The production cost difference between integrated steel producers and others is expected to increase sharply after the aggressive bidding by merchant iron ore in Karnataka.

The iron ore cost is set to rise 30-40 per cent for non-integrated steel companies after the Karnataka auction. Bidders have to commit a portion of their iron sales realisation as premium to government at the time of bidding.

Disruptions in mines, elevated inventory levels and high bid premiums in the recent auctions in Karnataka pose hiccups on the supply side, even as dampeners abound on the demand side, said a Crisil Research report.

Following this, even the upcoming mine auctions in Odisha are expected to see high bid premiums.

The development will deliver a blow to non-integrated steelmakers, who account for 76 per cent of domestic crude steel capacity, it said. These companies procure iron ore from the merchant miners, who will directly pass on the high premium committed to the state governments.

With global iron ore prices falling continuously, port-based steel companies can potentially consider imports.

While the profitability of non-integrated steelmakers is expected to come under pressure following the Odisha auctions, higher realisations and declining coal prices should provide some relief, said the report.

The existing captive steel makers will continue to enjoy lower iron ore cost as before, while steel companies that have bought mines in the last two fiscals, would see a 5-8 per cent rise in their iron ore cost against the merchant procurement price earlier, as new iron ore leases had come at high premiums.

The bid premiums have surged as players want to ensure long-term supply of iron ore and lower dependence on merchant procurement. However, till the new mines start operations, steel companies have to procure iron ore from the existing merchant miners.

The mines that won in the recent auctions are expected to take two-three years to become operational. Taking the global cues, the Crisil Research report said steel prices are expected to be range-bound with a downward bias.

While coking coal prices are expected to decline in the next fiscal, the rising iron ore cost after auction will weigh on the spreads of non-integrated players, even as merchant miners will potentially absorb 5-10 per cent of the rise in iron ore cost as they operate at a relatively healthy profitability margin of 25-35 per cent.