A brief update on steel following a few days on the road in China this week… 1) Production cuts may take time. There has been a lot of chatter lately about imminent steel output cuts in China, particularly following Songting Iron & Steel’s recently announced 5Mtpa closure. However, output reductions on a larger-scale basis may be relatively gradual. In the shorter-term, cash flow and debt pressures may still incentivize production at a loss. Over the medium term, consolidation in the industry will likely result in moderate reductions, while growth from new projects will partially offset many of the smaller closures.
2) Steel exports clearly have political backing. Earlier this week, CISA said recent trade frictions and anti-dumping duties against China have been unfair and are against free trade principles (recall the ministry of commerce was also vocally defensive on Chinese steel exports earlier this year). Their logic was that intense domestic competition has meant China’s exports have simply become highly competitive globally, and that it is inappropriate for other countries’ less competitive producers to cry out for protectionist support. Without a solid rebound in domestic steel demand or significant production cuts, and with clear political backing, it is difficult to see a material reduction in China’s steel exports over the next year.
3) Exports to ASEAN to become highly competitive. A significant amount of Chinese exports head to ASEAN, and the region is expected to remain a key driver of demand growth in the years ahead. That said, steel exports into ASEAN may become intensely competitive over the coming years as (i) China continues to build market share in the region, (ii) other north Asian exporters (Japan, Korean etc.) aim to maintain market share, (iii) domestic ASEAN mills attempt to ramp up capacity, and (iv) traditional north Asian producers look increase their ASEAN-based operations/JVs. Interestingly, there has been some growing interest in arbitrage/pair trade opportunities between SGX ASEAN HRC and SHFE HRC derivatives.
4) Bank pressures may continue to hamper credit flows. Chinese banks appear to be facing growing pressures following the growth slowdown during the summer months (particularly in manufacturing), which has likely driven an increase in overdue/non-performing loans on their books. Debt levels continue to rise as companies seek to refinance/raise new debt to pay interest on existing obligations, indicating the great deleveraging that is required has yet to really get going. Leverage is still rising and more companies have been facing default (China Shanshui Cement Group defaulted on some of its debt last week; Sinosteel postponed some of its interest payments again this week). Such pressures on China’s banks at least partially explains the weaker than expected loan data for October. Things look bleak…
5) Consolidation will be coming soon for China’s steel traders. In addition to widely anticipated consolidation among China’s steel mills (CISA expect the number of steel mills in China to fall from around 500 currently to 200 over the next decade), consolidation is also likely to increase amongst steel trading companies. In order to survive the next few years, steel traders will likely require greater scale and more sophisticated risk management practices. In particular, more efficient financing structures and greater utilization of derivatives for hedging purposes will be key.
6) Are India’s current safeguards proving ineffective? After India implemented a temporary 20% safeguard duty on imports of certain steel products in September, imports immediately saw a decline. However, steel imports bounced back to record levels in October as participants allegedly found ways to circumvent the duty. A higher cost of capital in India (often >10%) was one factor cited that makes it harder for domestic Indian mills to compete internationally. On India’s aggressive steel output growth target of reaching 300Mt by 2025, Essar Steel mentioned that this was highly ambitious and didn’t see national output exceeding 225Mt within this timeframe (though this would still represent a strong rise from the c89Mt last year).
Zhejiang Yaang Pipe Industry Co., Limited (www.yaang.com)