Some 20 years ago, the Coega Industrial Development Zone (IDZ; now the Coega Special Economic Zone [SEZ]) in South Africa embarked on an experiment: to create a fully vertically integrated industrial cluster targeting steel. Ultimately, the experiment would fail and serves today as a cautionary tale for other SEZs attempting similar strategies.
The Coega SEZ is located near the city of Gqeberha (known as Port Elizabeth until February 2021). In 2001, when the zone first opened, officials planned to create a fully integrated steel hub.
The plan would ultimately prove ruinous. Due to a change in macroeconomic conditions, the overly ambitious project failed to attract a major tenant. The story demonstrates the importance of zones being forward-looking, nimble and having fall-back industries.
The story demonstrates the importance of zones being forward-looking, nimble and having fall-back industries.
Location, location, location
On paper, the location was perfect. It was located at the mouth of a stream, with plenty of fresh water to cool down smelting equipment. It also had a location suitable for a deep-water port, which would make the exportation of steel easy. It was located near Port Elizabeth, which had a large labour pool. Global macroeconomic conditions favoured ever-increasing steel production.
South Africa also had some of the cheapest electricity in the region, which is critical when it comes to heating the massive forges used to produce steel. Most importantly, the raw minerals needed to produce the steel — iron, manganese, zinc, arsenic, chromium, and nickel — were already major South African exports.
Adrift without an anchor
Immediately, signs of trouble appeared. For the plan to work, Coega would need an anchor tenant — someone who could finance the construction of the infrastructure which would attract other tenants.
The first potential anchor tenant which was targeted was the German Submarine Consortium. It was composed of three German companies — HDW, Thyssen Nordseewerke, and Ferrostaal — and had been established for a single deal to sell military submarines to the South African government.
As part of the deal, the steel for the submarines would be produced in a South African industrial cluster, possibly Coega. The consortium would invest in infrastructure and equipment, which would later be used by South African steel producers and Port Elizabeth’s existing auto part manufacturers.
The deal proved extremely controversial. The South African public was generally hostile to what they saw as a deal that heavily favoured the military industrial complex. Worse, as the deal progressed, serious corruption allegations came to light. The bad image of the deal would ultimately cause it to collapse, and the German Submarine Consortium would never invest in the production of a steel hub.
Coega had a backup in mind: French aluminium producer Pechiney.
In 2001, Pechiney began investigating Coega as a test site for its brand new AP50 smelter technology. Other Pechiney facilities used older AP35, which was less efficient and environmentally friendly.
Two years later, the South African government inked the agreement for Pechiney to establish the steel smelter. However, the agreement would come at a significant cost to the South African taxpayers. The South African government would provide Pechiney with marine transportation infrastructure, along with railroads, electricity and numerous other pieces of key technology. Pechiney was to fund 45% of the $2bn project, with the state-owned enterprises funding 25%. The remaining 30% would be funded by other international investors.
Then, only months after the ink had dried, the Pechiney ceased to exist.
As Pechiney was negotiating with the South African government, it was also fighting for its life. Its competitor, the Canadian aluminium producer Alcan, had been lining up a hostile takeover of the company, which came to fruition in 2004. Pechiney became a subdivision of Alcan.
Alcan executives publicly expressed their desire for the Coega smelter deal to go through; but at the very same time quietly backed out of the deal.
The circumstances, they claimed, had changed. By 2004, the world was awash with aluminium — the entire industry was in crisis. Worse, electricity would account for 30% of the smelter’s planned operating costs. The South African power grid had begun deteriorating and electricity had gone from a key selling point into a major problem.
The feasibility studies carried out by Pechiney expired in November 2004; and Alcan carried out a new set of studies later that year. Negotiations would drag on until 2007. Alcan insisted on getting a better deal — the smelters would be downgraded and only use the old AP35 technology, rather than the new AP50 technology. The South African government would now have to cover up to 55% of the project’s costs, provide a $100m loan to the project and build many other pieces of expensive infrastructure. Reluctantly, the South African government agreed.
The following year, in 2008, the world economy would go into recession and it became Alcan’s turn to disappear.
By the end of 2008, Alcan had, in turn, ceased to exist. It was bought by its competitor, the British mineral giant Rio Tinto. Rio Tinto initially made several token gestures implying that they planned on picking up where Pechiney and Alcan had left off; but by 2009 ultimately backed out of the project. In addition to the German Submarine Consortium, Pechiney, Alcan and Rio Tinto, Coega approached at least five other potential anchor tenants during this time. All backed out.
There are three key lessons that can be drawn from the failure of the Coega IDZ steel hub. Firstly, it is more prudent to focus on future conditions, rather than the present. In 2001, electricity was cheap and plentiful in South Africa. However, warning signs were already present.
Load shedding — a practice where distribution of energy is temporarily switched off to certain geographical areas in order to reduce demand — would begin three years later. Likewise, macroeconomic conditions would also change to favour industrial consolidation, preventing Coega from attracting key tenants.
Secondly, this is an example of how central economic planning fails. It is always tempting for governments to embark on large-scale projects which, on paper, look like they will create thousands of jobs. In reality, small, nimble, and privately funded SEZs are more likely to succeed. Coega would have had a higher chance of success if it had entirely private funding, been given leeway by regulators and attempted smaller scale projects.
Finally, having a good fallback plan is critical. Coega would ultimately survive, but only by relying on South African state-owned enterprises. It would have been more prudent for Coega to have a strong secondary fallback industry, such as agro-processing, which would prove to become a major component of the zone 20 years later. This would have meant that the failure of the steel hub would not have proven so critical.
Thibault Serlet is the director of research at the Adrianople Group, a business intelligence advisory firm.
This article first appeared in the October/November 2022 print edition of fDi Intelligence. View a digital edition of the magazine here.
Thibault's previous columns:
- Digital nomads open door to new SEZ models.
- How universities lead to successful SEZs.
- Lessons for FDI practitioners from the history of Venice.