What’s Next for British Steel, Britain’s Second-Largest Steelmaker, After Liquidation?

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The British government did not find common ground with private equity owners Greybull Capital and Britain’s second-biggest steelmaker, British Steel, went into insolvency this week.

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As we wrote earlier this week, Greybull has blamed Brexit uncertainty for the double whammy of falling sales to the firms’ European clients, who are nervous about what kind of relationship the U.K. will have with the E.U. post-Brexit and by the E.U.’s withdrawal of carbon credits (forcing the company to go cap in hand to the British government last month for a loan).

Greybull has some merit in their claim; Brexit is causing the firm problems. A combination of elevated iron ore prices — exacerbated by the weakness of sterling since the June 2016 referendum — and high energy costs have been squeezing margins at the same time as manufacturing sectors, like oil and gas and the automotive industry, have been facing headwinds in the U.K.

But does that, as many claim, mean the British government should step in and either nationalize or otherwise financially support the company?

Ministers claim they are prevented by E.U. rules from providing state aid in such circumstances and that to extend aid would be illegal. While direct state aid is against E.U. rules, a point I will come back to, there is nothing to stop the British government offering loans on commercial terms, as it did with £120 million provided last month to fund the carbon tax credit shortfall.

The reality is the British government can probably see little chance of ever getting its money back.  Indeed, last month’s loan will only be recoverable in the autumn if the company is still running and gets its carbon credit back.

Not surprisingly those with an adverse view towards the European Union stridently point out that if the U.K. were not in the E.U., it could simply bail out British Steel (much as previous governments did with Rolls-Royce, British Leyland and various other large industries considered at the time too big to fail).

But such arguments miss the point about why E.U. state subsidy rules — which were brought in with firm support from the British, it has to be said — precisely to counter European governments bailing out failing industries.

The U.K. was far from alone in lavishing state funds on propping up dead ducks and, in the process, delaying the restructuring of industries suffering from chronic underinvestment and overcapacity. Nor is the argument that British Steel should be kept alive on the basis that it plays a crucial role in the production of steel for defense and domestic infrastructure.

It’s true the company is a major supplier of rails to the British rail industry, but much of the company’s output is exported and the U.K. imports most of the specialist steel it needs for critical defense applications. Notoriously, Britain’s nuclear submarines rely on high-strength French steel for their hulls.

A more deep-rooted problem challenging British Steel is the need for a strategic shakeup.

The company runs two blast furnaces at the Scunthorpe plant, but according to the Financial Times, it does not have enough capacity for all their output at its downstream processing plants. One senior employee is quoted as saying “we produce 2.8 million metric tons of steel, which is too much for our profitable accessible market, so half of our products don’t make money.”

Greybull promised to spend £400 million investing in British Steel when it purchased the company for £1 in 2016 from previous owners Tata Steel. However, it’s unclear how much, if any, of this money has been forthcoming.

The accounts show that Greybull’s investment vehicle, Olympus Steel Ltd, has loaned British Steel £154 million. Although the accounts provided for over £17m of interest, both profits for 2016 and 2017 and the interest have been left in the company to provide cash flow, the BBC reports.

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It is estimated any new owner will need to spend at least £250 million investing in plant upgrades.  Although prospective buyers such as Liberty Steel have been mooted as potential new owners, in today’s pre-Brexit uncertainty it would be a brave investor who would take on a business like British Steel, with all its incumbent challenges, without a blank check from the U.K. government in some form or another.

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