Pakistan Steel Mills: The white elephant for the government

Insanity is a precise legal term and here is part of the first line from law.com’s lengthy definition: Insanity. n. mental illness of such a severe nature that a person cannot distinguish fantasy from reality. Those who dreamt up the project in 1971 to build an integrated government owned steel mill from scratch on the coast of the Arabian Sea near Karachi might not have been insane. But they did fail to distinguish fantasy from reality.
The project was doomed before it started. Pakistan Steel Mills (PSM), as it is known today, would employ 10,000 workers and produce one million tons of steel a year using obsolete technology provided by the then Soviet Union. The technological disadvantage may have been offset by the availability of local raw materials. But the Karachi mill was designed to use imported raw material - coal and iron ore - imported from as far away as Brazil and Australia.
PSM remains a white elephant. Despite having a monopoly in the Pakistani market, it has rarely made money. Last year, it reported a net loss of $200 million. This translates to a loss of $200 on every ton of steel produced. Today, because of political malfeasance, it employs 20,000 workers not 10,000. This means that PSM employs one worker for every 50 tons of steel it produces. The same ratio for the world's largest steelmaker Arcelor Mittal is one worker for every 400 tons! These fundamental disadvantages mean that, even with good, honest management, PSM is not a viable enterprise. So what to do?
The short answer is that PSM must be shut down. Privatization, a solution that is being considered by the government, is not an option. This is because the project by design destroys economic value. Privatized or not this is a project that damages Pakistan. Consider that it takes a ton of coal and three tons of iron ore to make one ton of steel. At current market prices the cost of these imported materials amounts to $450 per ton of steel. PSM currently sell steel at $570 per ton. So their gross margin defined as raw materials minus selling price is $170. And this money has to cover all other expenses such as labor, capital, power, overheads, depreciation etc. But it does not. Worse, we the owners have to cough up $200 for every ton produced. This means that all other costs amount to $370 per ton. So the real cost of producing the steel is $450 plus $370, which is $820 per ton. We need to ask: Why should we pay $820 per ton of steel when we can import the stuff at the current world price of $520 per ton?
An important issue is: What happens to PSM’s workers, land and machinery if it is shut down? The machinery is probably not worth much more than its scrap value and could be easily sold to scrap dealers. The land is invaluable and given the existence of basic industrial infrastructure it should be developed into an industrial park. Relocating workers will take time. The total annual payroll of PSM is of the order $100 million. To make the transition easy for workers the government could continue to pay them for a year or two to give them time to relocate. This would still be a lot cheaper for the Pakistani taxpayer than continuing to swallow the huge, never ending losses of running the PSM. The argument for having indigenous steel manufacturing is a good one: Steel is the basis of modern industrial society and nations serious about development must have the ability to make it. This is a desirable goal. But the way to achieve it was not to build a white elephant with obsolete technology, based exclusively on imported raw material and at a scale that left it congenitally inefficient. The logical way to proceed begins with the realization that Pakistan has ample reserves of coal and iron ore. One or more small mills located near these deposits should be built. A relatively new technology called DRI has made such mills feasible.
Twice in the past, proposals to establish such mills were made. The first was as early as 1956 when the German company Krupp AG offered to set up a mill at Kalabagh based on local ore and coal and the second in 1967 when another German company Salzgitter AG made a similar proposal. Salzgitter went a step further. To prove viability of its project it bought 15,000 tons of Kalabagh ore and converted it to 5,000 tons of steel at its German mill. The steel was sold to Volkswagen who used it to build cars. Both projects were viable and if implemented would have provided Pakistan with a basis on which to develop its steel industry.

• Nadeem Mumtaz Qureshi is the chairman of Mustaqbil Pakistan Party.