RealKapital

**Edward Chancellor** (0:08)
Welcome to another episode of The Capital Cycle Podcast. I have with me Tytus Zurawski, who is an analyst on Marathon's European portfolios.

**Tytus Zurawski** (0:20)
Pleasure to be here.

**Edward Chancellor** (0:21)
So Tytus, changing global trade patterns pose a risk to capital cycle investors. The markets that were previously closed to foreign competitors are suddenly opened up. Dominant local players lose their competitive advantage. Their moat is breached. The rise of China's trading superpower has had that effect on many industries over the past three decades, including the European steel industry, which we're about to talk about.
Capital cycle investors, however, need to be alert to such changes. Your argument is that they also need to be alert to the opportunities thrown up by de-globalisation.

**Tytus Zurawski** (1:09)
Yes, the orthodox capital cycle dynamic of high returns, inviting competition, returns compressing, capital exiting and so on isn't actually abandoned. It's rearranged by the state instead of free market forces.

**Edward Chancellor** (1:27)
So, let's talk about the capital cycle and globalisation, de-globalisation in the context of European steel making, and in particular ArcelorMittal are holding in Marathon's European portfolios.

**Tytus Zurawski** (1:42)
ArcelorMittal is one of the largest steel producer with circa 55 million tonnes of annual output. It's a product of a hostile takeover in 2006 That story alone probably deserves a separate podcast.
It involves a Russian oligarch as a failed white knight. Metalsteel was a low-cost consolidator, famously known for opportunistic acquisitions of distressed assets in the former Soviet bloc. Arcelor, on the other hand, was a specialized producer of premium steel, for example, for the automotive industry. After the merger, it had been the largest steel producer globally until it lost its reign to a Chinese stand-on group.

**Edward Chancellor** (2:33)
So how does ArcelorMetal operate today?

**Tytus Zurawski** (2:36)
It has a truly global footprint. It spans emerging markets in Brazil, India, South Africa, Ukraine, alongside Western operations in the US, Canada, France, Belgium, Germany and Spain. It's a vertically integrated producer, which means, apart from Mills producing the end product, it also owns iron ore mines, which is the feedstock. Around 72% of its iron ore needs come from mines that are owned by ArcelorMetal, which reduces its exposure to fluctuations in iron ore prices. This is an operational hedge, if you will. But make no mistake, it's still a textbook cyclical, capital-intensive business with high fixed costs. A steel furnace never stops. You cannot turn it off. Otherwise, the molten iron solidifies and wrecks it. A costly decision to make, which also explains why capacity is so sticky.
Hence, the economics, the cash margins per tonne, are extremely sensitive to small changes in utilization rates and steel prices.

**Edward Chancellor** (3:50)
And since the turn of the century, China has had an extraordinarily powerful impact on the global steel industry, both positive and negative, you could say.

**Tytus Zurawski** (4:00)
Yes. The industry entered the new millennium with an exceptionally strong demand, driven by China's rapid industrialization. Early 2000s were truly the golden age of steel making. This is probably best illustrated by the fact that the metal family was one of the richest in the world back then, and they broke two Guinness World Records for most expensive wedding and most expensive house purchase.

**Edward Chancellor** (4:30)
And this commodity super cycle, as it was called, lasted quite a long time, but it didn't last forever. It grew weaker and more fragile with time.

**Tytus Zurawski** (4:42)
Yes, it peaked with China consuming as much steel as the rest of the world combined. And then 2008 global financial crisis came, vaporized demand, while China has been building out enormous domestic capacity in parallel. This created structural oversupply, which only got worse as Chinese property market, another big demand source, entered the downturn in 2014

**Edward Chancellor** (5:12)
Yeah, so with regard to China's steel demand, the joke used to be at the time that the Chinese were producing steel in order to build steel plants to produce more steel. At a time when the Chinese steel industry was operating with chronic excess capacity, and most of the demand for steel in China was coming from the great epic real estate boom that didn't exactly die in 2013-14, but it slowed, and that led to a step down in the demand for iron ore and other commodities, leading to a great bust across the commodity world and mining stocks crashed, and the global steel industry, as you say, was left in a position of chronic excess supply.

**Tytus Zurawski** (6:04)
Back then, global capacity reached the excess of 700 million tonnes. In other words, we are producing 40% more than we consumed, and the Western markets became the dumping grant for the excess supply from China.