El-Dikheila Reinforcing Bar Project - Background - Performance - Impact - Overall Assessment (World Bank)


1. In the early 1970s, Egypt's construction industry was highly dependent on steel reinforcing bars which, despite some domestic production by the integrated steel plant at Helwan and other mini-mills, were mainly imported. This high dependency on imports, and the periodic shortages of rebars in the market had placed a brake on the growth of the construction industry, affecting all economic activities. The discovery of natural gas in 1970, offshore from Alexandria, created a new opportunity for Egypt to meet its domestic requirements for reinforcing bars by constructing a steel mill based, instead of scrap, on directly reduced iron (DRI or sponge iron) which would be produced in a Direct Reduction Plant (DRP) using natural gas as reducing agent for iron ore.

2. Since the early 1960s, the concept of mini-steelworks consisting of electric arc furnace, continuous casting of billets, and rolling mills had been extensively used in the industrial countries and some developing countries (including Egypt) for the manufacture of reinforcing bars. The majority of these plants were based on local scrap iron as their raw materials and the output was mainly directed towards the same geographical area. Because of the erratic nature of the international scrap market and wildly fluctuating prices, none could depend wholly on imported scrap. The technological advances in the production of DRI resolved the problem of scrap availability, especially for that group of developing countries which possessed sufficient quantities of natural gas.

3. In 1976, the idea of creating a steel plant at El Dikheila using the gas-based DRI process was proposed, in an IFC report, to the Government of Egypt. This report suggested the formation of a joint venture company with an expatriate operating steel company (OSC) for the construction of the proposed steelmaking plant. Upon acceptance of the concept by the Egyptian Cabinet, a search got underway for such a partner. In June 1978, the Egyptian Government formally requested the World Bank Group (WBG) to participate in the financing of the project. Discussions between the WBG and the Government culminated in the preparation of a memorandum of understanding that spelt out a framework for implementing and operating the project. The framework envisaged that, in addition to taking an equity position, the OSC would also provide engineering, managerial and training services during the implementation as well as the early years of operation, all provided that such an arrangement with an OSC not be linked to the supply of equipment.

4. Contacts with interested operating steel companies produced two offers: one from a Japanese Consortium (JC), and the other from a German Group. Whereas neither group offered proposals totally in line with the provisions of the memorandum of understanding, the WBGs analysis leaned in favour of the JC. Despite the stipulation in the memorandum of understanding regarding the delinking of equity participation and supply of equipment, the WBG accepted the proposition by the JC that they possessed proprietary technology that could significantly increase the operational efficiency of the meltshop and, therefore, they could supply the meltshop equipment on a negotiated basis. They were also permitted to participate in the international competitive bidding for the rest of the plant, again on the grounds that their previously supplied DRP and rolling mills had performed extremely well. In order to resolve the conflict of interest issue, it was agreed that an independent consultant would conduct the technical and commercial evaluation of the meltshop proposal and 'all other bids. These provisions were accepted by the Government of Egypt and the JC was nominated as partner in the joint venture in January 1979. In February 1979, the Japanese International Cooperation Agency (JICA), was asked to prepare the feasibility study.

5. Four years ago, the OED prepared an audit of the El-Dikheila Reinforcing Bar Project. The audit gave an account of the efforts that went into its preparation, appraisal, implementation and the first two full years of production. The report rated the project's outcome as satisfactory and its sustainability as likely. In addition, the report concluded that there were: "two major risks which were glossed over in the risk analysis conducted at appraisal-the possibility that long-term international rebar prices would be much lower than the high equilibrium price forecast at appraisal and the possibility of large exchange losses stemming from the high exposure of the project to the cross-currency exchange risk between the yen and the dollar". Since then, both these risks materialized and yet the company has survived the shocks.

6. This Impact Evaluation aims at recounting Alexandria National Iron and Steel Company - El Dikheila's (ANSDK) achievements since the audit, its impact and, finally, the chances of its sustainability.

