2018 has commenced with continuing strong steel mill margins and iron ore prices that peaked at almost $80/mt. We take a look at the key themes that could impact steel and raw materials prices in the coming year.
With so much uncertainty around environmental policies, capacity reduction and economic factors, the only thing that seems certain for the year ahead is price volatility.
1. GLOBAL IRON ORE SUPPLY: MINIMAL GROWTH FOR 2018
In 2017 the message from major miners was “value over volume” as annual production volume projections were wound back throughout the year.
This sentiment is continuing in 2018 with Rio Tinto expected to have the lowest volume increase at 5 million mt in 2018, as forecast by S&P Global Market Intelligence.
Pilbara miner Roy Hill is expected to see the largest gains from the Australian producers as it enters this year at full capacity. Vale is expected to increase production by 29 million mt in 2018.
However, this could change during the year as the company continues to respond with market conditions.
Fortescue are expected to maintain production volume at 168 million mt.
The quality of the FMG products will be one to watch in the coming years after the announcement in November 2017 that they are exploring options to increase the iron content of their products in order to compete with ores from other majors above 60% Fe, however this is likely to incur higher production costs.
The major miners appear to have no intention of flooding an already oversupplied market and risk driving iron ore prices down.
2. QUALITY IS KEY FOR THE CASH RICH
At the beginning of 2017 steel mill margins commenced the year in negative figures.
As the Chinese central government continued to implement the closure of steel mill capacity, including the illegal induction furnaces, steel supply tightened and prices soared.
At the beginning of December margins reached $172/mt for HRC and $231/mt for rebar.
As the mills made money the appetite for higher grade iron ore increased and low grade ore suffered over 40% discounts.
This contributed to the increase in volume of Chinese port stocks across the country with inventory levels in January 2018 at over 150 million mt.
The start of 2018 has seen margins for both products drop to around $120/mt.
Mills that Platts Analytics visited in the third week of January in the steelmaking city of Tangshan, Hebei, commented that they may commence procuring lower grade ores again if margins stayed at these lower levels.
One mill procurement manager commented: “When steel prices were high we wanted to maximize productivity by using higher grade iron products.”
The market has seen a partial structural shift in 2017 with the value placed on each iron unit higher than ever before.
While mills remain quietly confident that margins will hold at similar levels to currently for 2018 they suspect the premium for higher grade iron products will fall quicker than the recovery of the discounts for lower grade products.
This trend is already visible in Q4 2017. The remainder of the year could see low grade producers continue to have margins squeezed, especially with quality differentials for alumina, silica and phosphorous recently at all-time highs.
3. CAPACITY REDUCTION AND REPLACEMENT
China’s central government announced in 2015 that it would aim to slash a total of 150 million mt/year of steel capacity in the five-year period between 2016 and 2020.
The first two years saw 115 million mt/year moved with the remaining 35 million mt/year expected to be complete in 2018.
However the new trend to watch is capacity replacement. S&P Global Platts reported in the article “China approves 128 million mt/year capacity ‘replacement’ in 2017” including approximately 44.45 million mt/year of new EAF capacity.
According to our calculation 30-35 million mt of this newly-built EAF capacity could commence production in 2018.
Platts analysis carried out on Chinese steel prices suggests this new capacity could translate into an 8-9% slump on current prices.
The analysis focused on the impact of supply/demand shock on China’s steel prices, based on market behavior data gathered in the past two years.
Discussions with Chinese steel mills have suggested that replacement of old technology furnaces with newer, larger one could increase capacity in 2018.
Some mills mentioned that old furnaces may not be switched off immediately also resulting in greater capacity in 2018.
4. ENVIRONMENTAL FOCUS: MORE BLUE SKIES AHEAD
In the past two months China’s steel industry has enjoyed perhaps the most profitable period in history, led by the government’s environmental policies which almost halved winter-season productions in the country’s northern areas.
As Platts Analytics analyzed in a previous article “A breath of fresh air – China’s steel suspensions”, the policy was expected to impact 33 million mt of steel production between November 2017 and March 2018.
The cuts appear to be working as clear blue skies are currently enjoyed across the Tangshan area.
Production restrictions have varied from 20% to 70% for private enterprises.
Those with cleaner technology or the ability to provide heating to the local community were given the ‘green light’ to operate at higher rates.
Although the cuts are expected to cease at the end of March, many mills believe that winter cuts are the new normal for the industry.
They also expect intermittent cuts throughout the summer period, possibly more focused on sinter production.
This could see demand for lump and therefore lump premium increase over the next two quarters of 2018.
5. MACRO ECONOMICS: WHAT’S THE RISK?
China’s economy recorded a 6.9% growth in the last quarter of 2017, beating that of the previous quarters.
Such a rebound could ease the concerns that the economy is slowing, however the enormous debt level of the Chinese government looms large.
In 2016 the country’s government debt to GDP ratio stood at 46.2%.
Fixed asset investment has undoubtedly been one of the major drivers for China’s GDP growth in the past decade.
However in recent years the fixed asset investment growth rate has been declining.
Fixed asset investment is of great importance to China’s steel demand, as it indicates the level of investment on infrastructure spending and housing construction, which account for approximately 70% of China’s steel consumption.
Given the central government’s ‘de-leverage’ projection, this could suggest a slow down on infrastructure investments to control debt levels, even at the cost of a slower GDP growth.
Such reduction will no doubt induce a fall of fixed asset investment, and therefore reduce domestic steel demand, at least from the government sector.