Background
1. In the early 1970s, Egypt's construction industry was highly dependent on
steel reinforcing bars which, despite some domestic production by the integrated
steel plant at Helwan and other mini-mills, were mainly imported. This high
dependency on imports, and the periodic shortages of rebars in the market had
placed a brake on the growth of the construction industry, affecting all
economic activities. The discovery of natural gas in 1970, offshore from
Alexandria, created a new opportunity for Egypt to meet its domestic
requirements for reinforcing bars by constructing a steel mill based, instead of
scrap, on directly reduced iron (DRI or sponge iron) which would be produced in
a Direct Reduction Plant (DRP) using natural gas as reducing agent for iron ore.
2. Since the early 1960s, the concept of mini-steelworks consisting of electric
arc furnace, continuous casting of billets, and rolling mills had been
extensively used in the industrial countries and some developing countries
(including Egypt) for the manufacture of reinforcing bars. The majority of these
plants were based on local scrap iron as their raw materials and the output was
mainly directed towards the same geographical area. Because of the erratic
nature of the international scrap market and wildly fluctuating prices, none
could depend wholly on imported scrap. The technological advances in the
production of DRI resolved the problem of scrap availability, especially for
that group of developing countries which possessed sufficient quantities of
natural gas.
3. In 1976, the idea of creating a steel plant at El Dikheila using the
gas-based DRI process was proposed, in an IFC report, to the Government of
Egypt. This report suggested the formation of a joint venture company with an
expatriate operating steel company (OSC) for the construction of the proposed
steelmaking plant. Upon acceptance of the concept by the Egyptian Cabinet, a
search got underway for such a partner. In June 1978, the Egyptian Government
formally requested the World Bank Group (WBG) to participate in the financing of
the project. Discussions between the WBG and the Government culminated in the
preparation of a memorandum of understanding that spelt out a framework for
implementing and operating the project. The framework envisaged that, in
addition to taking an equity position, the OSC would also provide engineering,
managerial and training services during the implementation as well as the early
years of operation, all provided that such an arrangement with an OSC not be
linked to the supply of equipment.
4. Contacts with interested operating steel companies produced two offers: one
from a Japanese Consortium (JC), and the other from a German Group. Whereas
neither group offered proposals totally in line with the provisions of the
memorandum of understanding, the WBGs analysis leaned in favour of the JC.
Despite the stipulation in the memorandum of understanding regarding the
delinking of equity participation and supply of equipment, the WBG accepted the
proposition by the JC that they possessed proprietary technology that could
significantly increase the operational efficiency of the meltshop and,
therefore, they could supply the meltshop equipment on a negotiated basis. They
were also permitted to participate in the international competitive bidding for
the rest of the plant, again on the grounds that their previously supplied DRP
and rolling mills had performed extremely well. In order to resolve the conflict
of interest issue, it was agreed that an independent consultant would conduct
the technical and commercial evaluation of the meltshop proposal and 'all other
bids. These provisions were accepted by the Government of Egypt and the JC was
nominated as partner in the joint venture in January 1979. In February 1979, the
Japanese International Cooperation Agency (JICA), was asked to prepare the
feasibility study.
5. Four years ago, the OED prepared an audit of the El-Dikheila Reinforcing Bar
Project. The audit gave an account of the efforts that went into its
preparation, appraisal, implementation and the first two full years of
production. The report rated the project's outcome as satisfactory and its
sustainability as likely. In addition, the report concluded that there were:
"two major risks which were glossed over in the risk analysis conducted at
appraisal-the possibility that long-term international rebar prices would be
much lower than the high equilibrium price forecast at appraisal and the
possibility of large exchange losses stemming from the high exposure of the
project to the cross-currency exchange risk between the yen and the dollar".
Since then, both these risks materialized and yet the company has survived the
shocks.
6. This Impact Evaluation aims at recounting Alexandria National Iron and Steel
Company - El Dikheila's (ANSDK) achievements since the audit, its impact and,
finally, the chances of its sustainability.