Performance Since 1991

7. The technical performance of the plant has been truly outstanding. The complex has continuously broken its own records, reaching production levels far above the nameplate capacity in every producing division. In 1994, the actual production figures stood at 8 percent, 55 percent, 33 percent and 67 percent above the rated capacities of the DRP, Meltshop, Bar Mill and Wire Rod Mill, respectively. Considerable productivity gains have, of course, been at the root of this impressive performance. High output to input ratio, declining energy consumption, declining tap to tap time in the Meltshop, increasing operating ratios in the Rolling Mill Shop and improvement in a host of other indicators all speak of an increasingly more efficient operation. These technological improvements have been associated with the introduction of many new grades of rebar as well as the establishment of a quality control system that has made it possible for ANSDK to obtain the ISO 9002 Certification. ANSDK was recognised by Midrex Corporation (the license-holder for the direct reduction plant) as a worldwide leader for its superior performance in 1989 when production reached a level of 12 percent above rated capacity.

8. In contrast with ANSDK's excellent performance, the outcome of the other steel project supported by the Bank at the same time-the HADISOLB Rehabilitation Project (Loan 2002-EGT)-has been disappointing. Therefore, it is important to find out what made ANSDK such a success and which lessons can be learned from it for future projects. As noted later, the incorporation of ANSDK under Law 43n4, which provided for joint government ownership with a foreign partner, and provided a considerable degree of autonomy to the enterprise, accounts for most of the difference with respect to the fully Government owned HADISOLB. But some specific aspects of ANSDK performance are worth exploring in more detail.

9. ANSDK has fully realized its objective of supplying a major part of Egypt's requirement for reinforcing bars. Its continued excellent technical performance can be attributed to its corporate culture that delegates authority and demands accountability, rewards good performance and retains the loyalty of its workforce. The choice of the top echelon of ANSDK's management and the continuity of their service as well as the selection of other managerial and supervisory personnel contributed greatly to the high human resource quality of the enterprise. The human resource development program has consistently remained at the core of the company's efforts to maintain its competitiveness. The intensive on-the-job training of the workforce has not only resulted in increasing labor productivity, but it has also made it possible to reduce the number of expatriate ahead of time, thereby providing more managerial positions for the Egyptian staff. Meanwhile, the company has taken full advantage of the services and advice of the personnel seconded by the joint venture partners in putting in place an efficient and competent operational organization.

10. Another important factor has been the maintenance philosophy pursued by the company. Starting with preventative maintenance, then introducing condition based maintenance (CBM) and eventually total productive maintenance (TPM) concepts, the company has improved its maintenance systems considerably in the last few years. To improve productivity, safety, plant availability and product quality, the company has instituted quality control circles whose recommendations are often put into practice.

11. The manufacturing costs (variable and fixed costs excluding financial charges and general administrative and sales costs) per ton of rebar have remained fairly stable at US$230 per ton of output in recent years, increasing in 1994 to around US$250 because of the jump in several input costs. ANSDK's total costs per ton of output have now stabilized around the equivalent of US$290-300 which, although marginally higher than the steel mills in the European Union (EU) and ANSDK's own export prices, are considerably lower than export prices for rebars from Japan in recent years. The company started exports in 1988 (when export prices were actually higher than domestic prices), which reached 30 percent of total sales in 1994. The profit and loss account of the company shows that despite heavy depreciation, amortization of pre-operating expenses and financial charges the company has been profitable since 1988 with the net profit increasing to around LE 1 15-120 million (nearly US$35 million) in recent years. ANSDK has paid dividend every year since 1991.

Impact of the Project

12. In addition to its contribution to the growth of the industrial sector and the creation of 2400 jobs, a major impact of the project has been to provide a secure supply of considerable quantities of reinforcing bars to the domestic construction industry, as well as exports. Now with ANSDK supplying 40-50 percent of the domestic demand, and other rolling mills (including HADISOLB) supplying another 3040 percent, the local market's dependence on imports has declined to around 15 to 20 percent. While small, these imports, nonetheless, regulate the prices in the domestic market and maintain the competitiveness of the local producers.

