At noon on February 26, from a temporarily set up "war room", ArcelorMittal SA's executive team were making frantic phone calls to directors, preparing them for the trading halt in the company's shares on the JSE.
They had just two hours to do this. Earlier, around 11 am, ArcelorMittal SA CEO Nkululeko Nyembezi-Heita and her executive team went to the JSE seeking advice on Kumba's plans to cancel a 2001 price accord that allowed the steel giant to purchase 65% of its iron ore at cost plus 3%. The JSE wanted to suspend the shares immediately, but Nyembezi-Heita and her team asked for more time.
ArcelorMittal's Nkululeko Nyembezi-Heita and Chris Griffith, Kumba Iron Ore
The JSE obliged, even though it may have left avenues for insider trading. What the JSE didn't realise was that the local steel giant, 52%-owned by Luxembourg-based ArcelorMittal, had received a letter from Kumba on February 5 giving it notice that the agreement would end on March 1. The company then took 21 days seeking legal advice before asking the JSE to suspend its shares. During this time, even its biggest local shareholders - the Public Investment Corp (8,95%) and the Industrial Development Corp (8,79%) - were kept in the dark.
Now the JSE is investigating whether ArcelorMittal SA breached rules on disclosing information - "when this situation became known and the timing". The JSE has asked Nyembezi-Heita for a report clarifying the delay, which the company says it has provided. If the JSE finds ArcelorMittal broke disclosure rules, it faces the possibility of penalties.
But news of Kumba's plans to pull the plug on the accord is not as sudden as shareholders have been made to believe. The FM has learnt from two sources that Kumba, then headed by Con Fauconnier, had notified ArcelorMittal SA, then headed by Davinder Chugh, about five years ago that the evergreen contract was not secure because mineral rights needed to be renewed.
The contract may have initially intended to support an ailing SA steel-making industry when state-owned iron and steel company Iscor was unbundled in 2001 into separate steel and mining businesses, Kumba Resources and Iscor (see timeline left). However, its impact changed over time. The heart of the fight now lies in the "sweet" iron ore supply accord made during the unbundling.
In January 2001 the ArcelorMittal group acquired its first holding in Iscor. It was a great deal for Indian entrepreneur Lakshmi Mittal, who in the next two years raised his stake to 52% and renamed the company ArcelorMittal SA. The local entity was awarded a 21,4% mining right in Sishen Iron Ore Co, a Kumba subsidiary.
Steve Meintjies
Around 2005, Fauconnier informed Chugh about the need for the steel giant to renew its mining rights. But someone at ArcelorMittal SA dropped the ball. It is unclear why the rights were not renewed, but it seems the steel giant may have assumed that Kumba, as the biggest shareholder of the Sishen mine, had made a single application to renew the rights on behalf of all its shareholders.
So when Nyembezi-Heita replaced Chugh as ArcelorMittal SA CEO in March 2008, she probably didn't identify it as a priority. As a result ArcelorMittal SA's 21,4% right, which is integral to the cost plus supply agreement, lapsed on April 30 last year and reverted to government.
Government could award these rights to another party and companies may have already applied for these rights. Kumba, under CEO Chris Griffith, may take advantage of this situation.
In January this year, Kumba's full board of directors voted to move away from the cost plus supply arrangement on the basis that ArcelorMittal SA did not apply for "new order" mining rights. But the question is why was there a 10-month delay between the expiry of the rights and its decision to cease supplying on a cost-plus basis. Kumba says it was seeking legal advice.
"[Competitively priced steel] is a key input and a lot depends on being able to achieve that" - EBRAHIM PATEL
For a company to successfully convert its "old order" rights to the "new order", it needs to comply with a long list of black economic empowerment (BEE) requirements, including equity ownership at certain levels. Kumba has been compliant for years and was granted conversions in 2008 for all its old order mineral rights. ArcelorMittal SA, though, had been seeking BEE partners but terminated its negotiations in 2008.
Should heads roll at ArcelorMittal SA? Insiders say there is no finger-pointing. CEO Nyembezi-Heita has the full support of the ArcelorMittal group in London and is spearheading an energetic defence. But are she and her board really made of steel? And can they appease the market?
When ArcelorMittal SA's share resumed trading on the JSE on March 3, it plunged 24%, to R88,21. Kumba's shares, however, which continued trading, climbed 13%, to R381,50, in the initial day or two of the standoff. Asked why ArcelorMittal SA's shares were halted but not Kumba's, JSE listing head John Burke says not enough information was available and that the bourse took the view that ArcelorMittal's shares would be more severely affected. ArcelorMittal SA's share has gained some ground in the past few days as the market waits to hear of a renegotiated contract. While an interim arrangement has been reached - the details of which are not being disclosed - it is understood that Kumba has proposed it continues supplying material to Amsa on a commercial basis and the price be adjusted later, depending on the outcome of arbitration.
The reverberations of this dispute will be felt beyond the JSE. It threatens the future of SA's biggest steel producer, government's job-creation strategy to grow downstream manufacturing industries and SA's attractiveness to foreign investment. There is a strong correlation between GDP growth and growth in SA steel consumption. A 2,6% growth in GDP will sustain similar growth in demand for steel. GDP growth above 2,6% will drive higher demand for steel.
