In the beginning of the 1980's Rautaruukki Oyj had an existing steel mill in Raahe, Western Finland. The steel mill did not include an integrated coking plant (as steel mills usually do), because the coke needed in the steel production was acquired through long-term contracts with coke producers in the Soviet Union. The price of coke from the Soviet Union was relatively low, negotiated to be near the cost of production (this was possible, because of the special trade relationship between Finland and the Soviet Union).
The arrangement had worked fine for the first 20 years of the life of the steel mill, however, by the end of 1970's the reliability of coke deliveries, of which the steel production was dependent on, begun to deteriorate. This was due to transportation and production problems in the Soviet Union. On some occasions Rautaruukki Oyj had to buy coke from the world markets at the market price, to secure the steel production, when deliveries had not arrived in time from the Soviet Union. The price for the coke bought from the world markets was considerably higher, than the price for the coke from the Soviet Union. On the background of increased and still increasing insecurity about the availability of coke from the Soviet Union and about the world market price of coke, Rautaruukki Oyj decided to build a coking plant to complement the steel production.
The coking plant investment was of strategic importance, as the uncertainty about the availability and price of coke was a risk to the profitability and continuation steel production. Rautaruukki Oyj was at that time a state owned company, which meant that the return on investment requirement did not play as large a role as in privately owned companies. The opportunity cost of capital was (artificially) considered low. This was done, because for state-owned companies raising financing was not a capital markets related problem, but the capital came from the state of Finland (tax-payers). This also had the effect that investments were more easily considered profitable, as the state-owned companies often used a low opportunity cost of capital due to the lower risk, caused by the risk free financing. In addition, the Finnish economy was highly regulated until the end of 1980´s, which meant that capital markets were not functioning freely.
In the beginning of the 1980's availability of coke on the world markets had deteriorated, meaning that if deliveries from the Soviet Union experienced problems, Rautaruukki Oyj would have to pay a relatively
high price for coke to keep its steel production at an unchanged level. The building of the coking plant would mean that Rautaruukki could reduce the amount of coke bought from the Soviet Union and at the same time shield itself against the market price risk of coke. The raw material for a coking plant is coal, which is not a scarce raw material (significantly lower risk). On this background of financing possibilities and a scenario of growing risks the decision to build the coking plant was made in October 1984. After a three year building period, in October 1987, the coking plant became operational. The initial investment in the Plant was FIM 900 million (~150 M€). The production capacity of the plant was 475Kt of coke per year, which covered 60% of the demand for coke in the steel production. A coking plant produces coke-gas as a secondary product in the production process. The gas can be used to power the steel production. The energy needed, previously produced by using oil, could be fully replaced with energy generated by using coke-gas, thus generating savings. The planning, building know-how, and the machinery of the coking plant were mostly bought from Russian companies, due to Finnish inexperience with coke production. When the plant was built, it was the first coking plant in Finland and the technology was at an internationally high level. In the planning and building phases, possibilities to expand production were taken into consideration, e.g., the coal handling facilities were designed to be able to handle double the production volume originally built to the plant. This meant investing more initially, to support a possible expansion in the future.
In 1990 a decision was made to start the planning of an expansion to the coking plant. The reason for the expansion was the still further deteriorating coke deliveries from the Soviet Union. World market price of coke had also risen.
The Finnish economy had little earlier gone through a deregulation, and the basis on which profitability was to be examined had (also) changed. As mentioned above, the original plant infrastructure was designed and built to be functional with larger capacities, causing a reduction in the cost of the following expansion investment. The investment cost of the expansion was FIM 660 million (€ 110M). The expansion became operational in 1992, and the production of the plant rose to 940Kt annually. After the expansion, the coking plant produces all of the coke needed in the steel production, the unit has become self-sufficient.
The strategic change brought by the giga-investment was a change from a unit fully dependent on coke deliveries from the Soviet Union and the world markets for coke, to a unit totally insulated from coke market risk. This change in risk was brought about by the change in the input raw material from coke to coal. The overall market risk was reduced, as coal is not as scarce as coke. The output steel markets were unaffected by the investment. The unexpectedly fast collapse of the Soviet Union in the beginning of the 1990's, and the following time of uncertainty in Russia, proved the timing of the building of the addition to the coking plant to be
strategically excellent. The investment saved Rautaruukki from a need to buy up to 40% of the coke needed in the steel production from the world markets. The value of being able to avoid the losses caused by coke scarcity must have been difficult to evaluate ex-ante, however, ex-post it is clear that the value was high.
Because the investment was an addition to an already existing steel plant it is not straightforward to analyse the profitability of the investment separately from the profitability of the steel plant. The giga-investment in the coking plant can be viewed as a part of the larger investment (the steel mill), with an option to postpone the investment partly (the coking plant). The option to build later was exercised, when the price of uncertainty became too high
coke o i l coal coke 40% coking plant 60% coal coking plant
before investment after investment
1987
after additional investment
1992 steel production steel production steel production
Figure A-1. Changes to the production process brought by the giga-
Calculation of the ex-post profitability of the plant must take into consideration the changes in the input and the output markets and the changes in the circumstances affecting financing. Also other circumstances that were the reality at the time the plant was planned and built must also be taken into consideration. The change in the situation and the need to use different decision making criteria for the follow up add-on investment make the profitability assessment even more difficult. The case is been presented in the M.Sc. thesis of Linda Blom (2000).