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 
----------------------------------------- 
 
¶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 
------------------------------- 
 
¶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 
--------------------------------------------- ----- 
 
¶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