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- [00:00]
A
Foreign. Welcome to another episode of the Capital Cycle podcast. I have with me Titus Zaraski, who is an analyst on Marathon's European portfolios.
- [00:20]
B
Pleasure to be here.
- [00:21]
A
So, Titus, changing global trade patterns pose a risk to capital cycle investors. Markets that were previously closed to foreign competitors are suddenly opened up. Dominant local players lose their competitive advantage. Their moat is breached. The rise of China as a trading superpower has had that effect on many industries over the past three decades, including the European steel industry, which we're about to talk about. Capital cycle investors, however, need to be alert to such changes. Your argument is that they also need to be alert to the opportunities thrown up by de Globalization.
- [01:10]
B
Yes, the orthodox capital cycle dynamic of high returns, inviting competition, returns compressing capital exiting and so on is isn't actually abandoned. It's rearranged by the state instead of free market forces.
- [01:27]
A
So let's talk about the capital cycle and globalization. De Globalization in the context of European steel making and in particular Arslo Mittal, A holding in Marathon's European portfolios.
- [01:43]
B
Arsler Metal is one of the largest steel producers with circa 55 million tons of annual output. It's a product of a hostile takeover in 2006. That story alone probably deserves a separate podcast. It involves a Russian oligarch as a failed White Knight Metalsteel was a low cost consolidator, famously known for opportunistic acquisitions of distressed assets in the former Soviet bloc. Arcelor, on the other hand, was a specialized producer of premium steel, for example, for the automotive industry. After the merger, it had been the largest steel producer globally until it lost its reign to a Chinese state owned group.
- [02:33]
A
So how does Arcelometer operate?
- [02:36]
B
Today it has a truly global footprint. It spans emerging markets in Brazil, India, South Africa, Ukraine, alongside western operations in the U.S. canada, France, Belgium, Germany and Spain. It's a vertically integrated producer, which means apart from mills producing the end product, it also owns iron ore mines, which is the feedstock. Around 72% of its iron ore needs come from mines that are owned by Arcelor Metal, which reduces its exposure to fluctuations in iron ore prices. This is an operational hedge, if you will. But make no mistake, it's still a textbook cyclical capital intensive business with high fixed costs. A steel furnace never stops. You cannot turn it off. Otherwise the molten ion solidifies and and Brexit a costly decision to make, which also explains why capacity is so sticky. Hence the economics. The cash margins per tonne are extremely sensitive to small changes in utilization rates and steel prices.
- [03:50]
A
And since the turn of the century, China has had an extraordinarily powerful impact on the global steel industry. Both positive and negative, you could say.
- [04:00]
B
Yes, the industry entered the new millennium with an exceptionally strong demand driven by China's rapid industrialization. Early 2000s were truly the golden age of steel making. This is probably best illustrated by the fact that metal family was one of the richest in the world back then. And they broke two Guinness World records for more most expensive wedding and most expensive house purchase.
- [04:31]
A
And this commodity super cycle, as it was called, lasted quite a long time, but it didn't last forever. It grew weaker and more fragile with time.
- [04:43]
B
Yes, it peaked with China consuming as much steel as the rest of the world combined. And then 2008, global financial crisis came, vaporized demand, while China has been building out enormous domestic capacity. In parallel, this created structural oversupply, which only got worse as Chinese property market, another big demand source, entered a downturn in 2014.
- [05:13]
A
Yeah, so with regard to China's steel demand, the joke used to be at the time that the Chinese were producing steel in order to build steel plants to produce more steel, at a time when the Chinese steel industry was operating with chronic excess capacity. And most of the demand for steel in China was coming from the great epic real estate boom that didn't exactly die in 2013 14, but it slowed. And that led to a step down in the demand for iron ore and other commodities and leading to a great bust across the commodity world. And mining stocks crashed. And the global steel industry, as you say, was left in a position of chronic excess supply.
- [06:04]
B
Back then, global capacity reached the excess of 700 million tons. In other words, we are producing 40% more than we consumed. And the Western markets became the dumping ground for the excess supply from China.
- [06:21]
A
And where does that leave Oslo Mittal today?
- [06:24]
B
Today, the problem is only marginally less severe than it was back then. On its own economic merit. Neither are solar metals European nor its North American operations can compete with Chinese mills, even after accounting for extra transport costs. Its footprint in India and Brazil sits in a more comfortable position on the cost curve because of cheaper energy and labor costs. But operations in Europe and North America are uncompetitive.
- [07:00]
A
Some people, including influential figures in the Trump administration and the European Chamber of Commerce, have long complained that Beijing subsidizes its industrial exports, including steel.
- [07:13]
B
That's always been a debate whether China has a genuine cost advantage or merely a persistent state subsidy. One side points to the fact that they have cheaper and more abundant energy. Nevertheless, the answer is of secondary importance. Until there are credible signs of subsidies being withdrawn.
- [07:37]
A
Well, we won't talk about Europe's disastrous energy policy, which has pushed industrial electricity costs to several multiples of what they are in China. But you think there's still strategic potential for steel to be made outside of China?
- [07:53]
B
Strategic is the key word here. A free market absolutist would be inclined to ride the Western steel industry of that is short sighted in my view, especially at a time of rising uncertainty, because it implicitly ignores the costs from a loss of self sufficiency from domestic steelmaking capacity.
