Industry Risk Score : Sponge Iron

Over the last few years, production of sponge iron in India has grown at a steady pace in proportion with the rising capacity. During FY19, production rose by 8% y-o-y to 33.04 mt from 30.51 mt in the previous year. In fact, India is the largest producer of sponge iron in the world with the coal based route accounting for 79% of total production in the country during FY19. Capacity, on the other hand too, has increased over the years and stood at 49.6 mt for FY18 as per the latest data available.

Growth in the sector has been underpinned by the rapid expansion of secondary steel making route in India where it’s utilized. Majority of the sponge iron plants in India use non-coking coal based rotary kilns due to ample reserves. However, supply of coal is available through e-auctions and sponge iron producers are obliged to pay a premium to secure long-term supplies as it being a non-priority sector. Further, natural gas-based plants too face fuel supply constraints and thus, have been operating at lower utilisation levels. The recent iron ore mining bans too have impacted availability of the key raw material for this sector accentuated by shortage of rail rakes for evacuation creating logistical bottlenecks.

Further, the industry has to compete with its direct substitute in the form of steel scrap. As a result of several efficient global manufacturers, and sponge iron being a single grade commodity, there is no export competitiveness for domestic sponge iron producers.

Government’s initiatives such as the National Steel Policy, 2017, however, are likely to support the industry in terms of increased demand albeit over medium to long term horizon. Over the short term, with domestic economy facing headwinds with dwindling GDP and the stress in the infrastructure and automobile sectors, overall demand in the steel industry is expected to lower which in turn is expected to trim the demand for the sponge iron industry.

Consequently, growth in the Indian sponge iron industry in FY20 will be confined by tepid rise in domestic steel industry. Further, any issues with iron ore availability, coal and natural gas is likely to cripple growth as well.

Key Risks & Attributes

• Steel sector demand dynamics
• Steel scrap, a direct substitute, poses a threat
• Domestic iron ore supply issues

Sponge iron is primarily used in the EAF and IF routes of steel production. These steel manufacturing methods which are primarily utilized by the secondary steel players account for ~55-60% of domestic steel production. Hence, the demand for sponge iron continues to be driven by capacity additions in the EAF/IF steel production routes in the country. Sponge iron being a single grade commodity and with several efficient global DRI producers, export competitiveness in the global market is fairly constrained for domestic sponge iron players. Notwithstanding, there still exists some exports albeit at a lower proportion. Further, demand for sponge iron is also affected by availability of steel scrap, which can act as a substitute for the former. Moreover, with the domestic economy facing headwinds with subdued GDP growth and stress in some of the key end use sectors such as the infrastructure and automobile, overall demand in the steel industry is expected to lower which is expected to limit the demand in the sponge iron industry.

The National Steel Policy, 2017, which targets production of 80 mt of sponge iron to achieve the targeted 225 mt of crude steel production by FY31, provides the policy support for the sector.

During FY19, production rose by 8% y-o-y to 33.04 mt from 30.51 mt in the previous year. In fact, India is the largest producer of sponge iron in the world with the coal based route accounting for 75- 80% of total production in the country during FY19. Capacity, on the other hand too, has increased over the years and stood at 49.6 mt for FY18 (as per the latest data available).

Odisha accounts for the largest share of sponge iron manufacturing capacity followed by Chhattisgarh, Jharkhand, West Bengal and Karnataka.

Acuité expects the demand scenario to remain a key monitorable with some short term headwinds with respect to slowing economy affecting demand. In addition, rising dumping of scrap further dampens the sectoral growth prospects.

Despite, the sponge iron industry being highly fragmented, around 20 producers account for 60-65% of the overall production. Further, it being a commodity of a single grade, there exist no major quality differentiating factor thereby deterring any branding attempt. Also, since it is a cyclical industry, capacity expansion on a large scale too possesses increased risk exposure to the players in terms of underutilization of the capacity during periods of subdued demand.

Domestic steel manufacturing industry being concentrated in geographic clusters, logistic costs makes this secondary industry compete regionally. Jindal Steel & Power, Monnet Ispat, BMM Ispat, Godawari Power & Ispat and Tata Sponge Iron are some of the major producers.