Performance Since 1991
7. The technical performance of the plant has been truly outstanding. The
complex has continuously broken its own records, reaching production levels far
above the nameplate capacity in every producing division. In 1994, the actual
production figures stood at 8 percent, 55 percent, 33 percent and 67 percent
above the rated capacities of the DRP, Meltshop, Bar Mill and Wire Rod Mill,
respectively. Considerable productivity gains have, of course, been at the root
of this impressive performance. High output to input ratio, declining energy
consumption, declining tap to tap time in the Meltshop, increasing operating
ratios in the Rolling Mill Shop and improvement in a host of other indicators
all speak of an increasingly more efficient operation. These technological
improvements have been associated with the introduction of many new grades of
rebar as well as the establishment of a quality control system that has made it
possible for ANSDK to obtain the ISO 9002 Certification. ANSDK was recognised by Midrex Corporation (the license-holder for the direct reduction plant) as a
worldwide leader for its superior performance in 1989 when production reached a
level of 12 percent above rated capacity.
8. In contrast with ANSDK's excellent performance, the outcome of the other
steel project supported by the Bank at the same time-the HADISOLB Rehabilitation
Project (Loan 2002-EGT)-has been disappointing. Therefore, it is important to
find out what made ANSDK such a success and which lessons can be learned from it
for future projects. As noted later, the incorporation of ANSDK under Law 43n4,
which provided for joint government ownership with a foreign partner, and
provided a considerable degree of autonomy to the enterprise, accounts for most
of the difference with respect to the fully Government owned HADISOLB. But some
specific aspects of ANSDK performance are worth exploring in more detail.
9. ANSDK has fully realized its objective of supplying a major part of Egypt's
requirement for reinforcing bars. Its continued excellent technical performance
can be attributed to its corporate culture that delegates authority and demands
accountability, rewards good performance and retains the loyalty of its
workforce. The choice of the top echelon of ANSDK's management and the
continuity of their service as well as the selection of other managerial and
supervisory personnel contributed greatly to the high human resource quality of
the enterprise. The human resource development program has consistently remained
at the core of the company's efforts to maintain its competitiveness. The
intensive on-the-job training of the workforce has not only resulted in
increasing labor productivity, but it has also made it possible to reduce the
number of expatriate ahead of time, thereby providing more managerial positions
for the Egyptian staff. Meanwhile, the company has taken full advantage of the
services and advice of the personnel seconded by the joint venture partners in
putting in place an efficient and competent operational organization.
10. Another important factor has been the maintenance philosophy pursued by the
company. Starting with preventative maintenance, then introducing condition
based maintenance (CBM) and eventually total productive maintenance (TPM)
concepts, the company has improved its maintenance systems considerably in the
last few years. To improve productivity, safety, plant availability and product
quality, the company has instituted quality control circles whose
recommendations are often put into practice.
11. The manufacturing costs (variable and fixed costs excluding financial
charges and general administrative and sales costs) per ton of rebar have
remained fairly stable at US$230 per ton of output in recent years, increasing
in 1994 to around US$250 because of the jump in several input costs. ANSDK's
total costs per ton of output have now stabilized around the equivalent of
US$290-300 which, although marginally higher than the steel mills in the
European Union (EU) and ANSDK's own export prices, are considerably lower than
export prices for rebars from Japan in recent years. The company started exports
in 1988 (when export prices were actually higher than domestic prices), which
reached 30 percent of total sales in 1994. The profit and loss account of the
company shows that despite heavy depreciation, amortization of pre-operating
expenses and financial charges the company has been profitable since 1988 with
the net profit increasing to around LE 1 15-120 million (nearly US$35 million)
in recent years. ANSDK has paid dividend every year since 1991.
Impact of the Project
12. In addition to its contribution to the growth of the industrial sector and
the creation of 2400 jobs, a major impact of the project has been to provide a
secure supply of considerable quantities of reinforcing bars to the domestic
construction industry, as well as exports. Now with ANSDK supplying 40-50
percent of the domestic demand, and other rolling mills (including HADISOLB)
supplying another 3040 percent, the local market's dependence on imports has
declined to around 15 to 20 percent. While small, these imports, nonetheless,
regulate the prices in the domestic market and maintain the competitiveness of
the local producers.
