Sunday, September 16, 2012

As Goes Steel, So Goes China

This does not bode well for Australia or Canada. Aivars Lode. Avantce
“We reckon traders and mills have accumulated steel inventory of almost 100 million tons,” said Citigroup analyst Scarlett Chen to theWall Street Journal this month.  Steelmakers are the core of Chinese manufacturing, and manufacturing is the core of the Chinese economy.  The gross overproduction of steel tells us China will not recover this year.

CISA thinks the trend will continue for the remainder of the year.  A report on its website, written by Xue Heping of Steelinfo Consultancy, says steel production could fall 10% in the second half of this year.  As he writes, “A significant decline in China’s second half steel output is a foregone conclusion.”
In the middle of August, inventories were 26% higher than a year earlier, according to the China Iron & Steel Association, CISA.  It’s no surprise, therefore, that last month steel production fell.  Output, according to official statistics, was off 1.7% from the same month last year and 4.8% from July.
How significant?  Steel output, he projects, will reach 678.7 million metric tons this year.  That represents a 0.7% decline from 2011’s record 683.3 million tons.  Mr. Xue, in short, is projecting the first fall in 31 years.
Is CISA trying to exaggerate the woes of the mills to get even more government help?  Actually, the situation is probably worse than the trade group represents.  CISA surveys only large producers, which are doing better than their smaller counterparts.  Moreover, there is suspicion that mills are inflating their production figures.  “There are a lot of incentives to not report what is happening,” said J Capital’s Tim Murray to theAustralian Financial Review.
So how bad is the situation?  According to Murray, production may have fallen 10% over the first half of August.  “There are some seasonal factors at play, but the volume coming off is unusual,” he said.
In any event, CISA said producers were selling products below cost and that prices had more room to fall.  A four-month price decline looks set to continue.  The association also says steelmakers’ profits were down a stunning 95.8% in the first half of this year compared to the same period in 2011.  Stanley Li of Mirae Asset Securities, speaking to theSouth China Morning Postsaid most steel mills lost money in August.
So mills are cutting production, losing money, and trying to dump inventory.  Why is Beijing authorizing the building of even more of them?  At a time when as much as a quarter of the nation’s steelmaking capacity is going unused and many mills will not restart production after the summer repairs, the National Development and Reform Commission approved the building of two more plants with a total construction cost of $20.5 billion.
One of the projects became famous in China in May when a photo of Wang Zhongbing was splashed across the country.  The celebrated pic showed Wang, the mayor of Zhanjiang in Guangdong province, kissing a document just outside the offices of the National Development and Reform Commission in Beijing.  The NDRC, worried about overcapacity, sat on his city’s request for a steel mill for more than a decade—the plant was first conceived in the 1970s—but Beijing’s new desperation meant that the happy mayor got his approval pronto.
Wang, however, won’t be so ecstatic when the plant faces difficulties because it doesn’t have enough customers.  As financial columnist Yu Fenghui said to theWant China Times, “Mayor Wang kissed the approval today, but the next mayor might cry over it.”  It’s no secret that the industry’s current troubles are the result of wild expansion—China makes just about half the world’s steel—and the new approvals can only make matters worse.
Unless Beijing starts shuttering mills soon, profitability of Chinese steel producers will be poor for far longer than the next two years that analysts predict.  “Globally steel companies are all hurting, but the Chinese industry could be the worst off,” said S&P’s Suzanne Smith, chief of Asia-Pacific commodities ratings, in a conference call early this month.  “In Europe, a number of blast furnaces have been closed down, but we have not seen much of that in China.”
China has been plagued by overcapacity since 2005, but the country is now building even more mills.  Beijing is scrambling for things to spend money on, and local officials need the tax revenue and employment that the plants provide.  So it was perhaps inevitable that the NDRC approved Mayor Wang’s dream.  It may have made sense 34 years ago when his city first conceived of the project, but it makes no sense now, except in the very short term.

In the longer run, Wang can expect troubles at the new mill to ripple through his city.  As CISA points out, problems at steel plants affect suppliers.  Suppliers’ problems, in turn, burden the banks, put people out of work, depress property markets, and ultimately decrease consumption in affected communities.
The NDRC does not seem to mind, however.  Beijing technocrats are pushing China’s steel industry off a cliff—and the rest of the economy with it.

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