13. The project's impact in terms of foreign exchange savings is estimated at US$850 million up to the end of 1994. This level of foreign exchange savings approaches the actual cost of the project at completion, when calculated at the prevailing exchange rates. This is a considerable achievement, especially when viewed against the backdrop of heavy financial charges which resulted from the movements in the yen/dollar exchange rates.

14. The project appears to have also had an important impact, as a role model, on the Egyptian industrial sector in recent years. After incorporation of ANSDK, a number of other entities were created under Law 43/74 and its successor Law 230/89, in which the Government or publicly owned enterprises held the majority of shares, with a minority foreign partner. But these laws were not the right vehicle for the restructuring of the existing public sector enterprises because the main objective of these legislations was to attract foreign investment into Egypt. With the promulgation of Law 203/91 which provides a framework for the reorganization of the public enterprise sector into holding and affiliated companies, some 314 enterprises valued at around LE 70 billion, with a total labor force of about 1. I million have been earmarked for restructuring and privatization.

15. The environmental impact has been well managed. In the course of iron and steel making, considerable quantities of dust, fumes, noxious gases and waste water effluents are generated. These environmental hazards are much more serious in the traditional large scale steelmaking because the blast furnace process requires sintered iron feed and coke. Steelmaking through the direct reduction process obviates three processes-coke production, sintering and the blast furnace-which generate large quantities of environmental pollutants. To this extent the problem is more manageable and the mitigation measures less costly. Nonetheless, the DRP itself is the source of significant dust and carbon monoxide emission. So are the remaining processes in the chain such as the electric arc furnace Meltshop, the continuous casting and the rolling mills. The plants also generate considerable quantities of slag, water pollutants and sludge.

16. From the outset, the company decided to adopt environmental pollution control standards applicable in major industrialized countries, in this case Japan. When the plant was being designed, attention was initially focused on two major pollutants: atmospheric dust and sewage water quality. Dust was to be controlled in the DRP, Melt Shop (Electric Arc Furnaces) and the Lime Calcining Plant by dry cyclones, bag filters and wet scrubbers, suitably installed at locations in the plant where considerable dust is generated. A monitoring system was put in place for measuring, on a monthly basis, the dust content in the exhaust gases from bag filters. Measurements of dust content in exhaust gases from various polluting units result in figures that are consistently below the 100 milligram (mg)/cubic meter standard adopted in the original design.

17. In addition to dust monitoring and control, the plant has now instituted the measurement of a number of other parameters such as carbon monoxide, sulphur dioxide, nitrogen oxides, chlorobenzenes, noise and radiation. In terms of the noxious gases, the S02 and N02 concentrations remain well below the permissible levels both inside and outside of the plant, indicating that the pellets contain low quantities of sulphur. The wastewater from the various units runs through a treatment plant where the sludge is removed and the effluent flow to the sea is brought within the water discharge specification. Most water quality measurements are done on a weekly basis. In addition to the parameters considered at the design stage, analyses include total alkalinity, total hardness, chlorine and calcium content and total iron content. The system handles some 200 cubic meter of water every hour. Except for the suspended solids content which is close but still below the standard, the other parameters are, on average, well below the permissible levels. The plant also generates considerable quantities of slag and other waste materials notably collected dust, sludge, scale and limestone fines. Such wastes including cold slag are disposed of at a special site not far from the plant. All data concerning this disposal such as quantity, type and location are recorded and plotted on maps to ensure that waste materials do not contaminate underground water resources.

Overall Assessment and Sustainability

18. A number of factors account for the current strength of this company and the manner in which it has overcome adversity. To start with, the insistence of the Bank and IFC in having an operating steel company as a joint venture partner with hands on management responsibility both during implementation and the initial operational phase was instrumental in endowing the company with a reasonable chance to succeed. The incorporation of the company under Law 43 provided the necessary autonomy and independence without which it would not have been possible to implement the project ahead of schedule. The role and quality of the Egyptian management team and counterparts was crucial in ANSDK's successfull performance. Equally important was the attention paid by the management to human resource development especially through on-the-job training, twinning and other ways of transferring the skills from the expatriate staff and consultants to the Egyptian personnel. This was coupled with delegation of responsibility-cum-accountability, attention to employee welfare and a genuine production incentive system, all providing the motivation for the outstanding performance of the workforce.

