Energy & Resources, Talking Point

Steeling jobs?

How China’s steel industry is shaking Wales – and the rest of the world

Facilities of a closed steel factory are seen in Tangshan

More of these required: a closed steel factory in Hebei province’s industrial city of Tangshan

Last November the historian Angela John published a book about Port Talbot called The Actor’s Crucible. It looked at a paradox: how this decidedly unthespian, industrial town had produced some of Britain’s greatest actors. Among the best known to hail from Port Talbot: the late, great Richard Burton, the Oscar-winner Anthony Hopkins and Michael Sheen (who has played Tony Blair, Brian Clough and David Frost on the big screen). Also a Talbot boy: comedian Rob Brydon (who you may have seen impersonating Michael Caine alongside Steve Coogan in the hilarious Trip to Italy).

But just as John was focusing on Port Talbot’s soft power exports, the industry the town is most familiarly associated with was experiencing a crisis. In the past couple of years steelmaking has become steadily more lossmaking for the blast furnaces in this south Wales town – a sad outcome for a place that has been churning out steel for more than a century.

Something had to give and last week British newspaper front pages were dominated by the announcement that Indian conglomerate Tata will close the town’s steel plant unless a buyer can be found. At least 4,000 jobs will be lost at the works, which accounts for more than a third of Britain’s 10 million tonnes of annual steel production.

Port Talbot’s problems are said to be symptomatic of the wider crisis in steel prompted by a glut of supply. A key contributor to the current mess, many international steelmakers have suggested, are the Chinese, who are trying to export their way out of a steelmaking crisis at home by selling abroad at below-market prices – a practice called dumping.

A series of countries have already imposed tariffs on Chinese imports, while Beijing has responded in kind by slapping duties on steel sales from South Korea, Japan and the European Union. As talk of a trade war intensifies, how are the Chinese reacting to the steelmaking slump, and what are the prospects for a recovery of their homegrown producers?

Stop complaining, we’ve got it tougher…

Liu Xiaoming, China’s ambassador to the UK, denied the dumping allegations in an article in Britain’s Daily Telegraph last weekend, saying that the Chinese keep to market rules. Nor was he tremendously sympathetic to the difficulties of steel plants like Port Talbot’s, pointing out that oversupply is a global problem and that Chinese steelmakers are in bigger trouble, with 500,000 steelworkers set to lose their jobs in the near future.

Chinese steel only makes up a small share of Britain’s total imports, Liu argued, and British producers don’t compete directly with Chinese firms, who generally make lower-end steel. Besides, cheaper steel has hardly damaged British interests. “On the contrary, by importing steel from China, the auto, machinery, construction and other British industries have effectively lowered their costs and increased their profit margin,” he claimed.

Much of that is true. Steel capacity has been growing quickly in places like Africa and the Middle East as well, and CRU, a commodities consultancy, has highlighted that countries like Brazil and Russia export a higher proportion of their domestic production.

But China’s steel industry is so gigantic that its influence swamps everyone else. Some of the orders of magnitude are incredible. The International Steel Statistics Bureau estimates that the Chinese have forged more steel in the last two years than Britain did in the entirety of the twentieth century. China also exported more steel last year – about 100 million tonnes – than Japan, the second largest manufacturer, produced in total. That was the most steel exported by any country this century, and few analysts query that the Chinese market is setting the direction of global prices.

Why have steel prices fallen there?

The fundamental problem is the mismatch between supply and demand – HSBC estimates that Chinese mills are capable of producing about 1.2 billion tonnes of steel a year, but that 400 million tonnes is currently surplus to requirements.

WiC has reported in the past how most of the surge in the steelmaking base came after 2008 when Beijing launched its Rmb4 trillion stimulus plan in the wake of the global financial crisis. Banks were encouraged to lend to state firms and the authorities kicked off a massive round of infrastructure projects in roads, railways and buildings. Steel firms grabbed the cheap finance and the industry grew by half in the five years after 2010.

A lot of the new supply has been coming onto the market over the last two years, just as demand has started to soften. In the longer term the Chinese want to shift away from investment-driven growth to more of a consumer-oriented economy. But the current glut really came into the spotlight last year, with weakness in the property sector exacerbating the sense of crisis.

Steel production did fall slightly (for the first time in 30 years) but demand has dropped faster and further. One of the consequences was that the Chinese diverted their excess output to export markets. The volumes sent overseas reached new record levels, leading to the complaints from steelmakers in other countries about dumping.