- [08:17]
A
Now, the first Trump administration took action against China's dumping, as they called it, of cheap subsidized exports on the West. And that benefited Osler mittal in the
- [08:29]
B
U.S. yes, the fortune for Osilol Mittal North America changed in 2018. Washington viewed imported steel as an issue of national security. A weak domestic steel industry was viewed as a strategic weakness because steel plays a key role in the making of ships, tanks, aircrafts, missiles, rails, grids, pipelines, you name it.
- [08:59]
A
And so what did the Trump administration
- [09:01]
B
do to keep the domestic steel industry afloat? The US needed higher utilization rates. Best way to do that was to increase domestic prices, which they did by introducing tariffs under the section 232. The framework has survived. Presidents from both sides of the aisle indicated bipartisan support. As a result, ArcelorMittals North American segment generated $180 of operating profit per tonne since then, ahead of its historical range and group average.
- [09:36]
A
And the Europeans, despite ostensibly deploring Trump's actions, have followed in his footsteps.
- [09:43]
B
Brussels has been trying to engineer a similar outcome with different measures. In 2019, they introduced a 25% tariff on imports above gradually raising quota levels.
- [09:58]
A
But you say that this backfired.
- [10:00]
B
As policy triumphs go, this one was mainly a triumph for the foreign mills it was supposed to keep out. As demand for steel softened, imports continued, gaining market share and domestic production shrunk.
- [10:14]
A
So can you explain why exactly the policy backfired?
- [10:17]
B
The design was the problem. The quota was set off. The previous three years of import volumes. That level was growing by 3% a year. And European policymakers implicitly assumed robust steel demand. They couldn't be more wrong. Demand was falling. While quotas were rising. More Chinese steel without tariff was being allowed in the market. Imports naturally climbed and the domestic production declined. The policy achieved almost the exact opposite of what it was intended to do.
- [10:50]
A
And what was the upshot of all this for European steel industry?
- [10:55]
B
Pain. A silo metal idled part of its capacity. ThyssenKrupp, another European steel maker announced 11,000 job cuts. Import competition became a luxury Europe could no longer afford. It forced European lawmakers to revisit their approach. And 2026 is the year of renewed European policy activism.
- [11:18]
A
And what exactly does that involve?
- [11:20]
B
First of all, at the beginning of the year, eu, EU introduced a carbon border. Before this, European producers had an extra burden of complying with European emission trading system. Buy carbon credits, capture your own emissions or switch to clean technology. Now the carbon border introduces a levy on imports to level the playing field for domestic players.
- [11:45]
A
And that I think is important because. And tell me if I'm wrong, Chinese steel is largely produced with electricity generated from coal energy sources, isn't that correct? So there's much more greenhouse emissions associated with Chinese steel than European steel under the current regulatory regime.
- [12:03]
B
Yes. They rely vastly on blast furnaces that are much more pollutive than electric arc furnaces.
- [12:10]
A
So what change they made to the tariff free quotas?
- [12:15]
B
From 1st of July, tariff free import quotas will be cut in half to 18 million tonnes, while the tariff rate will double from 25% to 50%. This should reduce the share of imports to 15%.
- [12:31]
A
And you think that the upside opportunity from this European protection is potentially enormous?
- [12:36]
B
Yes. For example, in 2024, Arcelometa produced three times more steel in Europe than in North America. Yet its North American segment generated more profits for the company. If that gap in cash margin per tonne between those two regions can close, the upside is enormous.
- [12:57]
A
So, Tyson, I want to shift the conversation a bit here because Marathon has been holding Oslo Mittal for a long period, even when European operations were coming under pressure from China. And I think one of the reasons European portfolio managers held onto this position is that Marathon was attracted to the way ArcelorMitt allocated its capital and in particular how the family's stake in the company aligned its interests with those of outside investors.
- [13:29]
B
Capital cycle dynamics and broader supply demand isn't fully in management's control, but what they do with cash flows generated by the business is. The Mittal family still runs the business and owns 45% stake. It makes them well aligned operators rather than myopic agents. It's best illustrated by the actual capital allocation. As Chinese mills were flooding the market, management decided to cut down investments in capacity and focus on repurchasing back its own shares. In their eyes, it was the most attractive investments available to the company at the time.
- [14:11]
A
And can you put some numbers this?
- [14:14]
B
Since 2020, Ursula Metal spent over 11 billion, cancelling around 38% of its shares rewarding patient investors with 33% accretion during a period where the valuation discount persisted.
- [14:30]
A
And you view the outlook as being positive now?
- [14:33]
B
Yes. Rcellar Metals earnings power in Europe can change and expand without any change in Chinese supply thanks to conducive policy.
- [14:43]
A
So from a capital cycle perspective, investors need to look at how the state is intervening and changing competitive dynamics for industries, not just steel.
- [14:56]
B
Interventions in various forms such as tariffs, quotas, CAR carbon borders, security reviews or sheer political necessities can influence economic profitability that would otherwise prevail in a free market in both directions, when industries are mission critical and interventions sustainable and rational, they can be lucrative for capital cycle investors.
- [15:22]
A
And the last word on we see
- [15:25]
B
a retreat from the doctrine of free trade and comparative advantage. This has altered capital cycles of the US And European steel industries. In place of global competition and excess supply, these regions now resemble oligopolies with disciplined capacity control, which, at least from
- [15:46]
A
a capital cycle perspective, should be good news for investors in those sectors. Well Titus, thank you very much for conversation. Look forward to seeing you again soon.
- [15:55]
B
Thank you.
- [15:59]
A
Thank you for your time today. I hope you will listen to the next edition of the Capital Cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.