13. The project's impact in terms of foreign exchange savings is estimated at
US$850 million up to the end of 1994. This level of foreign exchange savings
approaches the actual cost of the project at completion, when calculated at the
prevailing exchange rates. This is a considerable achievement, especially when
viewed against the backdrop of heavy financial charges which resulted from the
movements in the yen/dollar exchange rates.
14. The project appears to have also had an important impact, as a role model,
on the Egyptian industrial sector in recent years. After incorporation of ANSDK,
a number of other entities were created under Law 43/74 and its successor Law
230/89, in which the Government or publicly owned enterprises held the majority
of shares, with a minority foreign partner. But these laws were not the right
vehicle for the restructuring of the existing public sector enterprises because
the main objective of these legislations was to attract foreign investment into
Egypt. With the promulgation of Law 203/91 which provides a framework for the
reorganization of the public enterprise sector into holding and affiliated
companies, some 314 enterprises valued at around LE 70 billion, with a total
labor force of about 1. I million have been earmarked for restructuring and
privatization.
15. The environmental impact has been well managed. In the course of iron and
steel making, considerable quantities of dust, fumes, noxious gases and waste
water effluents are generated. These environmental hazards are much more serious
in the traditional large scale steelmaking because the blast furnace process
requires sintered iron feed and coke. Steelmaking through the direct reduction
process obviates three processes-coke production, sintering and the blast
furnace-which generate large quantities of environmental pollutants. To this
extent the problem is more manageable and the mitigation measures less costly.
Nonetheless, the DRP itself is the source of significant dust and carbon
monoxide emission. So are the remaining processes in the chain such as the
electric arc furnace Meltshop, the continuous casting and the rolling mills. The
plants also generate considerable quantities of slag, water pollutants and
sludge.
16. From the outset, the company decided to adopt environmental pollution
control standards applicable in major industrialized countries, in this case
Japan. When the plant was being designed, attention was initially focused on two
major pollutants: atmospheric dust and sewage water quality. Dust was to be
controlled in the DRP, Melt Shop (Electric Arc Furnaces) and the Lime Calcining
Plant by dry cyclones, bag filters and wet scrubbers, suitably installed at
locations in the plant where considerable dust is generated. A monitoring system
was put in place for measuring, on a monthly basis, the dust content in the
exhaust gases from bag filters. Measurements of dust content in exhaust gases
from various polluting units result in figures that are consistently below the
100 milligram (mg)/cubic meter standard adopted in the original design.
17. In addition to dust monitoring and control, the plant has now instituted the
measurement of a number of other parameters such as carbon monoxide, sulphur
dioxide, nitrogen oxides, chlorobenzenes, noise and radiation. In terms of the
noxious gases, the S02 and N02 concentrations remain well below the permissible
levels both inside and outside of the plant, indicating that the pellets contain
low quantities of sulphur. The wastewater from the various units runs through a
treatment plant where the sludge is removed and the effluent flow to the sea is
brought within the water discharge specification. Most water quality
measurements are done on a weekly basis. In addition to the parameters
considered at the design stage, analyses include total alkalinity, total
hardness, chlorine and calcium content and total iron content. The system
handles some 200 cubic meter of water every hour. Except for the suspended
solids content which is close but still below the standard, the other parameters
are, on average, well below the permissible levels. The plant also generates
considerable quantities of slag and other waste materials notably collected
dust, sludge, scale and limestone fines. Such wastes including cold slag are
disposed of at a special site not far from the plant. All data concerning this
disposal such as quantity, type and location are recorded and plotted on maps to
ensure that waste materials do not contaminate underground water resources.
Overall Assessment and Sustainability
18. A number of factors account for the current strength of this company and the
manner in which it has overcome adversity. To start with, the insistence of the
Bank and IFC in having an operating steel company as a joint venture partner
with hands on management responsibility both during implementation and the
initial operational phase was instrumental in endowing the company with a
reasonable chance to succeed. The incorporation of the company under Law 43
provided the necessary autonomy and independence without which it would not have
been possible to implement the project ahead of schedule. The role and quality
of the Egyptian management team and counterparts was crucial in ANSDK's
successfull performance. Equally important was the attention paid by the
management to human resource development especially through on-the-job training,
twinning and other ways of transferring the skills from the expatriate staff and
consultants to the Egyptian personnel. This was coupled with delegation of
responsibility-cum-accountability, attention to employee welfare and a genuine
production incentive system, all providing the motivation for the outstanding
performance of the workforce.