Aren’t more of China’s steelmakers supposed to be shutting down?

In March the State Council announced a further round of efforts to cut 100-150 million tonnes of capacity. That’s an increase on previous goals. But that still accounts for no more than 12.5% of the total, says Chris Chen, an analyst in HSBC’s metals and mining team. And plants are still opening even as the older ones are decommissioned, too, with another 37 million tonnes of new capacity likely to go live within three years.

Policymakers have an unconvincing record in shutting down older mills. In November 2011 they announced commitments to closing mills with older furnaces and two years later there were promises that smaller, less efficient mills would be left to go out of business as the industry rallied behind the larger, more sophisticated steelmakers. But very few facilities have shut up shop and the industry hasn’t coalesced around the bigger producers. The opposite, in fact: the market share for the top 10 steelmakers has declined and industry bosses have put back the target date for completing the consolidation around the key firms by 10 years.

Last year there were more closures than in previous years but the trend was primarily driven by the awful trading conditions. Producers suffered their worst year ever with combined losses of Rmb100 billion ($15.5 billion), according to data from the China Iron and Steel Association (CISA), a leading industry body. Chinese steel is selling for about a third of prices at the 2008 peak.

“The sharp downturn sent life-or-death signals to some companies and posed grim challenges to our business in 2016,” CISA’s secretary-general Liu Zhenjiang warned this month.

More of this life-or-death message needs to get through, however, forcing the biggest lossmakers to shut down their plants. CISA has reported another Rmb11.4 billion of losses for its members in January and February alone, with Angang Steel, one of the larger producers, blaming an “ice age” in the market.

And as we mentioned last week, other distress signals are blinking red, including news that Dongbei Special Steel has become the ‘first’ locally administered state firm to default on a debt repayment, after Liaoning’s provincial government refused to bail out investors (see WiC319).

Could the market meltdown prove a turning point in the struggle to shutter more of China’s steel firms? In the past producers simply shrugged their shoulders when times were tough and waited for prices to recover, says Cai Rang, chairman of the China Iron and Steel Research Institute. “Everyone would think:‘winter has come, so spring cannot be far off,” he told China Economic Times.

This time it might be different, Cai believes: “Now the macro environment has changed, and most people believe that the steel industry won’t have another springtime. In short, steel has already entered the post-industrial era, and the effects of restructuring, mergers, acquisitions and capacity reduction going on now may be different to before.”

Any signs that resistance to shutdowns could falter?

Most local governments are fiercely opposed to plant closures. The prospect of 500,000 job losses in the first phase of cutbacks is especially alarming in the rustbelt provinces, where many of the steelmakers are based. “The number may not appear large relative to China’s working population, but the steel industry tends to be geographically concentrated in northeast China, north China’s Hebei province, and east China’s Shandong province,” Laura Zhai, an analyst at Fitch, the ratings agency, told the Financial Times.

The central government has shown signs that it is getting more serious about the rationalisation campaign by launching an Rmb100 billion fund to support laid-off workers. But HSBC’s Chen says that it doesn’t look large enough to provide a proper safety net. Beijing’s own estimates are that 1.8 million workers in the steel and coal sectors will lose their jobs through the closure of unproductive mills and mines, implying payouts of Rmb56,000 for each worker – not a vast sum in terms of subsidies or retraining costs.

And while the gloom enveloping the sector will put off new entrants, the incumbents are much harder to dislodge. Any inkling of good news is enough to persuade incumbent players to keep their furnaces firing.

For example, last month there was an unexpected uptick in sentiment, prompted by orders from customers that had run down their inventories in the lead-up to Chinese New Year. “Every day, the price is higher than yesterday,” Zhang Mingkun, a salesman at a steel product merchant in Hebei, told the South China Morning Post of the recent rally. “Market sentiment is completely different from a few months earlier, and everyone is now expecting the prices to go up further.”

The rebound in prices will have heartened even the most stricken of the steelmakers, who argue that demand is going to get a long term boost from China’s urbanisation story, which still has a long way to run, and that there will be plenty of new customers from China’s ‘One Belt, One Road’ infrastructure spending in overseas markets.

This kind of optimism keeps the zombie steelmakers in business and prompts reactivation of their production lines in pursuit of short-term profits. Chen says that less than a fifth of last year’s shutdowns are likely to prove permanent, for instance, and media reports from producers like Songting Steel in Hebei seem to underline the point – two out of the five furnaces shut last year by its local government were being fired up again over the weekend.

