China to Renew Bid to Curb Steel Industry's Sprawl
Jan 27 2011 - China will renew its push to reduce the production capacity of its sprawling steel industry, as its largest mills continued last year to make only limited progress in the industry's consolidation, the Ministry of Industry and Information Technology said. The country produced 626.7 million metric tons of crude steel last year, an all-time high that refocused attention on limited effectiveness of policy tightening and government's attempts over the years to curb the industry's size. The 10 largest steel mills raised their combined contribution to the country's total steel output to 48% last year from 45% in 2009, and a total of 179 million tons of obsolete steel and iron capacity was shut down, Ministry of Industry and Information Technology spokesman Zhu Hongren said. (WSJ)
Implications
This is one of many similar announcements the Chinese government has made since 2005, with little noticeable impact on the industry. Output has grown from 500 metric tonnes per year in 2006 to 625 in 2010, a CAGR of 8% despite the global recession. It appears that local governments interests and rampant demand are counteracting central government dictates. Until the production numbers start to back them up, the government announcements will not affect the market.
Should China succeed in consolidating its steel industry, it would impact the market in several key ways. The reduced capacity would certainly be an upward driver in the global supply and demand dynamics. Shutting down the more antiquated mills should increase overall efficiency and reduce production costs. It would also give China Iron and Steel Association (CISA) the increased negotiating power it craves, which could lead to lower steel input costs. The past few rounds of negotiations between CISA and the big mining companies have undeniably been victories for the miners, in large part because the Chinese mills could not maintain a united front. Consolidation would benefit Chinese mills (those that remain in operation), but how it would impact global steel prices is unclear.
Background
With demand uncertain, the key forces in the medium term will be raw material costs and capacity utilization. Iron ore and coal have had an analogous market shift to steel over the past 10 years. However, since supply is more consolidated, with three global suppliers controlling 50% of seaborne production, raw material prices do not drop as rapidly as steel prices do. Therefore, steel suppliers often face high raw material costs and struggle to pass through the costs, especially when, as now, the industry is suffering from overcapacity. In the United States, capacity utilization has plateaued at 75%, well below the long term average of 90%. Although, mills have become more disciplined about not bringing idle capacity back online at the first sign of a market uptick, the constant temptation does keeps a ceiling on prices. European utilization is even lower. And despite the Chinese government's campaign to trim steel capacity, production still far exceeds the 500-million-ton level Beijing is targeting. It appears raw material cost and capacity utilization will push against each other in 2011, with steel producers caught in the middle.
Customers have had to adapt, as suppliers are no longer willing to enter into long term fixed price contracts and new financial instruments are being developed for steel. Buyers that persist in pursuing long term fixed price contracts will have to pay a significant premium. Other risk mitigation tools are being exploring, including the nascent steel futures market. Other strategies include indexed pricing with shared risk, attempts to pass through steel cost up the value chain, and physical hedging.
Other Recent News and Information
Expenses Outstrip Steelmakers' Pricing Gains: Major U.S. steelmakers said a stubbornly slow economic recovery was fueling a string of quarterly losses as soaring raw material and labor costs, coupled with lukewarm demand, offset the positive impact of recently rising prices. ( WSJ Jan 26, 2011)
China's Rising Steel Output Poses Hurdle in Placing Curbs: Despite China's campaign to slim down its steel industry, the country's crude steel production in September was the second-highest yet in terms of volume, underscoring the challenge Beijing faces in curbing capacity.(WSJ. Oct 23, 2009)