Analysts reckon if Kumba cancels the agreement, ArcelorMittal SA's net present value may fall R17,5bn. It is SA's biggest producer of flat steel products ( 70% of the market) and it dominates the long steel products market, with a share of about 55%. If the steel-maker is not profitable because of losing its low-cost iron ore feedstock, it may at the very least have to cut jobs and restructure. If it does not meet the group's targets, ArcelorMittal global could pull out of SA, which would be negative for the rand.
ArcelorMittal vice-president Nicola Davidson says one of the reasons the group invested in SA was the "integrated model of steel-making", and that it paid R2,8bn for the supply contract with Kumba. " It seems clear that ArcelorMittal SA paid a huge sum of money for a right to low-cost ore that simply cannot just be cancelled. Kumba has a responsibility to honour this contract. We're confident of our position in SA."
Citigroup analyst Johan Rode says ArcelorMittal SA would have remedies under the Mineral & Petroleum Resources Development Act and the constitution to retain the ownership of the Sishen mining rights "or to potentially extract full market value. The next few months will be critical to assess the value inherent in Arcelor but it could be years before this issue is resolved."
But insiders say a solution needs to be sought urgently in the current environment of rising prices (see story on page 34). The most influential party, government, could play a role in broking an agreement that, perhaps, sees Kumba supply ArcelorMittal SA and other new steel entrants at a price above cost plus 3% yet below spot prices.
The department of trade & industry is monitoring the dispute, and department of mineral resources spokesman Jeremy Michaels confirms the department has held talks separately with both parties. But he won't elaborate, to avoid prejudicing the negotiations. But economic development minister Ebrahim Patel said last week that competitively priced steel was crucial.
"It is a key input into our economy and a lot depends on being able to achieve that in our industrialisation plans."
When Iscor was unbundled, iron ore and steel prices were in the doldrums but steel was considered a strategic industry for SA, as a big employer and Eskom customer. Today ArcelorMittal employs 11 500 people in SA.
Former Iscor executive chairman Hans Smith says the IDC objected to splitting Iscor, fearing it would not be profitable as a steel-maker in the long term. The eventual deal involved some "through the night" negotiations. "The cost-plus agreement was entered into when Iscor was both a mining and a steel operation and it did not matter to shareholders if one was favoured above the other because they got shares in both entities."
The supply contract ensured that this would be a vertically integrated operation, even though Iscor's major shareholder became a foreign group. The agreement gives ArcelorMittal SA the right to buy 6,5 Mt of iron ore a year from Kumba for the life of Sishen mine and all of Thabazimbi mine's production, currently about 2,5 Mt/year. "Government realised very quickly it had got itself into a one-way street where steel was concerned," says an industry source. "The market was anti competitive. Government was keen to bring in other steel producers but this was not feasible because Arcelor got the raw material input at cost plus 3%. Government may be keen for Kumba to win [this dispute] as it may make it possible for new steel players to enter the market."
The IDC, though a shareholder in the steel giant, is conducting a feasibility study into building one or more new steel mills in SA, both to increase domestic competition and to supply the African market. ArcelorMittal SA has the capacity to make about 8 Mt of steel a year, though it produced less last year because of weak market conditions.
SA's two other major steel producers also have foreign shareholders: Russia's Evraz Group owns 81% of Highveld Steel and Spain's Acerinox owns 76% of Columbus Stainless. Smaller steel producers include the Safal Group of India, which is building a mill near Pietermaritzburg, Cape Gate, Cisco and Scaw.
ArcelorMittal SA's dominance in the local market, as well as its long-held import parity pricing policy, sparked a spate of investigations by the competition authorities into collusion and excessive pricing (see story on page 34). Since 2006, the company has followed a different pricing strategy, which is in theory about 10% cheaper than the cost of imported products as it excludes transport charges. It also gives substantial rebates to different steel-using industries, like tin can and automotive manufacturers.
WHAT IT MEANS
 Lengthy arbitration between the two parties
Costlier steel or job losses
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Its basket price is not regulated, though government is consulted on it monthly. The fact that it is determined by external benchmarks makes it more transparent than the previous pricing model but it does not reflect the cost of steel-making in SA. The flaw in this pricing model became apparent once Kumba decided it would not continue to supply the steel-maker at cost plus 3%.
Imara SP Reid analyst Steve Meintjes estimates ArcelorMittal SA was paying Kumba about R200/t for iron ore compared with current spot prices at the rand equivalent of 984/t. "If we take, for purposes of illustration, a more likely long-term contract price of US$95/t at R7,60, this would amount to R722/t. If we then apply an additional cost to Arcelor of say, R500/t, on the full contract quantity of 6,5 Mt, this would amount to an additional annual cost of R3,1bn," says Meintjes.
The ball looks to be in government's court. Sensible intervention may help avoid harmful, protracted battles between the two companies. It has the power to allocate mining rights and influence the pricing structure.
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