Mergers that will create the two newest global steelmaking groups are putting pressure for full-scale restructuring in a global industry squeezed by rising raw material prices and demands from end-use buyers for even more price cuts and cost reductions.

For the past quarter century, the U.S. steel industry has been urged to consolidate. But, despite poor earnings growth among domestic steelmakers since 1998 and restlessness among customers looking to globalize their supply base, no mavens or industry insiders see a winnowing of the weak anytime soon.

Now there are two mega-mergers under way offshore. The planned $3.1-billion merger by three European companies—Usinor of France, Arbed of Luxembourg and Aceralia of Spain—will create the world's biggest steel producer with annual output of 46 million metric tons. Atop that, Japan's second-largest steelmaker, NKK Corp., and third-ranked Kawasaki Steel Corp. now plan to merge into Japan's biggest steelmaker and the world's second largest at 33 million metric tons of annual output.

These mergers have prompted concern among analysts about the U.S. steel industry's ability to compete globally. Those concerns, however, are unlikely to force consolidation, according to the mavens, because the domestic steel industry remains stodgy and slow to change.

Wall Street insiders say sagging steel company stock prices suggest that investors worldwide are unhappy with an industry that hasn't fully recovered from the Asian financial crisis three years ago. "Industries do die and the reality is that steel could go away too, if the proper steps are not taken," says Dave Jardini, director of Pittsburgh-based consulting outfit Hatch Beddows. "Steel is on the brink of fundamental restructuring. Capital is scarce. Emphasis is on efficiency. There is opportunity for those willing to change."

Jardini says the changes can't happen fast enough. He points to the Internet and other information technologies that could help steelmakers to establish real relationships with end users—an area that has been sorely lacking in the past. "Steelmakers are isolated from the end users of their products," Jardini says. "Improvements in the supply chain offer opportunities to substantially increase industry returns." The current fragmented supply structure, he says, causes "minimum-output dilemma" and excessive inventory levels.

The challenge for steelmakers and distributors is to recreate the supply chain, using advanced technologies and innovative business models, Jardini says. Other industry trouble spots, in the consultant's view:

• A sustained bull market in terms of demand has yet to generate solid investment returns,
• Proven technologies have not performed as expected while new technologies have fared even more poorly, and
• Steel is a capital-intensive industry that no longer has sufficient access to capital.

Another market expert says that for U.S. companies to reduce their excess steel capacity and compete globally, two-thirds of the industry must consolidate. "There are approximately 20 companies in North America that sell at least one million tons of sheet each year," says analyst John Tumazos at Sanford Bernstein in New York, a brokerage subsidiary of Alliance Capital. "If five of them merged or disappeared, it would still be a very competitive market."

Analyst Mark Parr at McDonald Investments in Cleveland, the investment-banking arm of Key Bank, says a restructured U.S. steel supply base is needed to generate low-cost production. "We really don't need less capacity," Parr says. "What we really need is more low-cost capacity." He says the 45 million metric-ton-per-year powerhouse coming out of the planned European merger will have a lower cost structure and be a stronger global competitor. "This will put more pressure on domestic mills to forge dramatic new cost structures," Parr says.

Analyst Michael Gambardella says, "we've been waiting a long time for the steel industry in the U.S. to do something—anything—strategic and we believe that a few catalysts are developing that might bring action by domestic producers."

External capital supplies are extremely limited for the industry. Additionally, the industry has recorded 16 bankruptcies in the past two years, Gambardella notes. "These crisis-like conditions and limited external capital sources are forcing all the key steel industry constituents—labor, management and the government—to consider possible solutions," he notes. The key, Gambardella suggests, is that "steel managers in the U.S. finally are coming to the conclusion that if the steel industry is going to survive, it must quickly implement a strategy of consolidation, rationalization and globalization."

There's every indication that unfavorable conditions for the North American steel industry have become as bad as they will be for the current business cycle, suggests Roger Phillips, president and chief executive of Ipsco Inc., the U.S. and Canadian steelmaker. "Our industry has been hit by a slowdown in demand, particularly in steel for automotive applications, excess supply due to an unprecedented level of dumped imports, and a spike in costs due to the run up in energy prices, particularly for natural gas," he says. "The net result has been to drive a growing number of U.S. steel companies into bankruptcy. Steel prices are at the lowest in recent history, but seem to have bottomed out."

However, consolidation among U.S. steel companies would not resolve excess global capacity and pricing problems facing the domestic industry, says Alan McCoy, a vice president at Middletown, Ohio-based AK Steel. "What needs to happen in this country is that marginal companies have to be left to natural market forces. If they can't survive without some sort of government subsidy or other type of unnatural interference, then they ought to simply go by the wayside," McCoy says.

McCoy says there are many obstacles in the way of mergers despite current opportunities for grabbing some very cheap assets amid the financial crisis hitting the industry. A big obstacle is the legacy costs associated with healthcare, pension programs and other ongoing items, he says. There also are "tremendous hurdles" in terms of union contracts that would prevent saving any money by idling mills, McCoy says.

Bethlehem Steel Corp., the second-largest U.S. steelmaker, has called for consolidation in the industry, saying capital should be provided to struggling steelmakers so they are given a fair chance to compete. A spokesman for U.S. Steel Group in Pittsburgh, the nation's largest steelmaker, acknowledges that the industry needs to consolidate, but says there are too many obstacles—what he calls "little hidden land mines"—in the way. Besides retirement obligations and healthcare costs, the industry also faces costly environmental issues.

Global mergers are turning U.S. Steel, the nation's largest, into a second-tier world player.