Posted on 07 Sep 2022
For China's steel industry -- the world's largest -- winter has arrived early and is shaping up to be one of the harshest in years, with a slowing economy and escalation of the property market crisis tanking demand and evaporating profits.
The property sector, which accounts for over one-third of the country's steel consumption, has been squeezed by a liquidity crunch and sliding sales since the end of last year. This comes amid an ever-expanding mortgage boycott by disgruntled homebuyers over stalled construction projects.
Compounding these woes are the repeated COVID lockdowns that have disrupted business operations and supply chains across the country, while overseas demand has weakened due to a slowing global economic recovery amid the ongoing war in Ukraine.
Put simply, the steel market is caught in a perfect storm.
Consequently, more than 80% of China's 500 steel mills have been running at a loss, according to data from industry information portal Mysteel on July 22. Meanwhile, the average profit margins of 247 companies surveyed by the platform slid to 9.96%, approaching the record low of 4.29% in December 2015, when the industry was hit hard by overcapacity and weak demand.
The extent of the crisis was made clear in late July, when the world's largest producer China Baowu Steel Group shocked the market by issuing a warning at an internal meeting over the "great challenges" presented by tumbling sales, falling prices and declining profitability, according to the company's social media account.
"It is time to prepare for a long winter," said Chen Derong, chairman of Baowu, at a company meeting on July 25.
In a bleak forecast, Baowu said that the steel market is facing a steeper downturn than in 2015 with no end or bottom in sight.
The latest crisis, which has also been fueled by rising global inflation and geopolitical risks, has exacerbated deep-seated problems within China's steel industry, with experts saying it faces structural challenges caused by oversupply.
China's current steel production capacity is 1.2 billion ton a year, with annual consumption hovering around 1 billion tons. About 95% of China's steel output is consumed domestically, according to the China Iron and Steel Association (CISA).
"The contradiction between steel supply and consumption will be a long-term issue," said He Wenbo, executive chairman of CISA. As China's urbanization and industrialization advances, the overall demand for steel will gradually decline, said He.
This problem has long been in the making. China's steel industry has expanded rapidly for more than two decades as the economy racked up double-digit growth rates. The country has remained the world's largest steel producer since 1996, with production reaching a record of 1.07 billion tons in 2020.
It is also the world's No.1 steel consumer, accounting for more than half of the global total.
But the glory days are over, with industry analysts saying China's demand for steel has peaked and is heading into a decline, forcing the industry to adjust.
Bargaining power
To prepare for the hard times ahead, many in the steel industry have called for more government incentives to accelerate an industrywide revamp to get rid of outdated capacity, while improving technology and environmental standards.
At the same time, authorities have taken major steps to enhance the country's control over upstream raw material supplies in the hope of strengthening the domestic steel industry's bargaining power in the international iron ore market.
A crucial move in this direction was the launch of a state-owned iron ore conglomerate in late July to consolidate China's massive mining investments and coordinate global purchases of steelmaking materials for its mills.
The creation of the 20 billion yuan ($3 billion) China Mineral Resources Group was a part of China's long-pursued goal to increase the industry's bargaining position in the market dominated by four international mining giants: Rio Tinto Group, BHP Group, Fortescue Metals Group and Vale.
In 2021, China purchased nearly 70% of the world’s iron ore exports, spending about $180 billion.
Senior executives of the newly established China Mineral Resources -- which will also engage in exploration, mining, trade, supply chains and investment -- have been busy visiting state and privately owned steel mills as well as commodity exchanges and shippers to forge business ties that will facilitate its purchases of iron ore, Caixin has learned.
The global mining majors are closely watching the fledgling Chinese procurement giant, wary of what has been described by some as a "cartel" that could potentially undercut international iron ore prices, according to a report by Australian newspaper The Singleton Argus in August.
"It is unclear how the newly formed China Mineral Resources Group will operate, but we look forward to discussions with it regarding its operating model in due course," a staffer at Brazilian iron ore miner Vale said.
Downward spiral
The current predicament China's steel companies find themselves in did not happen overnight. They have been in a downward spiral since mid-March.
Since that time, the industry's profitability has plummeted with less than 20% of companies turning a profit in July, compared with above 80% before March, according to Mysteel. The figure rebounded somewhat to over 50% in mid-August.
Only five of the 25 domestically listed steel companies estimated a rise in profits for the first half of the year in recently released earnings forecasts.
Ferrous metal smelting and rolling plants, key segments of the steel industry, have seen total profits slump from 23.7 billion yuan in April to 2.4 billion yuan in June, a 94% decline, according to Mysteel. Meanwhile, steel inventories have increased 50% from the beginning of the year to 16.95 million tons at the end of June, according to CISA.
Steel producers have found themselves squeezed between rising material costs and sliding sales prices. During the first half, the import price of iron ore has hovered around a high of between $100 and $109 per ton, while prices of coking coal and coke have risen over 68% and 28% from a year ago, according to publicly available data.
At the same time, the most actively traded contracts for rebar on the Shanghai Futures Exchange dropped from 5,190 yuan per ton in early April to 3,683 yuan per ton on Sept. 2.
And as bad as things have gotten, the steel industry is facing even greater uncertainties in the second half amid concerns over ongoing strict domestic COVID control policies and possible global recession, several industry insiders said.
"The outlook has darkened significantly since April," said Pierre-Olivier Gourinchas, IMF economic counselor and director of research, in late July. "The world may soon be teetering on the edge of a global recession, only two years after the last one."
