Welded together

At the end of June, workers installed the final segment of the world’s longest sea bridge linking Hong Kong, Zhuhai and Macau. Guangzhou-based newspaper New Express proudly trumpeted how the 30-kilometre steel bridge has used as much metal as 60 Eiffel Towers.

One day earlier in the steel heartlands of Western Pennsylvania, presumptive US Republican candidate Donald Trump was more concerned with another iconic landmark: New York’s Empire State Building. In a speech to assembled steel workers, Trump noted that the building had been forged with American steel, but thanks to the Clintons’ globalisation policies in the 1990s the Washington elite were no longer putting “America first”.

Once again decrying China’s accession to the World Trade Organisation as the “greatest jobs theft in history,” Trump pledged to make sure that under him it will be “American steel that sends our skyscrapers soaring into the sky”.

While he was working on the details of how to make “America great again,” Trump may have missed an announcement just a few days earlier by the Washington-based US International Trade Commission. Its ruling concluded that with US steel producers having been hurt by Chinese imports, the way has been paved for exceptionally high anti-dumping duties on Chinese imports of cold rolled steel and corrosive resistant steel.

As Reuters noted, “China is running out of time to cure its steel problems. The trade walls are rapidly being erected”.

Meanwhile, Beijing’s attempt to mothball excess capacity has faced headwinds.

Last year, the government pledged to permanently remove 100 million to 150 million tonnes of steel capacity by 2020 and enforce consolidation on a highly fragmented industry, creating three to five ultra-large steel groups.

Initial attempts to remove capacity appeared to be successful. Analysts estimate that 50 million tonnes was shuttered in Hebei towards the end of last year as profits fell to record lows (in fact most steel companies were loss-making). However, when steel prices started rising over the first five months of 2015, “many mills bought back idle capacity,” according to Mysteel’s Beijing-based analyst.

Government efforts to tackle the problem have focused on consolidation. At the end of June, Baosteel and Wuhan Iron and Steel (Wisco) confirmed they were planning a “strategic restructuring”, according to circulars released by the duo’s Shanghai-listed units.

“The two parties are currently only at the very beginning of forming a restructuring intention, without any detailed work rolled out. So the process is full of uncertainties,” a spokesman for Wisco told China Daily. Rumours of a merger between the two state mills have been rife over the past 12 months. The combination of China’s second and fifth largest steelmaker by output would create the country’s largest steel firm, overtaking Hebei Iron and Steel (Hesteel) and becoming the world’s second largest behind ArcelorMittal.

In 2015, Baosteel and Wisco produced a combined 60.7 million tonnes of steel, compared to Hesteel’s 40.75 million tonnes and AcelorMittal’s 97.13 million tonnes. By contrast, the US as a whole produced 80 million tonnes.

The central government has been encouraging mergers between larger state-owned enterprises (SOEs) to create even bigger national champions. Train makers CSR Corp and CNR Corp, for example, were combined in 2014, and that was followed by a merger between shipping giants COSCO and CSCL a year later. Underlying their combined strength, the new SOEs have been dubbed by Chinese investors as the ‘Divine Train’ and ‘Divine Ship’ respectively.

But a merged Baosteel-Wisco doesn’t look like a ‘Divine Mill’. Together, they will only have 7.5% market share in China, underlining just how far consolidation has to run to make a meaningful difference.

Baosteel may be less keen on the proposed merger. “Poor Baosteel,” concludes Bloomberg. “It spent decades building that rarest of creatures, a Chinese state-owned steel maker that actually makes a profit and isn’t drowning in debt.”

As we wrote in WiC297, Wisco has not been so successful. It lost Rmb7.5 billion ($1.1 billion) in 2015 (although it did manage to turn a tiny Rmb31 million profit during the first quarter this year) and has resorted to pig farming and organic vegetable production to redeploy older steel workers who have known nothing but the iron rice bowl of cradle-to-grave job security.

Outside its plant stands a large statue of Chairman Mao who oversaw the first batch of steel to emerge from its furnace in 1958, just as the calamitous Great Leap Forward was getting under way.

Earlier this May, Premier Li Keqiang visited the plant. “Wisco has made an important contribution to our country,” he said in an article quoted by Jiemian.com. “But the reality is we have a steel industry suffering from excess capacity and a plant which is not as competitive as those in coastal areas because of transportation logistics. We must face its restructuring with determination and courage.”

Financial analysts who cover both Wisco and Baosteel agree the merger marks a positive step forwards. However, Chinese analysts have been more optimistic than their Western counterparts.

GF Securities says the merged entity will have enhanced bargaining power with upstream and downstream players. It will hold a 65% market share in the auto plate sector (mainly used in the car industry) and 75% in silicon sheets.

CICC believes the merger shows that China is making steady progress with supply side reforms. It flags the moves that the larger steel groups have been making to remove excess capacity. This includes Baosteel, which has mothballed a 2.5 million tonne blast furnace, and Hesteel, which has shut down a one million tonne plant, that accounted for 14% of its pre-tax loss.

CICC also thinks there is little chance that more mills will restart production in the second half of 2016 as many are only just operating at breakeven levels.

All the analysts say geographical proximity should make it easier for Baosteel and Wisco to find synergies serving the home appliances and car industries in southern China.

However, overseas analysts say administrative-driven restructuring is no substitute for market-driven capacity shutdowns.

HSBC analysts notes that the debt and cost-cutting programme will be complex and time-consuming.

Unsurprisingly, all three international rating agencies described the merger as credit negative for Baosteel. Moody’s had already downgraded it from A3 to Baa1 in May, while Standard & Poor’s rates it at the BBB+ level and Fitch responded to the merger by putting it’s A- rating on review for downgrade.

Together Baosteel and Wisco will account for 34% of the production of China’s top 10 producers. However, the task facing the government is underlined by the fact that the top 10 have a lower overall market share of 40% now compared to 52% back in 2010.

Many local governments are still throwing subsidies at their respective steel companies to keep them afloat. One of the biggest recipients is Chongqing Iron and Steel, which is still getting Rmb287 per tonne. It has done little to stem a sea of red ink. In 2015, the Chongqing steelmaker posted a loss of Rmb7.17 billion despite receiving Rmb969 million in subsidies.

Local governments are all too aware that while it may have taken 400,000 tonnes of steel to build the Hong Kong-Zhuhai-Macau bridge, that could be the same number of jobs (400,000) that Beijing thinks will need to disappear if China is to make its steel industry profitable again.

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