Energy & Resources

An agreement forged in iron

Why Chinese steel firms are looking for foreign partners

Electricians carry a cover with the logo of ThyssenKrupp AG at the company's headquarters in the western German city of Essen

One of many foreign steelmakers seeking growth in China

“This region will become a germinating cell for retraining centres devoted to high-tech industries, precision mechanics and other future-oriented technologies,” a politician tells reporters. Idle steel workers will be reskilled, new roads built and an old port turned into a duty free zone.

This sounds like it could be Li Keqiang discussing China’s plans to transform Manchuria’s ailing industrial heartland into a Northeast Asian free trade zone. But it is actually German Labour Minister Norbert Bleum speaking in 1988 about the Ruhr Valley, the cradle of his own country’s ailing heavy industrial base.

The port in question is Duisberg on the Rhine, home to Krupp AG, one of the powerhouses that forged Germany’s industrialisation during the nineteenth century. But in 1999, just over a decade after Bleum’s speech, Krupp voluntarily entered into a merger with another German industrial titan Thyssen AG.

The inefficiencies and overcapacity that had plagued the European steel industry were a factor. Even in 2014, ThyssenKrupp was still only reporting its first profit in three years after (again) overhauling its business and turning to higher margin products such as auto steel.

And like so many of its contemporaries, ThyssenKrupp is making China a key part of is strategy. In 2014, Chinese sales accounted for almost 17% of its €41.2 billion ($46 billion) total revenues. Last week, it moved its plans up another gear with the announcement of a new alliance with Angang Steel to set up a plant in Chongqing, where the partners will manufacture sheets of hot-dip galvanised steel (a form of zinc plating, which protects products such as car body panels from corrosion).

ThyssenKrupp will hold a 12.5% direct stake in the venture as well as 37.5% indirectly through TKAS Auto Steel (Tagal) a joint venture it established with Angang in 2002. Tagal manufactures hot-dip galvanised steel too, but currently does so in the northeastern city of Dalian.

“The current strong demand from the Chinese auto sector for hot dipped coated steel sheet and the growth prospects in this segment offer clear opportunities,” said Heribert Fischer, ThyssenKrupp’s head of sales and innovation, adding, “We want to strengthen Tagal’s position in this market.”

As for its Chinese partner, the new venture may help Angang turn around its fortunes, after it declared a profit warning in the first quarter. CBN describes the relationship between the two as one where Angang is clinging onto ThyssenKrupp for all its worth.

As WiC has reported many times, the Chinese steel sector remains in an extremely sorry state, suffering many of the same issues that bedevilled European steel plants before it. According to the China Iron and Steel Association (CISA), large and mid-sized steel producers made combined losses of Rmb11 billion ($1.78 billion) in the first quarter of 2015, up from Rmb3.4 billion last year.

By 2017 the central government wants to remove 80 million tonnes of excess capacity by shutting down inefficient and heavily polluting plants. But analysts believe its efforts to date have not been very successful thanks to equally vigorous campaigns to keep the mills running by local governments fearful of heavy unemployment, bad debt and lost fiscal revenues.

As a result, supply is still outpacing demand. According to CISA figures, output of finished steel products was only down 1.3% year-on-year to 270 million tonnes in the first four months of the year. However, demand fell even faster, down 5.1% to 240 million tonnes over the same period. Since 2010, capacity utilisation at Chinese steel mills has fallen from an average of 84.1% to 75.8% in 2014.

In 2014, the industry tried to export its way out of trouble – overseas shipments increased 50.4% over the course of the year to a historic high of 93 million tonnes. This represented almost 60% of total EU steel consumption and a big chunk of China’s domestic production. According to the World Steel Association, China produced 839.2 million tonnes in 2014, half of the world’s total. But CISA began to fear anti-dumping probes. Towards the end of the year, it began lobbying the central government to start rescinding the VAT rebates Chinese producers enjoyed on the export of cheap alloy steel products.

The government took this on board and in January it removed rebates on boron, a chemical element producers had been adding to products to qualify. In response many steel mills simply switched from boron to chrome and exports have continued to climb.

During the first four months of the year, exports were up a further 32.7% compared to the same period in 2013. And in early May, the EU responded to complaints from the European Steel Association with an anti-dumping probe into imports of cold-rolled steel coils from China.

All told, the Chinese government has found it tough to cut capacity via consolidation – its target is to have 300 steel manufacturers or less. As explains, domestic producers do not want to become “the little brother” in any state-driven merger. In fact, they’d much rather work with foreign competitors that can help them move up the value chain instead.

In March, the NDRC made this easier by cancelling the equity ratio requirements for Sino-foreign joint ventures in the sector. Qiu Yuecheng, a researcher with Xiben New Line, told CBN that the move could help transform the domestic sector through restructuring and technological upgrading.

Shen Bin, executive vice president of China’s largest privately-owned steel producer, Shagang Group, agrees. “It provides a new roadmap for domestic producers and is a good thing,” he comments to “We would be happy to sit down and discuss cooperation if we find the right kind of foreign partner.”

The tie-up between Angang and ThyssenKrupp exemplifies this trend. Angang hopes to use the joint venture as a springboard to double its output of higher margin auto steel over the next two to three years, leapfrogging the current number two, Wugang Steel.

However, it still has some way to go before it catches up with Baosteel, which has cornered about 50% of China’s auto steel market. Unlike many other steel producers in Asia, Baosteel is not affiliated to a conglomerate that also produces cars. As such, it has been able to secure a pricing premium over most of its competitors and has inked supplier agreements with almost all carmakers in China.

Analysts say supplying the auto industry is the one area of the Chinese steel industry, which is not only profitable, but actually suffering product shortages. Japanese and Korean imports are currently filling the gap, accounting for about 12% of the market, equivalent to about two million tonnes per annum.

Like ThyssenKrupp, the Japanese and Koreans have also formed joint ventures with Chinese entities and a number of auto steel plants are due to begin operations over the next few years. But analysts believe supply and demand will not balance out until at least 2017.

The world’s largest auto steel producer, Nippon Steel and Sumitomo Metal, has a joint venture project called BNA with Baosteel and ArcelorMittal in which it owns a 38% stake. This will produce about two million tons of auto steel when it comes on stream later this year.

Angang also has a second joint venture with Kobe Steel, which it formalised last August. This new plant will produce about 0.6 million tonnes of auto steel per annum when it comes on line in 2016.

As concludes, “No-one should underestimate Angang’s momentum in the Chinese steel industry.” In an editorial, it argues that capacity additions can actually help the steel industry overcome its problems. “This new foreign capital will breathe new life into China’s steel sector,” it comments, referring to the technology upgrades the new plants are set to receive.

Analysts also remain hopeful the steel industry may have bottomed. Prices for the sector’s key raw material (iron ore) are still falling as more global capacity comes onstream. In 2014, Chinese steel producers had no option, but to pass these savings through to their end customers because of their own overcapacity issues.

If the government can finally succeed in removing excess capacity from the domestic industry and if its producers successfully diversify into higher margin products, then the sector’s overall profitability may improve. In turn that could allow falling iron ore costs to drop straight to the bigger steelmakers’ bottom lines. And any recovery in their operating profits will be welcome news for China’s banks too, given the high levels of loan exposure to the sector and the ongoing fear that a lot of steel mills could default on their debts (see WiC208).

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