Research Speak - Iron & Steel and Infra Special

Week Ended – 9th April, 2010

Introduction

The impact of the US credit crisis on the commodities market is widely known, in line with other commodities like
crude oil whose price dropped to $30s the steel prices corrected from the record high levels in 2007. However,
with the easy monetary policy initiated by the US (in the form of quantitative easing) and followed by other
central bankers from Europe to Japan trying to implement Keynesen economics involving easy fiscal and
monetary policy to stimulate economy. China responded with $585 billion of stimulus and India has been no
exceptation in this regard. All these concerted effort started yielding result with demand started to pick up and
easy money and weak dollar sarted to have positive impact on the commodities and the equities market alike all
over the world.

The result of these measures are very much evident when we compare the prices of HRC, CRC, Long products etc
that are trading today vis-à-vis the lows in 2008-09. The HRC and CRC prices hit $250-300 during this period which
are currnetly trading at $750 and $850 respectively. Similar is in the case of plates which are trading at a price of
$850 fob USA, east of the Mississippi. In case of long products, the current rebar prices are trading at $650 fob
USA, east of the Mississippi and the same is available at $550 ex work Mainland China.

Current Price Trends

Indicative price of steel currently ruling in India as far as Steel sheets are concerned are as follows,

the price of 1 mm thick cold rolled sheet is at Rs 47,000 per ton, excluding VAT, which was earlier at Rs 44,000
per ton last week. Similarly, the price of 2 mm thick hot rolled sheet was at Rs 42,000 per ton, excluding VAT,
which was earlier at Rs 40,000 per ton last week.

Similarly the long product prices (in Rs.) are as follows:

Product Description Jan'10 Feb'10 1st 18th 29th

March March March
Billet 125x125mm IS 28700 25400 26750 29250 32250
2830
Billet 65x65mm IS 28850 25550 26900 29400 32400
2830
Bloom 320x250mm 28500 25200 26550 29050 32050
WT
Channel 150x75 33300 32300 33550 35550 38550

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 IS2062 Gr.A
Rebar 16mm IS 1786 34000 32500 34000 35500 38500
Fe 500
Rebar 8mm IS 1786 Fe 35000 33000 34500 36000 39000
500
Round 20.64 mm 40500 39000 39750 41750 44750
55Si7
Round 40mm IS 2062 31600 30600 31850 33850 36850
Gr.A
Wire rod 7 mm PC115 34000 33000 33750 35750 38750
Wire rod 8 mm IS7887 32950 31950 32700 34700 37700

Other things remaining contant the prices are likely to remain higher in the current and the next fiscal.

Over Capacity Still Exist…………Then Why prices are Going Up?

The current surge of prices of steel in particular is a function of both the increase in demand and also the prices
of the rawmaterial that goes in the manufacturing of finished steel. While formal causality study using
ecnometri c modeling could be performed, intuitive expalanation of this phenomenon can yield a reasonablely
satisfactory result.

In the western world especially in USA and Western Europe the capacity utilisation rate in the post crash era
dropped down to as low as 35-40%, as a consequence companies like Arcelor Mittal, Corus, Nucor, USA Steel,
etc., had cut down their production significantly to cope up with the falling demand and prices. Even today when
the demand in these countries have started to revive the average capacity utilisation has not exceeded 60-65%.
However, the demand and hence production seem to be in the continuous path of recovery. Thus, if we try to
explain the price rises from the supply side contraint it would be very difficult to explain as there does not exist
any constraint per se. However, the main contributor to this price rise is attributable to the unprecedented rise in
the raw material prices, viz., Iron Ore, Coking Coal, thermal coal etc.

The following is the indicative cost structure of a typical integrated Steel Manufacturing company through Blast
Furnace Route:

Item $/unit Factor Unit Unit cost Fixed Variable Total

Iron ore 1.435 t 62 88.97 88.97
Iron ore transport 1.435 t 20 28.7 28.7
Coking coal 0.519 t 128.5 66.69 66.69
Coking coal transport 0.519 t 19.5 10.12 10.12
Steel scrap 0.162 t 325 52.65 52.65
Scrap delivery 0.162 t 5 0.81 0.81

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Oxygen 80 m3 0.08 6.40 6.40
Ferroalloys 0.014 t 1400 19.60 19.60
Fluxes 0.521 t 30 15.63 15.63
Refractories 0.011 t 600 6.60 6.60
Other costs 1 13 3.25 9.75 13.00
By-product credits -20.00 -20.00
Thermal energy, net -2.68 GJ 12.50 -33.50 -33.50
Electricity 0.122 MWh 150 2.75 15.56 18.3
Labour 0.64 Man hr 35 5.6 16.8 22.4
Depreciation 40.00 40.00
Interest 44.00 44.00
Total 95.6 284.78 380.37