19. Since starting production, ANSDK has played a pivotal role in the development of the construction industry. While its production reached close to 63 percent of domestic demand in 1992, its export activities have provided not only a source of foreign exchange revenue for the company, but also a means of checking the level of prices in the international trade. The Company's technological activities have made different grades of rebar readily available in the Egyptian market while the high quality of its products has opened to it a wide export market. ANSDK enjoys a cost advantage in the production of directly reduced iron (DRI). The cost structure of the Company shows that the cost of producing sponge iron has been less than the landed cost of imported scrap (allowing for the degree of metalization). In 1994 the cost of DRI produced at ANSDK amounted to US$117 per ton as compared with a CIF scrap cost of US$145 per ton.

20. Designed to the Japanese standard of the early 1980s, and well maintained, the plant's environmental protection performance has been quite satisfactory. The installations of air and water pollution mitigation equipment and attention to their remaining in good working order have ensured that dust emissions from stacks and the quality of effluent discharge water have remained well within the prescribed limits. Through periodic studies by outside agencies, the Company makes sure that independent measurements are carried out and remedial suggestions are received. ANSDK has, in recent years, taken additional steps to reduce further the fumes that may still escape from the Meltshop into the atmosphere.

21. ANSDK enjoys all the conditions for a sustainable operation. It is an intrinsically economic and competitive plant operating under a substantially undistorted regime and facing an expanding domestic market. Except for the price of electricity which remains somewhat below long-run marginal cost, the price for other imported or domestic inputs are at, or close, to international prices. It is well established in the export market by virtue of its quality and price competitiveness. It is strategically located on the coast and is close to the natural gas resources. It has been operating within a competitive environment in the domestic market where supplies come from other Egyptian manufacturers and imports. Its impressive technical performance speaks of a most competent and knowledgeable management and work force. It has access to technical assistance through some of the most efficient steel producers in the world. It has successfully internalized the know how brought to it by the expatriate collaborators and built on it to continuously enhance productivity. Constant attention has been paid to cost control and savings. It has been pursuing operating and maintenance practices that have maximized plant availability and resulted in very high operating ratios.

22. The weakest aspect of the project has always been the financing package, which was fully discussed in the audit. The audit concluded that, as the project was appraised and approved at a time of a high dollar exchange rate in the early 1980's, despite the fact that the greatest part of the equipment was to come from Japan, the high level of cross currency risk was not appreciated and no efforts were made to advise ANSDK to hedge against those exchange risks. ANSDK was particularly vulnerable since the project's capacity to earn foreign exchange, either through exports or through domestic sales designated in foreign exchange were mainly in dollars.

23. In recent years, ANSDK has succeeded, with the help of the IFC, to reduce its currency exposure by swapping its Yen-denominated obligation into US dollars. This has brought in some measure of predictability to its costs until the loans are completely retired in the next decade. The re-estimated economic rate of return based on the actual performance in the last eight years comes to 10.5 percent. Once the initial project investments are depreciated and loans paid off, ANSDK will become similar to many mature steel plants where incremental investments will be associated with handsome returns. In fact one such expansion project is currently underway.

24. This project entitled: "The Production Rationalization and Expansion Project" is aimed at eliminating the imbalance that has arisen because practically all existing plants operate at levels totally different from their respective nominal capacities. The project also aims at upgrading the steel making facilities and expanding the rod mill capacity to meet the anticipated increase in demand for the small gauge "ire rods. Once completed, the annual capacity of ANSDK will be increased from 1.1 million tons to around 1.5 million tons of reinforcing bars and rods. This project is likely to be followed by a Second Direct Reduction Plant Project which aims at duplicating the existing direct reduction plant to provide the raw materials for the meltshop.

