China’s got too much steel

Chinese demand for steel is shrinking for the first time in 14 years. The country must act on its oversupply problem before producers break the dam

A steel manufacturing plant in Shanghai, China. The country must work out what to do with its surplus of steel in order to move the economy forward
A steel manufacturing plant in Shanghai, China. The country must work out what to do with its surplus of steel in order to move the economy forward 

China’s long and lasting love affair with steel happened upon a major stumbling block in September last year when statistics showed that demand had shrunk for the first time in 14 years. Sparked by the government reforms and a gathering economic slowdown, falling demand has compounded the issue of overcapacity and lopped 40 percent from the raw material’s asking price. Essentially, in setting their sights on stability and not expansion, at least not nearly to the same degree, policymakers have drawn the curtains on a period wherein steel demand has grown at much the same pace as the economy.

“The rebalancing of the Chinese economy is inevitable as China enters its next stage of development, but it will take time”, according to the World Steel Association’s (WSA) Short Range Outlook. “As these changes take effect, the steel industry will experience a slower pace of growth”, says the association’s Chairman Jürgen Kerkhoff. “It will focus on operational efficiencies and on the value that steel products generate for customers and society.”

Becoming number one
China produces more steel still than the rest of the world combined, and over four times what the US mustered at its peak in the 1970s. Here, the country’s mostly state-owned steelmakers have supplied a housing boom, an automobile boom, and featured heavily at major intersections of China’s 30-year-long industrialisation drive. Though as the government clamps down on the twin issues of overcapacity and pollution, it’s likely that both production and consumption will fall further, threatening the uninterrupted rise that has so characterised the commodity’s history.

China produces more steel still than the rest of the world combined, and over four times what the US mustered at its peak in
the 1970s

Beginning in 1945, when Chinese forces reclaimed Japan-occupied steel mills on the northeast rustbelt, the alloy came to be seen as a symbol of strength and prosperity for the world’s number two economy. Decimated by the spoils of war, only 19 steel mills stood in 1949 and total output clocked in at only 158,000 tonnes. Some 10 years later, it had risen to 5.9 million tonnes. Chairman Mao recognised the achievement by saying: “It is not good for us to name ourselves as the most superior in the world… but it is not bad to become the number one steel producer.”

Continuing along much the same trajectory in the decades that followed, steel production has thrived; through Stalinist state planning, through Maoist philosophy and through the strains of market liberalisation. A country much-changed from that of its pre or indeed post-war order, China’s growth story is one that is tied – inextricably so – to that of steel, and the alloy’s decline is evidence enough that the economy is entering into a new phase of development.

The slowdown
Demand for steel expanded just one percent in all of 2014, and WSA estimates show that the rate will slow further in 2015 to 0.8 percent. What’s more, in the opening month of the year, steel production was down four percent on the year previous. Industry officials said in May that steel consumption would likely fall six percent this year, greater even than the 3.4 percent slide last year, when consumption shrunk for the first time since 1981.

The figures also illustrate the issue of oversupply, which has haunted China for years now and is thought to number in and around the 300 million tonnes mark, while use is also on the decline (see Fig. 1). Worse, however, is that the downward pressure has squeezed prices to the extent that iron ore, the raw material on which steel relies and the second-most traded commodity after oil, has fallen to its lowest level since the spot pricing system came into being.

Analysts raised concerns that consumption could shrink first in 2014, when in the opening half of the year a sub-$800 per metric ton of steel price meant that producers were barely breaking even, and benefitting only as a result of associated tax breaks. A slump of even greater proportions, therefore, could force miners and producers into loss-making territory and bring a swift and decisive end to 30-plus years of breakneck expansion.

Nonetheless, the numbers have done little to dampen enthusiasm among major producers, whose projections for the commodity’s future are decidedly rosy. Vale and Rio Tinto, the world’s number one and two names in the iron ore business respectively, have each poured billions of dollars into their operations, in the hope that China’s urbanisation drive will continue on upwards for another decade before tailing off.

As of May, the price of iron ore had retreated some 39 percent in the space of 12 months, and production is set to shrink further as major producers look to expand upon their low-cost operations. Vale, for example, is targeting an annual output of 453 million tonnes before the year 2018, far greater than the 306 million it turned in 2013. Rio Tinto’s market evaluation is similarly optimistic. “We expect Chinese growth in steel consumption per capita to continue out as far as 2030. Rio Tinto’s assessment remains that China will reach around one billion tonnes of crude steel demand by 2030”, said Alan Smith, Asia President for Rio Tinto Iron Ore in a Frontier research note.

Aside from protecting market share, the focus on low-end production threatens smaller names for which the costs of extraction are far greater. And with prices in and around the $50 mark, some three quarters of China’s iron ore capacity is unprofitable, leaving those turning a low-grade, high-cost product dangerously exposed to collapse. Speaking to reporters in May, Rio Tinto’s CEO Sam Walsh estimated that over 160 million tonnes of iron ore capacity could fall out of existence this year as a result. And while domestic demand is doing much to stifle smaller producers, what’s more disconcerting even is the impact this could have on the global steel trade.

Top 10 steel-using countries 2014

Too much steel
With China’s economy expanding at its weakest pace since 1990 and on course to slow again in the coming year, steelmakers are finding no other place to send their product but overseas. Steel exports last year were up 50 percent and 40 percent again in the first quarter, according to Capital Economics, as struggling steel mills resorted, increasingly, to shipping their goods overseas. Figures cited by The Wall Street Journal, meanwhile, show that steel exports were up 63 percent in January to 9.2 million, putting them on track to surpass the 82.1 million tonnes that China offloaded last year.

Determined to keep on going down the same path, China’s bloated steel supply has resulted in complications for global trade, and left affected nations, particularly those in the West, with no answer to the country’s cheap product. In the US, steelmakers were slow to recover from the financial crisis, and the country has since come to be seen as none other than a dumping ground for countries much like China – though India and South Korea also – looking to offload excess supply. Not just today but in the last decade, steel production has risen far and ahead of demand, and slow-to-recover economies like the US have opted not to produce their own, but rather onboard bloated capacity from abroad.

Successful in reducing costs in the short-term, rising imports have succeeded also in crippling a once-prosperous US industry, and the changed circumstances in China are such that American steelmakers are campaigning for political support to clamp down on dumping. Both US Steel Corp and Nucor Corp have launched appeals for anti-dumping duties to stop foreign names selling below the cost of production.

Likewise, the European Commission has recently imposed tariffs on similar grounds, with India to follow, as they each look to fend off offending producers. Though the favoured approach currently is to impose duties on imports, analysts insist that this method will likely succeed for a short time only, as producers shift their focus to any nation slow to adopt anti-dumping policies. Furthermore, many of those affected claim that protection comes only when it’s too late, and that lawmakers, as in the case of the US, have been too slow to protect their own.

No matter the measures taken to contain Chinese overcapacity, what’s clear is that the government is all too willing to protect an industry that has time and again upset the natural order of supply and demand. Government-given subsidies and tax breaks are keeping loss-making operations in the black, and a failure to clamp down on unfair practices serves only to compound the imbalance. If the country’s steel market is to reclaim its status as a symbol of strength and prosperity, policymakers must retreat from its history of protectionist policies and seek instead to restore a greater measure of sustainability to the industry.