Cablegate: China/Steel: Xinjiang Mill (Sort of) Charts Its Own Course

VZCZCXRO0607
RR RUEHCN RUEHGH
DE RUEHBJ #6367/01 2710800
ZNR UUUUU ZZH
R 280800Z SEP 07
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC 2275
INFO RUEHKO/AMEMBASSY TOKYO 1586
RUEHCN/AMCONSUL CHENGDU 8665
RUEHGZ/AMCONSUL GUANGZHOU 3462
RUEHGH/AMCONSUL SHANGHAI 8418
RUEHSH/AMCONSUL SHENYANG 8319
RUEHHK/AMCONSUL HONG KONG 9721
RUEHIN/AIT TAIPEI 6666
RHEHNSC/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEHGV/USMISSION GENEVA 1966
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 006367

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EAP/CM, EB/TPP/BTA, AND EB/IFD/OIA
STATE PASS USTR FOR STRATFORD/WELLER/KEMP
TREASURY FOR OASIA/ISA
USDOC FOR 5101/ITA/IA
USDOC FOR 4220/ITA/MAC
USDOC FOR 1003/ITA/OUS
USDOC FOR 6310/ITA/TD/OIEM

E.O. 12958: N/A
TAGS: ECON EIND ENRG ELAB SENV WTRO CH
SUBJECT: CHINA/STEEL: XINJIANG MILL (SORT OF) CHARTS ITS OWN COURSE
AMIDST REFORMS

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SUMMARY
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1. (SBU) Econoff recently held a series of steel related meetings in
Xinjiang Province with local government officials and the Xinjiang
Bayi Iron and Steel Company (Bayi). A Bayi executive told us that
the company has successfully merged with Shanghai's Baosteel.
Xinjiang Province Government support was the key to a successful
deal. The merger will infuse much needed capital, management
expertise, and technology into Bayi while Baosteel gains access to
Bayi's rich natural resource holdings. Bayi is expanding its
production capacity, reducing its workforce, and eliminating some
social services, said the official. Xinjiang Government officials
noted that the national-level steel policy has little influence on
Bayi and Xinjiang's steel sector. Finally, we note that similar
cross-provincial border mergers in China's steel sector will remain
elusive until some tax issues can be resolved. End Summary.

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BAOSTEEL NOW CONTROLS XINJIANG STEEL MILL
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2. (SBU) Bayi's Deputy Director of Business Development told Econoff
during a meeting at the company that Bayi's merger this year with
Chinese steel giant Baosteel has been a big boost to the company.
Baosteel acquired a 66 percent stake in Bayi for 3 billion renminbi
(RMB). Baosteel acquired Bayi's iron ore, steelmaking, and energy
and natural resource companies in the deal. The executive stated
that Baosteel's primary motivation for the deal is gaining access to
Bayi's natural resource holdings, including coal and metals relating
to iron and steel production. Bayi gained access to management
expertise, technology, and capital from the merger. The biggest
impact of the merger on Bayi so far is coordination of its business
plan with Baosteel, said the executive.

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PROVINCIAL SUPPORT KEY TO MERGER'S SUCCESS
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3. (SBU) The Bayi executive said that support of the Xinjiang
provincial government, in particular the provincial party secretary
has been the key to the successful merger. The provincial
government is encouraging local enterprises to cooperate with
enterprises from other provinces. Xinjiang officials believe this
will open additional markets to local companies and bring in needed
managerial talent and technology. The Bayi executive told us that
the provincial government retained a 20 percent stake in Bayi. The
government also still has the right to select members of Bayi's
management team, according to the executive.

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BAYI's BUSINESS LOCALLY FOCUSED
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4. (SBU) The Bayi executive told us that the company is the largest
taxpayer in Urumqi. Larger state-owned enterprises (SOEs) have
operations in the area, most notably Sinopec, but their tax revenue
largely leaves Xinjiang since they are headquartered elsewhere. The
executive noted that 60 percent of Bayi's steel production is
consumed locally with the remaining 40 percent sold in nearby
provinces. The company has its own iron ore mines in Xinjiang
mitigating the impact of rising international iron ore prices.
International iron ore prices are twice that paid by Bayi for its
own iron ore, according to the executive. The executive did note
that Bayi imports most of the scrap metal it uses from Kazakhstan.

