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Rising steel prices may eat into Indian shipbuilders’ margins

Rising steel prices may eat into Indian shipbuilders’ margins
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First Published: Mon, Apr 07 2008. 11 01 PM IST

Preferred destination: The ABG Shipyard in Gujarat. Lower labour costs and manufacturing efficiencies, along with a government subsidy, have helped Indian shipbuilding stay competitive. (Photo: Ashesh
Preferred destination: The ABG Shipyard in Gujarat. Lower labour costs and manufacturing efficiencies, along with a government subsidy, have helped Indian shipbuilding stay competitive. (Photo: Ashesh
Updated: Mon, Apr 07 2008. 11 01 PM IST
Bangalore: Indian shipbuilders, already at a disadvantage to their competitors in China and Korea in terms of what it costs to build a ship here, could face further trouble because of the recent increase in the price of thick steel plates used to build ships, by up to 83% in some cases.
Preferred destination: The ABG Shipyard in Gujarat. Lower labour costs and manufacturing efficiencies, along with a government subsidy, have helped Indian shipbuilding stay competitive. (Photo: Ashesh Shah/Mint)
The increase will take off some of the sheen India has acquired as a builder of ships, especially small ones, in recent years. At best, it could entail a corresponding increase in the price of ships for which orders have thus far not been placed. At worst, it could erode the profit margins of Indian shipbuilders.
Local builders are currently building about 245 ships worth more than Rs20,000 crore as demand surges for ships to transport raw materials and finished goods across the world. More than 70% of these orders are from overseas fleet-owners.
India has emerged as a preferred shipbuilding destination because most yards in countries such as China and Korea that have traditionally dominated the business are booked to capacity and are turning away orders for smaller ships.
Lower labour costs and manufacturing efficiencies, along with a government subsidy, have helped Indian shipbuilders compete in the international market. Still, it currently costs about 51-56% more to build a ship in India— compared with what it costs in Korea and China—by way of duties, taxes, steel and freight, according to a report prepared by audit and consulting firm KPMG India Pvt. Ltd.
Indian shipbuilders said the increase in steel prices would affect those firms that did not have long-term steel supply agreements or could not renegotiate a price increase with ship buyers.
“The steel price increase won’t have any immediate impact on our business. But, it will if the prices hold at the current level or escalate further,” said Dhananjay Datar, chief financial officer, ABG Shipyard Ltd, India’s biggest private sector shipbuilder. ABG keeps a year’s stock or has placed equivalent orders of steel. It sources most of its steel from local steel makers such as Essar Steel Ltd and Jindal Steel.
Shipbuilding contracts are typically fixed-price contracts. This means that the value of the ship agreed upon at the time of signing the deal will hold even if there is an increase in input costs during the construction of the ship.
Steel supply contracts also follow a similar model where the price largely remains the same till the full contracted quantity is supplied.
Pipavav Shipyard Ltd, India’s newest shipbuilder located in Gujarat, said it “could be exposed to changes in the price of steel during the construction period after the price has been agreed with the shipowner.”
“An increase in steel price could significantly and adversely affect our business, financial condition and results of our operations if we are unable to proportionately raise the ship price,” said an executive at Pipavav Shipyard. He did not want to be identified because the company is waiting for its draft prospectus for a share sale to the public to be cleared by stock market regulator Sebi.
Steel typically accounts for a third of the cost of building a ship. Local builders such as India’s biggest engineering and construction firm, Larsen and Toubro Ltd (L&T), and state-run firms such as Cochin Shipyard Ltd and Hindustan Shipyard Ltd import steel from suppliers in Ukraine, Romania, Korea and China because local steel doesn’t meet their requirements.
Shipbuilders prefer thick steel plates having a width of 2.5m and above. Shipbuilding grade steel made locally has a width of less than 2m. “This has serious disadvantages because it requires welding of large number of steel plates from the ship’s keel to the deck,” said an official with L&T who did not want to be named. L&T will require more than 70,000 tonnes of steel for building ships once it starts operating a new shipyard at Kattupalli in Tamil Nadu by the end of 2009 in addition to its existing small yard at Hazira in Gujarat.
However, importing steel isn’t really cheap, especially given the freight costs involved. “We pay 3% more on freight costs than what developed countries pay,” said Ajit Tewari, chairman and manging director of Hindustan Shipyard. That works out to around 7.8-7.9% the value of the shipment. “As such, steel itself makes such a huge differential in the cost of making a ship,” Tewari added.
Shipbuilders are urging local steel makers to manufacture thick steel plates having a width of more than 3m.
“This will bring huge cost benefits to the Indian shipbuilding industry in terms of savings in ocean transportation costs and lesser welding requirements,” said an official at Bharati Shipyard Ltd who did not wish to be identified.
An executive at Cochin Shipyard said the firm was considering introducing a variable component in its contracts which will allow it to charge buyers more should input costs increase. “In a highly competitive market, this could drive away prospective customers to other destinations,” added the executive, who did not want to be identified.
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First Published: Mon, Apr 07 2008. 11 01 PM IST
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