19. Since starting production, ANSDK has played a pivotal role in the
development of the construction industry. While its production reached close to
63 percent of domestic demand in 1992, its export activities have provided not
only a source of foreign exchange revenue for the company, but also a means of
checking the level of prices in the international trade. The Company's
technological activities have made different grades of rebar readily available
in the Egyptian market while the high quality of its products has opened to it a
wide export market. ANSDK enjoys a cost advantage in the production of directly
reduced iron (DRI). The cost structure of the Company shows that the cost of
producing sponge iron has been less than the landed cost of imported scrap
(allowing for the degree of metalization). In 1994 the cost of DRI produced at
ANSDK amounted to US$117 per ton as compared with a CIF scrap cost of US$145 per
ton.
20. Designed to the Japanese standard of the early 1980s, and well maintained,
the plant's environmental protection performance has been quite satisfactory.
The installations of air and water pollution mitigation equipment and attention
to their remaining in good working order have ensured that dust emissions from
stacks and the quality of effluent discharge water have remained well within the
prescribed limits. Through periodic studies by outside agencies, the Company
makes sure that independent measurements are carried out and remedial
suggestions are received. ANSDK has, in recent years, taken additional steps to
reduce further the fumes that may still escape from the Meltshop into the
atmosphere.
21. ANSDK enjoys all the conditions for a sustainable operation. It is an
intrinsically economic and competitive plant operating under a substantially
undistorted regime and facing an expanding domestic market. Except for the price
of electricity which remains somewhat below long-run marginal cost, the price
for other imported or domestic inputs are at, or close, to international prices.
It is well established in the export market by virtue of its quality and price
competitiveness. It is strategically located on the coast and is close to the
natural gas resources. It has been operating within a competitive environment in
the domestic market where supplies come from other Egyptian manufacturers and
imports. Its impressive technical performance speaks of a most competent and
knowledgeable management and work force. It has access to technical assistance
through some of the most efficient steel producers in the world. It has
successfully internalized the know how brought to it by the expatriate
collaborators and built on it to continuously enhance productivity. Constant
attention has been paid to cost control and savings. It has been pursuing
operating and maintenance practices that have maximized plant availability and
resulted in very high operating ratios.
22. The weakest aspect of the project has always been the financing package,
which was fully discussed in the audit. The audit concluded that, as the project
was appraised and approved at a time of a high dollar exchange rate in the early
1980's, despite the fact that the greatest part of the equipment was to come
from Japan, the high level of cross currency risk was not appreciated and no
efforts were made to advise ANSDK to hedge against those exchange risks. ANSDK
was particularly vulnerable since the project's capacity to earn foreign
exchange, either through exports or through domestic sales designated in foreign
exchange were mainly in dollars.
23. In recent years, ANSDK has succeeded, with the help of the IFC, to reduce
its currency exposure by swapping its Yen-denominated obligation into US
dollars. This has brought in some measure of predictability to its costs until
the loans are completely retired in the next decade. The re-estimated economic
rate of return based on the actual performance in the last eight years comes to
10.5 percent. Once the initial project investments are depreciated and loans
paid off, ANSDK will become similar to many mature steel plants where
incremental investments will be associated with handsome returns. In fact one
such expansion project is currently underway.
24. This project entitled: "The Production Rationalization and Expansion
Project" is aimed at eliminating the imbalance that has arisen because
practically all existing plants operate at levels totally different from their
respective nominal capacities. The project also aims at upgrading the steel
making facilities and expanding the rod mill capacity to meet the anticipated
increase in demand for the small gauge "ire rods. Once completed, the annual
capacity of ANSDK will be increased from 1.1 million tons to around 1.5 million
tons of reinforcing bars and rods. This project is likely to be followed by a
Second Direct Reduction Plant Project which aims at duplicating the existing
direct reduction plant to provide the raw materials for the meltshop.
