Posted on 27 Jun 2022
Steel mill owners in parts of China are in a bad mood, Beijing-based commodities consultant Simon Wu said.
Steel inventories are slowly piling up in the warehouses of the country’s biggest steelmaking hub, the northeastern city of Tangshan, as well as in the provinces of Jiangsu and Shandong, mill owners told Wu, a senior consultant at Wood Mackenzie.
Demand for steel is falling amid pandemic lockdowns and crippled construction activity, they said.
“There’s negative energy all round. The steel industry is just not making any profit,” Wu said.
A lot of steel — a key raw material in the manufacturing powerhouse — is sitting idle around the country amid a stop-and-start economy which is forcing down demand and prices.
Prices of both steel and its main ingredient iron ore were volatile during the Shanghai lockdown but headed on a downward trajectory earlier this month.
Weak demand for steel, a bellwether of China’s economy, also reflected the country’s broader slowdown, though recent data pointed to some improvement as industrial production rose slightly by 0.7% in May from a year ago.
Crucially, China’s steelmaking industry — the biggest in the world — hosts extensive supply chains that stretch from Chinese blast furnaces to overseas iron ore mines in Australia and Brazil, the biggest suppliers of iron ore to China.
Because of that, any jitters within China can unravel an extensive network of supply chains, potentially heaping further pressures on existing global disruptions.
According to the China Iron and Steel Association, national daily outputs of intermediary steel products such as crude steel and pig iron as well as finished goods had been rising over the month of May by between about 1% and 3%. In contrast, demand, while still active, had fallen.
China’s consumption of crude steel, for instance, fell 14% in May compared with last year, S&P Global Commodity Insights iron ore lead Niki Wang said, citing in-house analyses.
“The year-on-year decline in steel demand was much greater than that of crude steel production. In that case, steel mills are indeed struggling (with the pressure on steel prices),” she said.
That period coincided with China’s biggest citywide pandemic lockdown yet in Shanghai.
Consequently, inventory levels are 12% higher compared with last year and may take nearly two months to fall to the median levels of the past five years, assuming steel demand roars back to life, said Richard Lu, steel research analyst at CRU Group.
The Chinese market is also competing with a proliferation of cheaper Russian semi-finished steel billets, said Paul Lim, lead analyst of Asia ferrous raw materials and steel at Fastmarkets Asia.
As outbreaks gripped the nation, the country’s biggest consumers of steels as well as the Chinese economy’s growth engines such as property construction and infrastructure development have gone quiet, said Navigate Commodities managing director Atilla Widnell.
That’s because “there is simply no one to work at the sites,” he added, pointing out the industry was taken aback by the return of lockdowns.
After a much-awaited opening of Shanghai in early June after new cases were recorded for both Beijing and Shanghai, China started re-imposing some restrictions.
Last week, new data from China’s National Bureau of Statistics showed property investment for the first five months of the year declined 4% from a year earlier, increasing from the 2.7% drop between January and April.
Home sales by volume fell 34.5% on year in the first five months of 2022.
“There had been signs of life for domestic steel consumption after China’s exit from lockdowns in early June, but the ‘stop-start’ disruptions caused by a relapse into scattered lockdowns [have] been an unwelcome blow to the country’s well-intended economic recovery,” Widnell said.
Can’t just shut down blast furnaces
Even though steel prices have fallen and eroded steelmaking profitability, steel mill owners have continued production, with many using iron ore of lower quality to produce smaller volumes.
Chinese blast furnaces are now operating close to full capacity, at more than 90% — the highest rate in 13 months — despite thinner profits, analysts said.
Lu said some mills suffered “largely negative margins” over April and May.
Pricing data shows prices of popular steel products such as rebar and hot-rolled coil used for building homes have fallen by up to nearly 30% after peaking around May last year following an industrial revival to kickstart the economy.
Shutting down blast furnaces can be inefficient, as large reactors used for turning iron ore into liquid steel need to run continuously.
Once they’re shut down, it takes a long time — up to six months — to restart operations.
“So, Chinese operators are keeping their blast furnaces ‘hot’ by utilizing lower grade ores to voluntarily reduce yields in the hope that they can ramp up swiftly and respond to recovering steel demand as and when temporary lockdowns are lifted,” Widnell said.
“We believe that these operators are also producing larger quantities of Semi Finished Steel products so as not to crush finished Steel prices with inflated inventories.”
Wood Mackenzie’s Wu said another reason producers soldier on is so they can hit their annual allowed output targets before Beijing reduces them next year as part of an effort to meet its emissions targets by 2030 and 2060.
“Each year’s production is defined by last year’s output. So it is to producers’ advantage to produce the maximum amount of steel each year as cuts will be applied to that year’s output,” Wu said.
Return of the slump?
Steel demand and prices slumped between 2012 and 2016 after the Chinese economy slowed heavily, causing commodity prices to fall.
For many miners servicing China, such as those in Australia, it was the end of the so-called mining boom.
In 2015 alone, China’s major steel firms suffered losses of more than 50 billion yuan.
For starters, this downturn is not 2015, Wu said, and steel producers have learned to be resilient against volatility.
“So, they will keep producing steel because they have to pay wages and maintain other cash flows. Many producers can probably last two years without making money. Many people on the outside [of China] don’t understand this resilience,” he said.
CRU’s Lu said while some mills are contemplating slowing production, inventory levels are “far far away from the panic levels” and storage capacity is not yet a serious issue.
There are, however, early signs that the industry is starting to adjust to these adverse conditions.
Recently, there were rumors that the Jiangsu provincial government had mandated local steel mills to cut production by about 3.32 million tonnes for the rest of the year.
It’s not clear if that is an effort to curb excessive steel inventory or part of wider adherence to cutting production and emissions.
“I think China is fully aware of the weaker domestic steel demand this year, and will use executive power to force mills to cut production just like it did before,” said Alex Reynolds, an analyst at commodity and energy price agency Argus Media.
“If steel prices continue to fall sharply with losses extending, the Chinese government may set exact numbers for production cuts – kind of like what the OPEC did when Covid was at its height in 2020-2021.”
S&P’s Wang agreed, adding that stimulus from Beijing’s looser monetary policies should also play a part in reviving steel demand down the track.
Meanwhile, others in the steelmaking supply chain, such as Australian and Brazilian iron ore miners, need not worry for now as lower output from the mines have offset lower demand, she said.
But miners are nonetheless concerned about bearish conditions in China, Wang added.
“The high pig iron production means demand for iron ore is solid. The iron ore inventory at China’s major ports has been trending down since the Chinese Lunar New Year holidays,” she said.
Iron ore prices have hovered between $130 and $150 a tonne in the past two months, compared with prices of low as $30 to $40 a tonne during the 2012-2016 slump.