Raw Mateial Dynamics

As it is evident form the above table that raw material cost consist of about 65% of the total cost of production of hot meta l.
If we factor in the current iron ore prices of $130/ton the cost of production goes up by $97 to $477.96. As per our
understanding we expect the prices of raw material to remain strong for the forseeable future. In the iron ore segment, the
world is dominated by ony few players viz., BHP Billiton, Rio Tinto and Vale of Brazil. Together they control northward of 75%
of the world iron ore market. After the collaps of last year’s negotiation with the China Iron & Steel Association, the iron ore
companies returned back with vengence, where they have offerd to sell their products to steel companies at a price which is
100% higher compared to the last year’s price. In the recently concluded deal with Eurpoean Steel makers the price
commanded by the iron ore producers have been accepted by the EUROFER, much to their dismay and reluctance. Apart
from the high price, the iron ore producers have also stipulated that vhence forth the long letm contracts are going to be set
on quarterly basis contrary to the previous 1 year time frame.

Same is the case with the coking coal. The prices quoted by BHP Billiton, one of the larget producer of coking coal in the
nd
world, is in the vicinity of $200. Some are quoting it at $250-300 for delevery in the 2 quarter of FY2011.

As it can be seen from the above discussion the prices of raw material has risen at acclerated pace in the last one year
compared to the prices of finisned steel. Thus, going forward, citeris paribus, the steel prices in the international market are
going to catch up to this hike in the raw material prices as steel majors all over the world will continue to pass on the hike in
cost of production to its ultimate consumers.

Demand Side Dynamics

Now, analysing the situation from the demand side as well, things are looking very price positive for the steel industry. As we
can see that despite slower growth in the export front, the Goldman Sachs China Activity index, gross domestic product
indicator for China, at the moment is growing at the rate of 14% annually. The Chinese government has taken up the
mandate to make its economy a self sustaining one and as such is spending heavely to improve infrastructure to enhance its
own standard of living and enhancing purchasing power of its citizens and from the look of it it seems they are doing preety
good job as well.

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On the same note the situaltion in USA and Europe, especially in Germany and France are visibly improving. India is also
doing resonably well.

Sources Of Steel Demand -The indian Scenario

As far as India is concerned, demand for steel is going to be on the upswing mainly on account of the
infrastructure development that has been lined up for the nation. As per CMIE estimates, projects worth Rs.
6500bn (~US$145bn) are scheduled to be commissioned in FY11 which will be the highest ever annual capacity
commissioning in the history of corporate India. In this Infrastructure segment will account for highest share of
incremental capacity creation. Electricity alone should account for >20% of the total capacity commissioning,
which is in line with our view that investment cycle is set to return. The Planning commission estimates that the
GCF in infrastructure could be much higher at ~Rs. 45750bn (~US$1000bn) in the XIIth Plan, with the GCF in Infra
rising to 10.25% of GDP by the end of the XIIth plan, implying doubling of the plan investments in infrastructure
over the XIth 5-year plan.

In the private space as well capex should be fortified by governmental push for infrastructure. Indian companies'
capex plans which had recoiled during the global liquidity crisis, seem at the threshold of a new upswing. Capacity
utilization has started to creep up in FY10 and may lead to higher capex if demand remains robust. We are
expecting the total installed capacity of steel would be in the vicinity of 95-100 million tonnnes by FY 2013-14. All
this points to the fact that India is going to require much more steel that is being produced currently and hence
would once again create upward pressure on steel prices.

Notable Development During the Week

Technology revolution to change SAIL’s Dinamics……….

This week Steel Authority of India Ltd (SAIL) has signed a memorandum of understanding with the Korean steel
major, Posco, for entering into a joint venture for steel production using its FINEX technology in order to bring
down the cost of production. The proposal has been cleared by the board sub-committee of the company
subsequent to the favourable feasibility study report submitted to the committee and the tentative time required
for commercial production to start has been estimated to be 2-3 years. However, the finer details of the deal
such as the nature of joint venture, and the estimated investments are still to be decided upon.