How about the financial implications of a ‘zombie apocalypse’?

Another risk is the financial fallout as the worst of the lossmakers are culled. Most of the ailing firms have been kept alive by their local government shareholders and their lenders – neither of which wants a day of reckoning for the industry’s bad debts.

We first raised concerns about the flaky financial foundations of the sector in WiC208 in a 2013 Talking Point that looked at calls for an asset management agency to take on the worst of the industry’s debts (which in that year had already grown to $490 billion). Since then the financial burden has grown, as have concerns about non-performing loans across the industry. HSBC has calculated that there could be at least Rmb510 billion in debt write-offs from the closures in the current capacity reduction plan alone, for example.

Fifteen years ago the central government used asset management firms to buy the non-performing loans of a number of poorly performing state-owned enterprises from the banks. The loans were then converted into stock or disposed of in other ways. The current talk is another round of debt-for-equity swaps, although the programme might be more market-driven. Previously, taxpayers funded the costs of the plan.

Critics of the scheme say that the central government has to take the lead in sorting out the financial mess, because it’s unrealistic to expect local authorities to close down the zombie firms and shoulder the write-offs themselves. But it’s hard to see why investors would be keen on taking equity in steelmakers that don’t have viable futures. Indeed, proponents of the plan have argued that zombie enterprises in saturated sectors like steel shouldn’t even be considered for the debt-to-equity deals because they will only waste further resources.

Just such swaps are said to be on the agenda in Tianjin, however, where Bohai Steel has been engaged in frantic negotiations over Rmb192 billion of its own debts since late March, when one of its affiliates missed a payment on a Rmb350 million trust product. News of the failure sent a chill through the firm’s other creditors, which include the Bank of Beijing, Bank of Tianjin and Tianjin Binhai Rural Commercial Bank, each of which is owed more than Rmb10 billion, Caixin Weekly has reported.

According to Caixin Weekly, the banks are waiting on a rescue plan being coordinated by Huang Xingguo, Tianjin’s mayor. The local government “has asked banks to continue lending” to Bohai “and the government will pay the interest”. Bohai would seem to be a classic candidate for the cull of unprofitable producers – indeed, it is one of the firms already targeted for cuts in output. Yan Bingzhu, chairman of the Bank of Beijing, told reporters last month that the central government has demanded the steelmaker reduce capacity by 15 million tonnes this year (well over half of its current capability).

In the meantime, trade tensions could worsen?

That looks likely, if more low-priced Chinese steel is shipped to global markets. Later this year the Chinese will also reach an important milestone, having spent 15 years as a member of the World Trade Organisation. This will trigger provisions to review its designation as a ‘non-market economy’. Currently the designation makes it easier for its trading partners to impose anti-dumping duties on goods like steel and cement. China wants its classification to be changed as soon as possible, although major economies like the EU, India, Japan and Mexico are yet to accept its claims to market status.

One option for lowering the tensions would be for the Chinese to adopt a policy of self-restraint in which the government asks steelmakers to reduce their exports, in the way that the Japanese curtailed car exports to the United States in the 1980s. Even if agreement can be reached, policing a common line has been difficult in the past, most notably in the efforts to get better terms from the global iron ore producers (see WiC25).

Others see China’s steel exports as a test case for how it is going to handle other surpluses in industrial goods, many of which could end up as exports to other markets. One example is coal, The Economist reports. China has traditionally needed imports to supplement its domestic production but today its miners are talking about excess capacity of 3.3 billion tonnes within two years, according to ratings agency Fitch. Shenhua Energy, the biggest coal miner, sold a little over a million tonnes to international customers last year but says that it plans to export much more overseas.

The situation is similar in sectors like aluminium, where production has ballooned, or chemicals, where the supply glut could prompt a more aggressive push into global markets. Five years ago Chinese demand for iron ore, coal and copper was so intense that it depleted the global commodity markets like a storm drain. Now China’s overcapacity in a range of industries is both its problem – and the rest of the world’s.

In terms of steel, the basic numbers just don’t add up, meaning things could be tough for the industry for the next five years and beyond. According to the Financial Times, an industry ministry official named Luo Tiejun this week confirmed that cuts to China’s annual steel capacity would reduce it to about 1.1 billion tonnes by 2020. However, the official also conceded that China’s own domestic consumption needs were unlikely to exceed 700 million tonnes that year. The glut continues…

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