Feeding the dragon: driven by Chinese demand, Chilean steel maker CAP shifts its business model.

How hungry is China? Chilean steel company Compania de Aceros del Pacifico (CAP) says profits from steel, up nearly 50% in 2005 to US$187 million, could be surpassed in 2006 by profits from iron ore. As much as the Chinese economy needs steel, it needs the raw materials for steel even more, and it needs them now. Ever a mining country, even Chile's steel makers are taking notice.

Accordingly, CAP has embarked on a $550 million expansion plan to boost its iron-ore business to take advantage of a booming market. "We have to recognize that we are far from the industrial activities for steel, and freight is expensive," says CAP President Roberto de Andraca. "We have ample reserves of iron and there is shortage of supply, so we are ready to go in that direction."

Compania Minera del Pacifico (CMP), a unit of CAP, plans to double iron ore production to 15 million tons annually by the end of the decade to keep pace with the growth plans of its major Asian clients. "Our iron ore has to continue occupying a space in the portfolios of our traditional clients, both international and domestic," says CAP General Manager Jaime Charles.

CMP's initial effort is a $40 million project co-financed by a China's Jinan Iron and Steel Group to process stockpiled low-grade ore at the Romeral mine near La Serena in north-central Chile. That ore will be turned into 68.5% iron pellet feed and saw its first shipment in January. The project will increase total production to 8 million tons per year from 6.5 million now.

Expansion also will continue through a unique $175 million project to recover magnetite from railings produced by the Phelps Dodge-owned Candelaria copper mine in northern Chile. The project, called Hierro Atacama I, will produce 3 million to 3.5 million tons a year of pellet feed beginning in 2008. "The innovation here is that this will be the first time in Chile for the processing of flesh tailings directly from a copper mine," says Charles.

Another 4 million tons of pellet feed could be added to production if the $200 million Hierro Atacama II wins approval later this year. Other projects could follow, including a $250 million plant that could double pellet production.

These investments do not mean CAP is neglecting its steel business. Its integrated steel subsidiary Compania Siderurgica Huachipato traditionally generates 75% of its profits. Steel is produced for the domestic market, 96% of sales and one in which CAP has a 60% to 70% market share.

The difficulties of exporting steel in a highly competitive world market means the company focuses instead on developing and supplying clients who export, and for similar customers abroad. Cans for tomato juice, for instance. Twenty thousand tons of tin plate for making cans, from CAP, head to Japan each year.

CAP is spending $80 million to increase capacity at Huachipato to 1.5 million tons annually from 1.2 million tons on such incremental market growth, with further investments to follow in the 2010-2020 period designed to maintain the company's position in the market. With a strong cash flow position and low debt, CAP will shoulder the bulk of its $550 million expansion plans through retained profits, and by issuing bonds.

Some importers are unhappy, though, complaining that Chilean construction specifications for products such as concrete-reinforcing rebar give CAP an advantage and act as a barrier to entry. Chile's construction chamber is trying to get rebar norms changed to those used in the United States. That would "liberalize the market and reduce steel costs," according to chamber spokesman Gonzalo Vidal.

Radimiro Petucio, a steel importer, says the market position enjoyed by CAP and by Brazilian producer Gerdau, totaling 95% of the domestic market, makes importing rebar difficult. "The antitrust laws are very soft in Chile," Petucio says. "I am not welcome in the market and the law does not protect me."

Despite the rules fluke, CAP nevertheless faces competition from low-cost production in Brazil, Turkey and Eastern Europe, says Caio Denemiatti, general manager of steel importer Siderint. "Other producers can meet these [rules]," Denemiatti says. "They have to stop the production line and change to the Chilean rebar norm, but they can do it and we are importing."

PAUL HARRIS * LA SERENA, CHILE