The FINEX technology uses non-coking coal fines and fines of iron ore, which are easily available to produce iron
to produce high grade steel which could be further processed by SAIL to make specialised steel. The feasibility
study has been conducted, the actual production might start in the next two-to-three years. The two companies
are believed to be looking at a joint venture to build a 5-million-tonne plant in Jharkhand. Posco, which has been
facing repeated delays in its proposed steel project in Orissa due to land acquisition and mining lease-related
problems, has been scouting for alternative opportunities.

Low production cost

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The cost of production of iron by using the FINEX technology was expected to be lower than the normal process
as it would not require the conversion of coal into coke. Usually iron is made in blast furnace using iron lumps and
coke (which we get from conversion of coal). The conversion cost of coal to coke is substantially high. However, in
this technology there would be no need to convert coal into coke as it is capable of using non-coking coal fines
and iron ore fines (no sintering or pelletisation will be required for iron ore fines).

Finex Technology
Finex is an innovative ironmaking process developed by Posco and Siemens VAI for the production of hot-metal
based on the direct use of iron-ore fines and non-coking coal. The production of hot metal is simplified because
the sintering and coking steps, necessary in the blast-furnace route, are eliminated.

The Process
Fine iron ore is charged into a series of fluidized-bed reactors together with fluxes such as limestone or dolomite.
The iron-ore fines pass in a downward direction through four reactors where they are heated and reduced to
direct-reduced iron (DRI) by means of a reduction gas – derived from the gasification of the coal – that flows in
the counter-current direction to the ore.

After exiting the final reactor, the DRI fines are hot-compacted to HCI (hot-compacted iron), transferred to a
charging bin positioned above the melter gasifier and then charged by gravity into the melter gasifier where
smelting takes place. The tapped product, liquid hot metal, is equivalent in quality to the hot metal produced in a
blast furnace or Corex plant.

Briquetted coal fines and/or lump coal are charged into the dome of the melter-gasifier, while pulverized coal is
injected into the vessel together with oxygen. The coal is gasified and a reducing gas is generated which is
comprised mainly of CO and H2 . After exiting the top of the melter gasifier, this gas is ducted to the fluidized-bed
reactor system to reduce the iron ore fines. A portion of the consumed reducing gas which exits from the top of
the fluidized-bed reactor train is recycled back into the system after CO 2 removal in order to achieve a higher gas-
utilization rate. The heat generated from the gasification of the coal with oxygen also serves as the energy source
for the melting of the HCI to hot metal as well as for the formation of liquid slag. Both hot metal and slag are
tapped exactly as in standard blast furnace procedure. The diagramatic representation of the tchnology has been
provided below:

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 Diargramatic Representation of Finex Tecnology Based Iron Making

The excess gas from the Finex Process is a valuable by-product which can be used for a variety of industrial
applications such as for heating purposes within a steel works, power generation or for additional DRI/HBI (hot-
briquetted iron) production.

Economic Considerations

The unique characteristics of the Finex process and its ability to use low-cost raw materials means that
both capital investment and production costs are much lower than in the blast furnace route. A 1.5-
million-ton-per-year Finex plant can produce hot metal more cost effectively than a modern three-
million-ton-per-year blast furnace. When oxygen and power plants are included in the comparison, the
capital and operating costs of a Finex plant will be approximately 20% and 15% lower, respectively, than
in the blast furnace route.

Environmental Aspects

The environmentally friendly nature of the Finex process ensures that it will be even more attractive in
the future. SO x, NOx and dust emissions are significantly lower in the Finex Process compared to blast
furnace route. This is due to the elimination of the coke oven and sinter plants – both major sources of
emissions. The sulfur contained mostly in the coal reacts with limestone to form CaS, which is bound in
the slag. Therefore, there is almost no opportunity for SO x to escape to the environment. NOx emissions
hardly occur in the Finex Process because the metallurgical reactions take place in a reducing
atmosphere, unlike the oxidizing atmosphere inherent in the sinter plant, coking plant and hot-stoves of

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the blast-furnace route. Dust emissions are low as well, due to the integrated and closed nature of the
Finex Process. It has also been verified that no dioxins are generated in Finex operations.

China puts Curb on the import of Low grade (Fe content <60%)………… Bad News For
Sesa Goa
Iron ore traders in China, the largest consumer of the steelmaking ingredient, have been asked to stop buying
low-grade material in a move to clamp down on speculative purchases. This “self-discipline” rule was agreed to
by the China Iron and Steel Association, and the China Chamber of Commerce of Metals, Minerals and Chemicals
Importers and Exporters.

