Energy & Resources, Talking Point

Steeling for tough times

Mergers announced in China’s giant steel industry

Steeling for tough times

China wants to consolidate the world's biggest steel industry into fewer, bigger players

Andrew Carnegie, a tycoon who knew a thing or two about the steel industry, once proclaimed: “The nation that makes the cheapest steel has other nations at its feet.” China has taken that mantra to heart – which is why the government has unveiled a plan to “adjust and invigorate” the steel industry. To this end, a wave of steel mergers was announced this week.

So does the steel industry need invigorating?

It would certainly seem so. China has added a lot of capacity in recent year – some would say a ludicrous amount. Despite boasting the world’s biggest steel industry, investment in new capacity added a further 27% in 2008. Major new projects included Beijing Shougang’s Caofeidian facility and Angang Steel’s Bayuquan plant.

According to a senior official at the China Steel and Iron Association, the mainland’s steel production capacity reached 660 million tonnes last year. However, actual output was only 500 million. That suggests there is about 160 million tonnes of excess capacity.

Is that a serious problem?

There are several reasons why it has become more serious. The first is obviously the collapse in demand for steel – a result of the current global slowdown. China has seen its steel exports fall rapidly as a result. In December, for example, only 3.17 million tonnes of iron and steel was exported, a decline of 33% from a year earlier. Chinese steel exports actually hit an all-time high last August when volumes reached 7.8 million tonnes. That means December’s exports were down 59% from the peak. Current overcapacity is also a major problem: it is killing profitability.

The China Iron and Steel Association surveyed 71 large and medium-sized steelmakers in November and calculated that 48 of them were loss-making. In aggregate, the 71 producers were making a combined loss of Rmb12.77 billion ($1.86 billion).

A telling indicator is that Baosteel Group, the country’s largest steelmaker, cut production by 30% in the last quarter of 2008.

What’s to be done?

On November 22, the nation’s prime minister, Wen Jiabao paid a visit to Baosteel. He saw firsthand some of the problems the industry faced and set a government taskforce to work to find solutions. The result is this week’s plan to “adjust and invigorate” the steel industry.

The plan proposes five measures. Those that relate to “adjusting” envisage a consolidation of the industry. The minister of industry and information technology, Li Yizhong has estimated that China has nearly 1,000 iron and steel smelting enterprises. The government wants the smaller players to be swallowed up by the big boys.

The first wave began this week. The China Iron and Steel Association announced that Baosteel would acquire Ningbo Iron and Steel and Baotou Iron and Steel. The industry body said Anben Steel – the country’s third largest steelmaker – would then take over Panzizhua Iron and Steel; while Taiyuan Iron and Steel will merge with rivals in Shanxi.

The goal is to create five mega steelmakers, controlling a combined 45% of the country’s output – and each capable of producing at least 50 million tonnes per year.

The other part of the plan is to move up the value curve. A Rmb15 billion fund will make low interest loans to steelmakers which make investments in higher value-added production – such as the manufacture of steel rail for high speed trains (see WiC1).

And in order to boost profitability, the government will once again provide export rebates on 67 different types of finished steel product. These had been revoked previously, so the industry has welcomed their return.

Anything else?

Did we forget to mention the government’s Rmb4 trillion economic stimulus plan? The steelmakers have high hopes that their finished products will see a surge in demand from the colossal amounts of construction (mostly of infrastructure) envisaged.

It is estimated that stimulus-related projects will require 20 million tonnes of steel.

Other approaches to the overcapacity issue are also being discussed. According to Reuters, the government will cap steel output at 500 million tonnes per year from 2011. That suggests 160 million tonnes of production will be mothballed between now and then – primarily targeting the smaller, less efficient mills.

So are steel prices still falling?

No, in fact, the evidence is that stimulus-related spending, and a surge in bank lending, have revived confidence. The price of March-delivered hot-rolled steel has increased from Rmb3,770 in October to Rmb4,170 a tonne. These are the first price hikes in five months. Some analysts now think the bottom for the steel price was in October-November.

So happy days are here again?

To quote Evelyn Waugh’s Scoop: “Up to a point, Lord Copper.” Some analysts are forecasting a drop in exports of 40 million tonnes in 2009, and say the average steel price this year will still be 30% below that of 2008.

Steel plants that began construction in 2007-2008 are now entering production, adding to the overcapacity issue. Additionally, around 40% of China’s steel capacity is derived from small producers whose plants make low value-added products, use energy unproductively, and create serious pollution as a result of their old-fashioned techniques.

But perhaps the most worrying statistic is that China needs to get the price of imported iron ore down by at least 25% just for its producers to break even.

Is that likely?

Chinalco’s recent investment in Rio Tinto (see WiC3) has proved controversial for this very reason. Since China is one of the main customers for iron ore, Rio’s institutional shareholders worry that Chinalco’s stake – which they fear is a proxy for the Chinese government – will allow Chinese steelmakers to exert downward pressure on the price of ore.

Rio, BHP Billiton and Brazil’s Vale do Rio Doce control 75% of the world’s traded iron ore. Ore prices jumped 97% last year and it is thought the Chinese will push for a 50% cut during the ongoing round of price negotiations it holds annually with all three firms.

The price meetings normally last a few months, but – with the world experiencing a synchronized global slowdown – Chinese steelmakers are confident that, this time around, they will be able to win their first price cut in seven years.

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