25. The shareholding structure of the company has, in recent years, changed
significantly towards more private ownership (and lower debt/equity ratio). The
IFC played a very crucial catalytic role in the privatization drive. The most
important change came with the Employee Fund subscribing nearly f. E 96 million
(13.72 percent) to the new capital of ANSDK. The IFC also decided to increase
its shareholding from 3 to 5 percent, whereas the Japanese shareholders chose to
maintain theirs at 10 percent. This latest capital increase has helped the
Company to reduce its debt to equity ratio to around 66/34 from about 80/20 in
199 1. With other private shareholders buying nearly another 7 percent of the
company's shares, the private shareholding stood at about 36 percent at the end
of October 1995.
Conclusions and Lessons Learned
26. Had it not been for its outstanding performance and early start of
production, the project would have succumbed to the financing problems it faced
arising from factors beyond its control. The project's technical and managerial
aspects were sound, bringing together several elements that have had
satisfactory results. Its main weakness in the financial area was in failing to
predict the long term change in the US dollar/yen exchange rate. Had the cross
currency exchange rates remained at the levels assumed in the appraisal, the
savings in the investment together with the early start of production would have
easily compensated for the sluggish increase in rebar prices in the
international market. By the time the plant was producing at capacity in 1988,
almost all import prices were far below those anticipated at appraisal (direct
production cost was US$200 per ton against an appraisal estimate of US$345).
27. The major lesson of this project is that the creation of large greenfield
industrial projects often requires the heavy and continued involvement, as a
shareholder, of a competent operating and producing company with extensive
experience. This kind of intimate association cannot be replaced by other
combinations such as the purchase of services of consulting engineers because
the owners are devoid of the necessary experience in the construction and
management of similar facilities. The close involvement of a competent operating
company, preferably as an owner, fills this void and usually guarantees a
smoother implementation. This is not to say that all industrial projects should
be implemented in this way. Where there exists an operating entity and the
management has a proven track record, new projects can be constructed under a
different regime with greater dependence on the in-house project management
capability, managing consulting engineers and services provided by vendors. What
is important is that the owners have a clear appreciation of their capabilities
and seek the most appropriate type of assistance for the successful realization
of the project.
28. But the intimate involvement of an operating company, though necessary, is
not sufficient. What is needed is the transfer of know how and work ethics to
the work force of the project. This requires an intelligent, competent and
knowledgeable indigenous management that creates an atmosphere conducive to the
maximum transfer from the expatriates to the nationals. Consequently, the choice
of top managers and, through them, the selection of middle management is of
paramount importance. A management philosophy that considers its human resource
as its greatest asset and is willing to invest heavily in this resource will
find that its efforts are handsomely rewarded. The lesson is that the quality of
management is of utmost importance in creating the likelihood of success and top
managers should be selected on the basis of their track records.
29. The incorporation of the Company under Law 43 provided the autonomy for
ANSDK, but it also brought in a good measure of accountability. Law 43 allowed
the company to compete in the labor market, but it also brought its discipline.
When confronted with the financial crisis, the Company was tempted (in 1987/88)
to seek financial relief or increased protection from the government, but its
Law 43 status stopped it from doing so. It could, however, legitimately ask for
the revision of the Government's Price Decree which was clearly against the
provisions of Law 43. The management's philosophy of delegating a high degree of
responsibility has been balanced with commensurate accountability. Thus, while
Law 43 provides other facilities which help the conduct of business, it also
creates a hard budget constraint for the enterprise because it weans it from the
Government. But the autonomy provided in Law 43 can only be of value if it is
used by an alert and fair-minded management in motivating the work force.
30. Another lesson of the project is that, for investments of this magnitude,
adequate financial engineering should include careful attention to
cross-currency exchange risks. The currency swaps of 1991, 1992 and 1994 were
useful in reducing the cross-currency risk exposure, but such measures to
minimize financial risks should have been taken as part of the project's initial
financial package.
31. This project satisfied a need, brought in new technology and up-to-date
management style, created employment, used resources and inputs efficiently, had
useful linkage effects, provided input to the construction industry at
reasonable prices, helped dampen wild market fluctuations and, above all,
provided a role model in a generally inefficient public industrial enterprise
sector. This experience should help the Government of Egypt in its ambitious
restructuring and privatization efforts. |