Energy & Resources

Red dawn?

Puzzling times as steel industry earns profits

CHINA-ECONOMY/HSBC PMI

Sparkier results

Last week Citic Pacific celebrated a milestone – and one that the company’s management readily admits was long overdue. At long last, it loaded its maiden shipment of Australian iron ore onto a vessel bound for one of its steel plants in the Yangtze valley in eastern China.

As we have detailed in the past (see WiC163) Citic’s Aussie venture has been plagued with problems. Last week’s shipment was four years behind schedule and work on the Pilbara project has cost $8 billion more than budget.

While Citic’s bosses can be excused a palpable sigh of relief, state planners in Beijing will also be pleased that the ore is finally on its way north.

The A$10 billion project is set to be the world’s largest magnetite mine, eventually shipping 24 million tonnes of ore to China every year. The hope is that this will help to bring down the cost of the raw material and reduce the country’s reliance on the three big iron ore producers: BHP Billiton, Rio Tinto and Vale.

As WiC has reported many times before, China’s steelmakers have been struggling, primarily due to stubbornly high prices for iron ore and huge overcapacity in domestic steel production.

But some analysts are daring to wonder if things are turning round for the sector. China Times points out that 70% of steel firms made profits in the third quarter, with even the most troubled producers Angang and Shougang edging back into the black.

In Angang’s case, its third quarter profit of Rmb765 million ($125.92 million) contrasted sharply with the Rmb3.17 billion it had lost a year earlier.

What happened? A pick-up in demand seems to have perked up steel prices. Mysteel.com analyst Shen Yibing told the China Times: “Steel enterprises’ third quarter performance was closely related to a rebound in steel prices in July and August.”

According to the industry body CISA, were there to be a repeat of the profitability enjoyed in July and August for the remainder of 2013, that could help steel enterprises make an aggregate Rmb20 billion for the full year.

This would be a reversal of fortune for an industry that we described in the bleakest terms in WiC208. Then, low prices for steel led some bankers to worry about widespread loan defaults. Losses in the first half of the year at many of the leading firms stoked concerns, especially as steelmakers have accumulated Rmb3 trillion of debt, according to the Economic Observer.

But the China Times says it’s too soon to call the third quarter results a major turning point. In particular it warns that results at some steelmakers have been boosted by another round of local government subsidies, while others have “dressed up” their financials with creative accounting. The newspaper noticed that one enterprise had changed depreciation schedules for its machinery, for instance, while another major firm has been selling land to its parent company.

A steel industry insider told the newspaper: “The use of such accounting is like a magic mirror, where you may see corporate performance that looks very beautiful, but which turns out not to be true.”

The fundamental issue of overcapacity in the industry also remains, the China Times says, and it will take years for much of the surplus in production to be phased out.

Of course, greater reductions in the price of iron ore could improve the financial situation for steelmakers. Since peaking at around $200 a tonne in 2011, ore remains at a relatively high price historically, at $139 a tonne this week.

But the Wall Street Journal reckons that about 350 million tonnes of ore could be added to global supply in the next three years (to put that in perspective, the same newspaper reports that BHP Billiton last year produced 187 million tonnes, which was a record volume for the miner). This is prompting predictions that spot prices could fall to $80 a tonne, the Wall Street Journal says.

If so, margins at Chinese steelmakers would get a boost. But in the meantime, analysts await the data for the fourth quarter to see if the surprise rebound in the sector’s P&L can be sustained.


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