25. The shareholding structure of the company has, in recent years, changed significantly towards more private ownership (and lower debt/equity ratio). The IFC played a very crucial catalytic role in the privatization drive. The most important change came with the Employee Fund subscribing nearly f. E 96 million (13.72 percent) to the new capital of ANSDK. The IFC also decided to increase its shareholding from 3 to 5 percent, whereas the Japanese shareholders chose to maintain theirs at 10 percent. This latest capital increase has helped the Company to reduce its debt to equity ratio to around 66/34 from about 80/20 in 199 1. With other private shareholders buying nearly another 7 percent of the company's shares, the private shareholding stood at about 36 percent at the end of October 1995.

Conclusions and Lessons Learned

26. Had it not been for its outstanding performance and early start of production, the project would have succumbed to the financing problems it faced arising from factors beyond its control. The project's technical and managerial aspects were sound, bringing together several elements that have had satisfactory results. Its main weakness in the financial area was in failing to predict the long term change in the US dollar/yen exchange rate. Had the cross currency exchange rates remained at the levels assumed in the appraisal, the savings in the investment together with the early start of production would have easily compensated for the sluggish increase in rebar prices in the international market. By the time the plant was producing at capacity in 1988, almost all import prices were far below those anticipated at appraisal (direct production cost was US$200 per ton against an appraisal estimate of US$345).

27. The major lesson of this project is that the creation of large greenfield industrial projects often requires the heavy and continued involvement, as a shareholder, of a competent operating and producing company with extensive experience. This kind of intimate association cannot be replaced by other combinations such as the purchase of services of consulting engineers because the owners are devoid of the necessary experience in the construction and management of similar facilities. The close involvement of a competent operating company, preferably as an owner, fills this void and usually guarantees a smoother implementation. This is not to say that all industrial projects should be implemented in this way. Where there exists an operating entity and the management has a proven track record, new projects can be constructed under a different regime with greater dependence on the in-house project management capability, managing consulting engineers and services provided by vendors. What is important is that the owners have a clear appreciation of their capabilities and seek the most appropriate type of assistance for the successful realization of the project.

28. But the intimate involvement of an operating company, though necessary, is not sufficient. What is needed is the transfer of know how and work ethics to the work force of the project. This requires an intelligent, competent and knowledgeable indigenous management that creates an atmosphere conducive to the maximum transfer from the expatriates to the nationals. Consequently, the choice of top managers and, through them, the selection of middle management is of paramount importance. A management philosophy that considers its human resource as its greatest asset and is willing to invest heavily in this resource will find that its efforts are handsomely rewarded. The lesson is that the quality of management is of utmost importance in creating the likelihood of success and top managers should be selected on the basis of their track records.

29. The incorporation of the Company under Law 43 provided the autonomy for ANSDK, but it also brought in a good measure of accountability. Law 43 allowed the company to compete in the labor market, but it also brought its discipline. When confronted with the financial crisis, the Company was tempted (in 1987/88) to seek financial relief or increased protection from the government, but its Law 43 status stopped it from doing so. It could, however, legitimately ask for the revision of the Government's Price Decree which was clearly against the provisions of Law 43. The management's philosophy of delegating a high degree of responsibility has been balanced with commensurate accountability. Thus, while Law 43 provides other facilities which help the conduct of business, it also creates a hard budget constraint for the enterprise because it weans it from the Government. But the autonomy provided in Law 43 can only be of value if it is used by an alert and fair-minded management in motivating the work force.

30. Another lesson of the project is that, for investments of this magnitude, adequate financial engineering should include careful attention to cross-currency exchange risks. The currency swaps of 1991, 1992 and 1994 were useful in reducing the cross-currency risk exposure, but such measures to minimize financial risks should have been taken as part of the project's initial financial package.

31. This project satisfied a need, brought in new technology and up-to-date management style, created employment, used resources and inputs efficiently, had useful linkage effects, provided input to the construction industry at reasonable prices, helped dampen wild market fluctuations and, above all, provided a role model in a generally inefficient public industrial enterprise sector. This experience should help the Government of Egypt in its ambitious restructuring and privatization efforts.

Source: World Bank