SHIGANG AND HANGANG: A TALE OF TWO HEBEI

UNCLAS SECTION 01 OF 05 BEIJING 008615

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EAP/CM, EB/TPP/BTA, AND EB/IFD/OIA
STATE PASS USTR FOR STRATFORD/WELLER/KEMP
TREASURY FOR OASIA/ISA
USDOC FOR 5101/ITA/IA
USDOC FOR 4220/ITA/MAC
USDOC FOR 1003/ITA/OUS
USDOC FOR 6310/ITA/TD/OIEM

E.O. 12958: N/A
TAGS: ECON EIND ENRG ELAB SENV WTRO CH
SUBJECT: SHIGANG AND HANGANG: A TALE OF TWO HEBEI
STEEL MILLS (corrected copy)



1. (SBU) Summary. Recent visits to two Hebei Province
steel mills provide an insightful look into how steel
industry reforms in China will play out during the
next several years. Handan Iron and Steel Group
Company, a large state-owned steel mill, has been
selected by the Central Government to become one of
the flagship steel producers in China and has been
authorized to triple its production capacity even as
government authorities seek to reduce China's overall
capacity by some 100 million metric tons. In stark
contrast, Shijiazhuang Iron and Steel Company, a
former state-owned steel mill that is now largely
privately held, is seeking to gain access to new
markets by improving its product line and targeting
niche segments of the market rather than through
adding new production capacity.
Despite these differences, both enterprises
say they are fully committed to meeting new government
environmental and energy conservation guidelines and
recognize that failure to do so could result in stiff
fines or public humiliation. The Hebei steel
enterprises also provide a proxy to understand the
different paths private and large state-owned
enterprises will take in the coming years as China
deepens reforms of its industrial base. End Summary.

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Same Harmonious Society Destination, But Different
Starting Points
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2. (SBU) Handan Iron and Steel Group Company, Ltd.
(Hangang) President of the Board of Directors Liu
Rujun said that Hangang, located in the south Hebei
Province industrial city of Handan, has some 25,000
employees who are on track to produce eight million
metric tons of steel in 2006. Hangang's production
will consist of six million metric tons of sheet and
plate products, 1.3 million metric tons of cold rolled
plate, and 700,000 metric tons of other steel
products. President Liu said that the enterprise is
building a new mill which will add five million metric
tons of capacity by 2007, and in conjunction with the
elimination of around three million metric tons of
outdated production, will lift the enterprise's
steelmaking capacity to 10 million metric tons.
Hangang is transitioning from being a low-value
producer oriented toward supporting the construction
industry to become a high-value mill making products
such as sheets and plates for the electronics
industry, according to President Liu.


3. (SBU) President Liu stated that Hangang is a key
player in Hebei Province's steel industry
reorganization. Hebei Province, working with the
National Development and Reform Commission (NDRC),has
ordered the consolidation of the steel industry in
Hebei. This will result in the creation of two large
state-owned steel enterprises, Tangshan in north Hebei
with an approved production capacity of 40 million
metric tons, and Hangang in south Hebei with 30
million metric tons of approved capacity. The goal of
the consolidation is to promote the rapid assimilation
of international steel production technology and to
foster more internationally competitive enterprises,
according to President Liu. Hangang is currently
negotiating joint venture (JV) agreements with two
private steel mills in south Hebei as a part of the
consolidation initiative.


4. (SBU) Standing in stark contrast to Hangang is

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Shijiazhuang Iron and Steel Company, Ltd. (Shigang)
located in Hebei Province's capital city of
Shijiazhuang. Yan Shengke, President and Chairman of
the Board of Directors of Shigang, stated that his
company's workforce of 4,000 employees annually
produce around 2 million metric tons of steel.
Shigang is a specialty steel maker seeking to become a
leading Chinese producer of steel products used in
various stages of automobile manufacturing. President
Yan said that Shigang served as an early evaluative
state-owned enterprise (SOE) reform model, with
private investors being allowed to purchase a majority
share of the company. Although U.S. investors
expressed an interest in purchasing Shigang, CITIC
Hong Kong ultimately purchased a majority 65 percent
share in the company while Hebei Province retained a
20 percent stake and Shigang management and employees
received a 15 percent interest.


5. (SBU) President Yan stated that ownership reform
went beyond a simple change in leadership. Shigang
now has more market responsive decision-making powers
and control over capital, freeing itself from the
tight bureaucratic control it experienced while
government owned. The reform also has resulted in
Shigang possessing a strategic partner committed to
developing a strong presence in China's specialty
steel sector. CITIC owns controlling stakes in
specialty steel mills in Jiangsu and in Hubei
Provinces and President Yan stated that he developed a
plan under review by the Ministry of Commerce (MOFCOM)
that would create a JV between Shigang and the other
CITIC-controlled specialty steel makers. The JV would
create the largest specialty steel producer in China
and should promote better natural and human resource
allocation by the enterprises, according to President
Yan.

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SOE Reform With Hebei Steel Mill Characteristics
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6. (SBU) President Yan said that Shigang was an early
leader in other SOE reforms arenas, most notably the
separation of social services, such as schools and
security forces, from its core business functions.
Shigang began the separation of social services in
1993, with the process culminating four years later in
the final transfer of most of the previously Shigang-
provided social services and associated employees to
the local Shijiazhuang and Hebei Provincial
governments for absorption and administration. A
notable exception was Shigang's hospital that is still
owned and operated by the company. President Yan
said that Shigang has teamed with a U.S. health care
company to create a joint venture hospital and
outpatient clinic that will compete in the local
health care market by offering basic health care and
pharmaceutical services along with medical exams and
testing.