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BAYI PLANS EXPANSION, GREATER EFFICIENCIES
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BEIJING 00006367 002 OF 003

5. (SBU) The Bayi executive said that the company's steel production
in 2007 will total 4 million metric tons, a 400,000 metric ton
increase over 2006. As part of its Eleventh Five Year Plan, Bayi
hopes to expand production to 6 million metric tons by 2011. The
company also intends to invest in energy conservation and
environmental protection equipment and technology. The executive
noted that Bayi is closing some of its older, inefficient production
capacity, including small blast furnaces, small scale rolling
machines, and hot rolling machines. Bayi uses 6.4 metric tons of
water per ton of steel it produces, according to the executive. A
significant improvement given that only a few years ago the company
used 13 metric tons of water per ton of steel produced.

6. (SBU) The executive noted that Bayi currently uses 700 kilograms
of standard coal equivalent of energy per ton of steel produced.
The company's goal is to reduce this to 600 kilograms per ton of
production, claimed the executive. The executive stated that Bayi
primarily relies on the Xinjiang power grid for its power supply.
The company maintains its own separate power generation capability,
but it is insufficient to provide full-time power. The executive
noted that Bayi is recycling its steel production waste gases to
provide some additional power, but does not have plans to expand
this beyond its current limited capacity.

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BAYI SLIMING WORKFORCE, LOSING SOCIAL SERVICE ROLE
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7. (SBU) The Bayi executive stated that the company is spinning off
several subsidiaries over the next few years. Bayi plans to reduce
its steel company workforce from 39,000 employees to around 20,000
employees. The company will only retain managers with direct
experience in the steel business. The executive noted that Bayi's
parent company is also downsizing. The parent company is made up of
around 40 subsidiaries divided into four main categories: Bayi,
construction and maintenance businesses directly related to Bayi,
non-steel sector enterprises, and social service enterprises. The
executive stated that a few of these enterprises have already been
spun off with ten more likely to follow.

8. (SBU) The executive noted that several of the enterprises already
separated from Bayi's parent company were social service providers.
These enterprises performed services ranging from running the parent
company's school system to managing company housing. The executive
stated that the parent company's vast employee housing stock has
been privatized. The parent company offered the housing to
employees at below-market prices before opening up to the public,
but employees are not required to purchase, or live in the housing.
The executive also said that the parent company's schools have been
turned over to the local government. A notable exception to this
ongoing social service reform is the parent company's medical
resources. The company hospital and clinics will probably remain
under the company's control, said the executive.

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NATIONAL STEEL POLICY NOT RELEVANT HERE
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9. (SBU) A Xinjiang Province Development and Reform Commission
official told us that national steel policies are important, but
they will have little impact on Bayi Steel. Xinjiang's steel sector
is not experiencing overinvestment or overcapacity problems like
other areas of China. Xinjiang only has around 1 percent of China's
total steel production capacity. The official said Xinjiang is
self-sufficient in power production and is not experiencing power
shortages like those areas with too much steel production capacity.
A Xinjiang Academy of Social Sciences official noted that some 70
percent of Xinjiang's steel production is used for local
construction needs. Local authorities want to increase provincial
steel production value by having local companies focus more on
making specialty steel products, such as natural gas and oil
pipelines, said the official.

BEIJING 00006367 003 OF 003

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COMMENT
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10. (SBU) The official Chinese press has highlighted Bayi's merger
with Baosteel as a groundbreaking cross-provincial boundary deal for
the steel sector. A similar deal by Baosteel with Inner Mongolia's
Baotou Steel, also rich in iron ore and energy resources, is in the
works. China's 2005 Steel Policy advocated these types of deals to
promote the growth of flagship enterprises such as Baosteel, reduce
outdated production capacity, and enable more efficient use of
natural resources. This has been slow to happen. Local experts
tell us that this is because of provincial capitals' concerns that
they will lose tax revenue to other provinces is a major reason why.
In Bayi's case, although not stated during our meetings, our
experience shows grounds to suspect a compromise has probably been
reached: Baosteel gains Bayi's iron ore and energy holdings and in
exchange Xinjiang hangs onto its tax revenue. Baosteel's success in
acquiring Inner Mongolia's Baotou and other sought after steel
enterprises for now probably requires similar tax deals.

RANDT

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