EU forges ahead with steel sector M&A – but it won't solve overcapacity

European steel's current major M&A activity -- driven by market recovery since mid-2017 -- aims to achieve synergies and boost cost-effectiveness in a global steel sector still plagued by as much as 657 million mt of overcapacity, according to Organization for Economic Cooperation and Development estimates.

ArcelorMittal (AM), the world's biggest steelmaker, is to acquire Italy's biggest, Ilva, while the knot has been tied between Thyssenkrupp Steel Europe and Tata Steel Europe in a union still to receive the European Commission's final blessing. But while both deals are expected to proceed, they won't solve Europe's steel overcapacity problem: analysts maintain actual capacity closures are still far off due to restrictions by local authorities and trade unions.

Big is not always beautiful, and especially not where the EC is concerned: the M&A merry-go-round of shifting assets will continue in a move to preserve jobs and improve loss-making installations. Social concerns play a pivotal role in the EC's holistic industrial restructuring scheme. The TK-Tata merger may require tinplate assets to be sold. AM's merger with Ilva will also require divestments: German steelmaker Salzgitter mid-July submitted an offer to buy production lines at AM mills in Dudelange, Luxembourg and Liege, Belgium.

Analysts estimate the EU steel industry's overcapacity in 2016 was more than 5 million mt/year, around 3% of regional domestic steel consumption of 157 million mt at the time: a small amount compared to the global figure and which followed major capacity cuts in the EU from 2014-2016, when 13.5 million mt was permanently taken out of production, according to OECD data.

However, even 5 million mt of inefficient or unproductive capacity may be costly to maintain when cost-effective production is the best tool to help correct the EU's steel trade deficit with the rest of the world: this deficit broadened to 7.9 million mt in the first five months of 2018, on an annualized basis nearly doubling from the previous year.

Recent M&A activity will "fail to reduce overcapacity issues as a result of takeover terms...smaller steelmakers will likely look to acquire rivals if the bigger deals go through in an effort to scale up their operations to better compete with these two larger groups. We also see the scope for niche M&A deals in specialty steel," said Moody's vice president, senior credit officer Gianmarco Migliavacca.

Cases in point: Schmolz +Bickenbach recently acquired Asco Industries (Ascometal) to strengthen its position in Europe's special engineering long steel segment, while Aperam is buying VDM Metals Holding GmbH to bolster its position in special alloys. Cross-border deals are playing a part: Japan's biggest steelmaker, Nippon Steel & Sumitomo Metal Corp., acquired Swedish engineering steelmaker Ovako Group AB in June.

From a purely commercial point of view, the odds are stacked against complete M&A success in the mature, high-cost European steel market while modern steel mills emerge elsewhere, particularly in Asia. The TK-Tata Steel Europe deal is seen very much in the hands of the unions, with promises of no compulsory redundancies until 2026 preventing any major cost savings in labor.

Charles de Lusignan, spokesman for Eurofer, the European Steel Association, said: "Consolidation in the sector does not a priori result in reductions in capacity, but it certainly does not preclude it either: it really rather depends on the circumstance-specific investment decisions of a given new company."

The backdrop is improving for European steel's profitability overall: the EC has over the past two years taken a more proactive stance on dumping of steel, and has stood up to the US Section 232 import tariffs with a carefully thought out tariffs and quota import control system. China has substantially reduced its steel exports and global steel prices have remained firm as protectionism has risen. According to Eurofer, production activity in EU steel-using sectors was forecast to grow by 2.8% in 2018 and by 1.9% in 2019, above expected GDP EU growth.

Still, this is perhaps a moment for Europe's mills to reinforce their emphasis on quality rather than quantity, especially as stricter production regulations loom in the region's carbon markets.