Adequate availability of ore plays an important role for the standalone players who do not have access to captive mines. Any significant void of the raw material can lead to players reducing production thus affecting their financials. Moreover, domestic sponge iron production is led by integrated steel manufacturers who utilize it for captive consumption. These players account for 75% of the domestic production, while merchant DRI plants account for only one-fourth of the total DRI capacity. Merchant DRI demand is dependent largely on the non-integrated EAF/IF capacity. The entry barriers are also low as sponge iron plants can be set up rapidly and a major plant can go on stream within a span of 18 months. Thus, competition is fairly intense amongst the merchant DRI players who have to cater to the non-integrated, smaller steel producing units.

Acuité believes that the competitive intensity in the sponge iron industry in the near term will continue to remain high due to large number of merchant DRI players competing for a share in the non-integrated EAF/IF steel player segment.

Iron Ore- For production of sponge iron, ore with iron content higher than 65% is required. Further, the ore has to be in the form of lumps or must be converted to pellets from iron ore fines. Consequently, both these forms command a price premium and are also exposed to global iron ore price trends. Going ahead, demand from the key consumer China is likely to lead the price dynamics. In terms of supply, domestic iron ore availability is exposed to the local mining bans, cancellation/expiry of mining leases. With imports often proving unviable due to land-locked manufacturing units and high logistics costs, it leaves the industry mostly dependent on domestic iron ore producers mostly merchant miners. The ability of sponge iron producers to pass on any cost increase depends on the steel demand and price scenario and the relative price of steel scrap.

Non-coking Coal- Around 79% of sponge iron manufacturing in India is via the coal-based route. The industry being a non-priority sector, has to however compete for coal allocation with other sectors through the e-auction mechanism leading to higher premiums. Moreover, the availability of coal is also affected during peak power demand owing to higher allocation towards the power sector.

Natural Gas- Key gas-based DRI producers such as Essar (Hazira, Gujarat), JSW Ispat (Dolvi, Maharashtra) and JSW Steel (Salav, Maharashtra) are exposed to gas availability risk.

Other key raw material, Dolomite, is used as a de-sulphuriser, though required in a much smaller proportion in the production process and possesses limited risk due to its satisfying availability.

Acuité believes that the input risk for the sponge iron industry will continue to persist in the near term as both the key raw materials, iron ore and non-coking coal, have supply constraints which is likely to continue atleast in short term.

Environmental concerns regarding emissions, especially from the MSME sector, have resulted in plant closure in the past and is likely to remain a key monitorable. Waste heat recovery systems offer a solution in terms of reducing their carbon footprint, earning carbon credits, and many large plants have incorporated it.

At a broad level, the regulatory risk is higher in terms of iron ore mining ban, mining licence cancellations and coal block de-allocations which have led to crippling of raw material availability thereby affecting sponge iron plants utilization levels. However, rationalization of customs duty on natural gas from 5% to 2.5% has been a relief for gas-based DRI units. The GST on sponge iron and its substitute steel scrap is at 18%, whereas the GST on its inputs, iron ore and coal is at 5%. Further, there are no quantitative restrictions on the import or export of sponge iron which can be double whammy.

Acuité believes that the sector is moderately exposed to regulatory actions of the government.

India forayed into this industry with the first coal-based plant of Sponge Iron India Ltd. set up in Andhra Pradesh. Different technologies are employed for sponge iron production based on the reductant and fuel used, i.e., coal or natural gas. The three major technologies successfully commercialized and used in sponge iron plants include Midrex technology, HYL III/Energiron technology and coal-based technologies

As there is no substantial competitive advantage of technological superiority, progress in technology upgradation, research and new technology implementation has been slow.

Acuité believes that Indian sponge iron players are well placed to harness the domestic coal-led technologies. There has been no major technological disruption so far and none is expected atleast in the near future that could change the sector dynamics.

Industry financial performance risk score

Operating Margin
(Marginally unfavorable)

Interest Coverage Ratio
(Marginally unfavorable)

Return on capital employed
(Marginally unfavorable)

Debt/ Equity
(Marginally unfavorable)

GCA days
(Marginally favorable)

Note: The industry financial performance risk score is provided on a 6-point scale