The reason South Australian steelmaker Arrium went into voluntary administration comes down to one simple fact — the cost of making steel at Whyalla is higher than what the market is prepared to pay.
The world is making so much steel at the moment that that Asian steel prices are at 12-year lows. This put the Whyalla steelworks, Australia’s second biggest manufacturer and the only one to produce “long products” such as rebars, wire rod, sections, rails, sheet piles and drawn wire, at an operating loss of $43 million for the six months to December.
The usual solution for businesses facing similar challenges is to cut costs and bring down overheads to a point where profit margins return, even at today’s low prices.
One aspect of steel costs, iron ore, is at a low but Australian wages and other costs at the Whyalla plant are still too high.
And Arrium is on a double-edged sword as an iron ore miner. Low ore prices mean smaller material costs to make steel, but also less revenue from mining operations.
Arrium Limited is an international diversified mining and materials company listed on the Australian Securities Exchange, with three key business segments: Arrium Mining Consumables, Arrium Mining, and Arrium Steel.
In the 2014, Arrium Mining sold 12.5 million tonnes of hematite ore from operations in the Middleback Ranges, exporting via its wholly-owned port at Whyalla, as well as supplying its steelworks.
In the 16 years since the company was spun off from BHP (known briefly as OneSteel), Arrium has been working on costs and shedding jobs. In the first half of this year, about 300 employees went and another 400 were due by the end of the financial year.
Bluescope steel has shown the way in bringing back profit via what it calls relentless cost cutting, including slashing jobs and freezing wages, and keeping the Port Kembla steelworks south of Sydney from shutting.
Arrium was advanced in its journey down the same path. It had a target of cutting $200 million, with $100 million in costs being stripped from the steel works, over two years.
However, in February Arrium said prices had fallen so low than another $60 million in costs would have to go from Whyalla just to break even.
There are two factors at play. China is using less steel as its economy slows and the world is producing too much steel at the moment, as this chart shows:
The company’s attempt to restructure debt and bring down costs were derailed when its lenders, the banks and note holders, rejected an equity financing deal because this would have meant they would have got back only 55 cents on each dollar loaned.
The deal the lenders didn’t want was a $US927 million recapitalisation plan by GSO Capital Partners, which would have given the Blackstone subsidiary a 15% holding.
This pushed the company to yesterday call in the administrators. Its finance costs are currently running at $80 million a year.
Australia’s four major banks are reported to be owed as much as $1 billion by Arrium from an overall debt of about $2.8 billion.
Arrium also appeared to keen to preempt the banks and appoint its own administrators rather than letting its lenders chose who took charge of the business.
And at stake for the community is about 7,000 jobs across Australia and at the Whyalla steel works.
However, administration doesn’t necessarily mean the end.
“I am heartened by the administrator’s words that it is business as usual at the plant and they have assured me that they are communicating this with the workers across Australia,” says South Australia’s treasurer Tom Koutsantonis.
“The South Australian government expects to work closely with the administrators, the banks and the Commonwealth Government to give this business and the workers in Whyalla a viable future.”
The Australian Workers’ Union says the focus is on keeping existing operations open.
“Arrium’s operations, including the Whyalla steelworks, absolutely can and should stay open,” says National Secretary Scott McDine.
The Australian Industry Group says the Arrium situation is a reminder of both the pressures on Australian manufacturing and the critical importance of the steel industry.
“Arrium employees and businesses up and down its supply chain will be justifiably concerned for their future,” says Innes Willox
“This is a situation with national implications and potential deep impacts for regional Australia involving an essential nation building industry.”
The Whyalla wipeout, long bandied around by Australian politicians may finally be coming true. Just not for the reasons many once predicted.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.