a new business which recently acquired the aluminium and foil assets of Kovohute Bridlicna - plans significant business expansion by targeting customers such as Philip Morris, Nestle, Danone, Kraft Jakobs, Suchard, Unilever and McDonalds;
• Investment in lead processing (lead accumulators) was recently completed at Kovohute Pribram in the Czech Republic;
• Suoftec, a US-German joint venture, reportedly plans to increase Hungarian production of aluminium wheels for the automotive industry; 
• Magyar Aluminium in Hungary is investing to increase capacity and improve product quality at its Kobal Kobanyai aluminium foil plant, where it has targeted the food industry and household products as important end use sectors of the future;
• Investment in new hot dip galvanising plants which proceeds apace in Poland, where 14 new plants have been brought on-stream in the last four years;
• Investment in the Polish copper pipe sector. From a demand base of ~12,000 tonnes in 1997, consumption in this high growth sector is expected to increase to 40,000 tonnes by 2005-2010. Hutmen invested in ~10,000 tonnes per annum of additional copper pipe production capacity some 18 months ago;
• Elcond in Romania, which, after its acquisition by the UK’s Allied Deals, plans to increase copper wire rod production from 20,000 tonnes in 1998 to 90,000 tonnes by 2004.
  

Whilst the above is undoubtedly not an exhaustive list, and it is a somewhat mixed bag, it nevertheless highlights opportunities in the non-ferrous metals sector which can both expand demand for locally produced non-ferrous metal products and create employment. Using steel as an example of processing, adding perhaps $50-$100/tonne of value at one extreme (Chart 2) and aluminium, as an example of processing adding perhaps $1,000-$2,500/tonne of value at the other extreme (Chart 3), it seems clear that participation in non-ferrous metal processing in Central Europe should also offer the opportunity to generate profit, particularly if production for export as well as domestic markets is planned.

Chart 2:  Value Chain for Steel

• institutional reform (financial markets, banking, law enforcement, the judiciary etc);
• corporate law (efficiency of bankruptcy procedures, financial openness, shareholder rights, creditor rights);
• more appropriate commercial behaviour (non-discrimination against foreigners, transparency where appropriate, objectivity in decision making etc).