The rules are designed to impact traders who imports low-grade iron ore but are not directed towards the
companies who comsume low grade ore directly. Indian iron ore exporters will have to directly export to the steel
mills in China in order to cercumvent this rule and maintain the quantum of the export to China in the medium
term. India and Australia are the two countries who ship substantial quantity of iron ore with less than 60 percent
content to China.

In this regard it is to be noted that the decision came when Vale SA, the world’s largest iron ore producer, and
BHP this year ended a four-decade system of setting annual prices by signing short-term contracts with Asian
mills, with the Brazilian company winning a 90 percent increase. The China Iron & Steel Association, representing
steelmakers, have declined to accept the move to quarterly contracts or the price increase.

China’s iron ore imports surged 42 percent to a record 628 million tons last year.

However in the short term indian exports of iron ore especially from Goa region would fall substantially.
Currently 80 percent of India's total iron ore exports are in that bracket of below 60 grades. In 2009/10, Indian
exported 106 million tonnes of iron ore out of a total production of 222 million tonnes, most of which went to
China.

Impact on Sesa Goa

Sesa Goa, which export more than 80% of its iron ore in China is likely to be majorly hit due to this
announcement. The company’s avarage ore grade would be below 60% Fe content as majority of its mines are in
Goa which produces “Blue Dust” having Fe content in the range of 57-60% Fe content. Moreose, though the
company has been trying to change its sales mix to 50% contract and 50% spot, however, the company is far
away from such situation. Currently the company sells 65-70% of its ore in the spot market, making the company
tremendously vulnerable to this development. Thus we change our rating on the company from last week’s Hold
to Sell at the current market price. Insteade we recommend to switch to NMDC.

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Stock Recommendation at current market price

Stock Name Recommendation

SAIL Hold
JSW Steel Hold
JSPL Hold
Bhushan Steel Hold
Sesa Goa Sell
NMDC Buy
Gujarat NRE Coke Hold
Welspun Guj. Hold
Jindal Saw Reduce

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Infrastructure
Amendments to model Request for Qualification (RFQ) for Mega Road Projects: Positive for Big Developers

Project Size (In Cr) Networth Limit of projects

without financial
closure
Less than 2000 25% of TPC 3
2000 to 3000 500 Cr + 50% 3
of amount by
which TPC
exceeds 2000
Cr
3000 or more 1000 Cr + 2
100% of
amount by
which TPC
exceeds 3000
Cr

As we see above the Ministry of Road Transport & Highways have made a major change in the qualification
norms to involve only serious bidders for future NHAI projects. This amendment would lead to the following
developments:

1. Infra developers with strong financial backing can only participate in mega projects going forward.
2. Pressure to complete financial closures for further bidding would lead to significant reduction in time
lag (currently 6-12 months) between receipt of LOA and commencement of construction.

Further developments on the NHAI projects:

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 1. MORTH has identified nine mega highway projects, each requiring an investment of Rs.4000 cr. The
bidding for mega roads — of length varying between 390 km and 700 km — would start end of this
month.
2. There would a curb on non-performers with a ban on submitting an application for any project “either
individually or as a member of a consortium” if it has been declared as non-performer or blacklisted by
the NHAI as on the date of application.
3. MORTH has decided to keep in abeyance the NHAI’s proposal to shortlist only 8-10 serious players in
projects as it was prone to cause litigation. The NHAI had recommended short listing eight players for big
projects over Rs.3000 Cr and 10 for projects costing less than Rs.3000 Cr.

The road and construction industry is witnessing a constant review of policies in the direction of faster execution
cycle. It also expected that the industry would be helped by increased flow of funds. But these norms in a way
will also test the execution capabilities of big players as well in FY11. While there are a lot of road projects on
offer, there are very few players with the required financial and technical muscle in this field. Hence we may see
concentration of projects among few giants. At present things look in favour of the big players but we should
cautiously track the performance continuously.

Our Recommendation

Stock CMP Target Recommendation

IRB Infra 282 313 Buy
IVRCL 177 193 Buy

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DISCLAIMER:
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Analyst Team

Analyst Name Sectors E-mail Contact Number

Samudrajit Gohain Oil & Gas, Engineering samudrajit@eurekasecurities.com +91- 9748860335
Kinshuk Acharya Steel, Agriculture kinshuk@eurekasecurities.com +91- 9681478735
Md. Riazuddin, FRM Banking, Economy, Power riazuddin@eurekasecurities.com +91- 9903062346
Rajiv Agarwal Auto, Tea, Sugar rajiv.ag@eurekasecurities.com +91- 9903076345
Ankit Kanodia Infrastructure ankit_kanodia@eurekasecurities.com +91- 9163278562

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