According to the IMF's World Economic Outlook Update published in July, global growth is expected to slow to 3.2% in 2022 from 6.1% last year, 0.4% lower than forecast in the last Outlook update in April. Last month, Goldman Sachs downgraded its 2022 forecast for China's GDP to 3% from 3.3% while Nomura slashed its outlook to 2.8% from 3.3%.
"The focus now is survival, and we can't blindly bet on a rebound because the chance is too low," a steel trader told Caixin.
Private steelmakers that aggressively expanded capacity when the market was booming are especially under pressure now.
"We need to prepare for loses over the next five years," said Li Ganbo, chairman of Hebei Jingye Group, a private company that acquired British Steel for about 50 million pounds ($65 million) in 2020.
Structural change
The key challenge facing China's steel industry is falling demand.
Property development used to account for over one-third of China's steel demand. But the housing market entered an escalating downturn last year due to a liquidity crunch facing developers, and slumping sales and investment amid repeated COVID outbreaks.
In the first seven months of this year, housing sales by area dropped 23.1% from a year ago, while nationwide investment in property development decreased 6.4% year on year, according to the National Statistics Bureau.
"There is no way the steel industry can be good when the property market is weak," said Wu Xiuqing, a senior executive at Hebei Xinda Iron and Steel. During the first half, production of rebar, the most widely used material in housing construction, dropped 13.8% year on year, according to Wu.
The property industry's steel consumption will decline 5% this year, equivalent to 50 million tons to 60 million tons, said Wu, adding that the drop cannot be offset by increased demand from other sectors such as infrastructure and automobiles.
Steel demand from manufacturing, home appliance makers and cargo container makers is also dropping amid the weakening economy, according to CISA.
Positive outlook
Yet despite the bleak business environment, major overseas iron ore miners have maintained their confidence in the China market.
Australia's BHP Group said in its earnings report last month that China is expected to "emerge as a source of stability for commodity demand in the year ahead, with policy support progressively taking hold."
"At the same time, we expect to see a slowdown in advanced economies as monetary policy tightens, as well as ongoing geopolitical uncertainty and inflationary pressures," said BHP.
Vale's marketing director Rogerio Nogueira said in an interview with Caixin there is still room for China to further expand its urbanization rate in the next five to 10 years, creating continued demand for steel products.
However, it is not just the demand side that offers a path out of the current doldrums, the supply side is in dire need of a revamp, say expects.
"Although the steel market is facing challenges from demand, the solution is in the supply side," said the China Iron and Steel Association's He.
Several industry insiders said they hope the government can further press steel companies to reduce outdated capacity to cut the oversupply, despite local authorities having shown a reluctance to do so out of concerns about growth and jobs.
Caixin has learned that the central government has sent orders to provincial authorities in May asking them to submit plans to reduce production.
And according to Mysteel, some steel companies in Jiangsu province received orders in June demanding they cut production by at least 5% from levels in 2021. Meanwhile, Shandong province in August announced plans to keep local crude steel production under 76 million tons this year, 0.65% lower than last year.
China's last round of steel capacity cuts was initiated in 2016 to combat severe overcapacity and unleashed a boom in the industry over the following years.
Bust and boom?
Such may be the case again now. The market downturn may lead to an industry reshuffling during which smaller players will be forced out of the market in a consolidation, said He.
"The next few years will be very difficult for steel companies," said one steel industry investor. "They need to survive first and then find their own niche."
Key to survival will be securing the best possible prices for iron ore, whose volatility has been a major headache for China's steel industry, which relies on imports of the material to meet more than 70% of its needs, mostly sourced from Australia and Brazil.
The country has for years sought to boost the pricing power of its steel industry and expand access to overseas mining assets, and the debut of the China Mineral Resources Group marks a major renewed attempt to achieve these goals.
People with knowledge of the company said it will act as a centralized purchasing platform for some state-owned steelmakers and traders to unify negotiations with suppliers.
While details of the new company's business remain unclear, some industry experts have expressed doubts about whether it can succeed.
"The idea is good but very difficult to deliver," said one industry source.
A major challenge stems from the likely unwillingness of steel companies to give up control over procurement, as well as difficulties in coordinating the highly diverse demand for iron ore in terms of quality, delivery and logistics, experts said.
Chinese steel mills use different ways to purchase ore from miners, with large state-run mills often preferring long-term supply contracts as they can bargain for better prices, while smaller operators buy on the spot market. About 80% of ore imported in China is purchased through long-term contracts, according to CISA.
Vote of confidence
In a major vote of confidence, Caixin has learned that several of China's top steelmakers including China Baowu Steel, Anshan Iron and Steel Group, China Minmetals and Shougang Group have agreed to acquire minerals through the new platform.
China Mineral Resources Group is also expected to assume control of overseas mining assets such as the massive Simandou iron ore project in Guinea to better secure access to raw materials.
The Simandou project, the world's largest known untapped iron ore reserve in West Africa, is one of China's biggest bets to reduce its reliance on suppliers in Australia and Brazil.
The project is divided into four blocks with two controlled by a consortium backed by Chinese and Singaporean companies and the other two owned by Rio Tinto and a joint venture between Chinalco and China Baowu.
But the development of Simandou in Guinea has repeatedly been delayed by legal disputes and political disruptions. Crucial progress was made in late July when parties agreed to develop infrastructure including a railway and port in a breakthrough that should help unlock the deposit.
China Mineral Resources Group will play an important role in stabilizing the iron ore price if it can consolidate China's overseas mining resources to coordinate investment and development, several industry sources said.
Source:Nikkei Asia