7. (SBU) President Yan said that Shigang formed and
separated five subsidiary companies and some 3,200
employees as a part of its SOE reform efforts. Shigang
kept the companies, mainly made up of functional
services such as transportation and maintenance, under
its corporate umbrella for three years after their
formation to ensure they were well matured before
release into the market. President Yan stated that he
believes this strategy accounts for the apparent
success of these new companies and for the willingness

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of the companies employees to separate from a parent
company where many had worked for years. President
Yan also highlighted other measures Shigang has taken
to become a more market-based enterprise, including
the establishment of a compensation fund created by a
regular draw on the companies net profits designed to
provide employees basic financial resources should the
enterprise undergo downsizing in the future.


8. (SBU) President Liu said that Hangang also has
completed its SOE reform obligations by separating its
social functions and non-core businesses. Hangang
completed the transfer of its social services
including its hospital, schools and security service
to the local government in 2004. They completed the
transfer of several independent companies away from
the core business areas in 2005. There were no laid
off workers as a result of this separation, according
to President Liu. The company spin-off effort
affected approximately 5,000 workers, reducing
Hangang's workforce to its current 25,000 thousand
employees. President Liu estimates that some five
thousand workers could be further trimmed from the
company rolls to fall more in line with international
competitors, but presently there are no plans to take
such a step.

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Burning to Conserve Energy, Save Environment
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9. (SBU) Turning his attention to environmental and
energy conservation issues, President Liu stated that
the NDRC has identified Hangang as a leader in the
Chinese Government's effort to promote more
environmentally friendly steel production. The NDRC
intends to use the environmental and energy
conservation measures listed in its 2005 Steel Policy
to eliminate steel enterprises that waste water,
power, and other resources. President Liu said
Hangang is under enormous pressure to meet government
set environmental and energy efficiency targets. To
that end, Hangang expects to be able to self-generate
approximately 40 percent of its needed power by the
end of the Eleventh Five Year Plan through the
harnessing and recycling of waste gases. Hangang also
has set a target for water savings that includes a
goal of using less than five tons of water per one ton
of produced steel.


10. (SBU) President Liu said that the Central
Government now requires steel SOE's to open their
resource consumption and environmental statistics to
the public so that their compliance can be monitored.
Steel SOE's found to be wasting energy or polluting
will have their infractions announced on local
television and subsequently, the infringing SOE leader
will be required to go on television to explain his
enterprise's failure. In a complementary local
initiative, President Liu stated that the Hebei
Provincial Government has erected environmental
monitoring equipment surrounding Hangang. The
enterprise will have to pay a high penalty to the
local and provincial governments if it is found to be
polluting. President Liu said that Hangang is
working hard to comply to the new environmental and
energy standards because as a large SOE, it has a
governmental function as well as its business role and
should be expected to be a leader in Central
Government mandated initiatives.


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11. (SBU) Shigang President Yan said that he and his
staff realized more than ten years ago that his
enterprise's location seven kilometers from downtown
Shijiazhuang and only 500 meters away from a major
residential area made environmental protection key to
the enterprise's long-term survival. This realization
led to the enterprise's strategy of growing its
business by producing specialty steel rather than
seeking to grow through increased production. Shigang
during the past decade has also invested some 1.3
billion RMB (USD 162 million) in environmental
protection measures, according to President Yan. The
investment included the installation of what President
Yan said was the first acid rain prevention equipment
in the Chinese steel industry.


12. (SBU) President Yan stated that Shigang is aware
that the Central Government will be closely
monitoring, and possibly eliminating, high polluting
and energy-consuming enterprises. Hebei provincial
authorities also are on the look out to find sulfur
dioxide producers and water polluters, and toward that
end, have established 24-hour monitoring of Shigang's
air pollution. In order to motivate its employees to
meet the new environmental protection standards,
Shigang's policy is to remove 5,000 RMB from managers'
bonuses if they are not meeting environmental targets.
President Yan said that because of a water shortage in
Hebei, Shigang is taking steps to reduce the amount of
water it uses when producing steel. Previously,
Shigang consumed about six tons of water per ton of
steel produced, but with recent advances the
consumption has been reduced to 3.9 tons of water per
ton of steel produced and the enterprise has a stated
target of 2.7 tons of water per ton of steel produced.

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Comment: Hebei Steel Mills As A Proxy For Steel
Industry and Broader SOE
Reform
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13. (SBU) Shigang and Hangang provide an illuminating
contrast of where steel industry and broader SOE
reform is heading in China during the Eleventh Five
Year Plan. Hangang is in many ways unreconstructed in
its view that as a large SOE it continues to perform
both business and governmental roles, despite the
recent shedding of some of the traditional SOE
trappings such as its own school system and police
force. This outlook will inform its compliance and
adherence to environmental and energy policies laid
out in the Eleventh Five Year Plan. It also will
motivate its efforts to quickly achieve its authorized
production capacity of 30 million tons through
expanded production and acquisitions while
concomitantly adding increasingly advanced steel
making capabilities, a feat private enterprise would
be hard pressed to match.


14. (SBU) On the other hand, Shigang as a now largely
private company recognizes that in order to survive it
must establish a presence as a high-end producer
tailoring its business to areas traditionally served
by imported products and from there, make a move into
the international market. Shigang recognizes that
mergers and acquisitions lay in its future, not as
part of a government launched initiative to reform an
industry, but rather as a means to improve its line of

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refined products and to more efficiently employ labor
and capital. The survival and success of private
enterprises like Shigang during the next five years
will depend on their ability to accomplish this feat
while staying one step ahead of government initiatives
such as environmental protection and energy
conservation measures laid out in the Eleventh Five
Year Plan. Failure to do so will probably lead to
their being overrun, or absorbed, by large SOE's with
a mandate to do so no matter the costs.

RANDT