Photographer: Michael Reynolds/EPA

China Bid to End Steel Glut Failing as Rally Revives Mills

  • Higher prices are tempting producers as profit margins jump
  • Plan to cut capacity behind schedule for state-owned industry

China can’t seem to avoid producing more steel than the world needs.

After the government said in February it would cut production capacity by as much as 13 percent, a rebound in prices from the lowest in more than 12 years proved too much of a temptation in a country that supplies half of the world’s steel. While the rally was fueled by expectations for less supply, the improved profit margins that came with it encouraged idle mills to restart. Output has swelled in 2016, reaching record levels.

QuickTake Iron Ore

Failure to reduce capacity by the target -- 150 million metric tons over the next five years -- spells trouble for an industry that saw widespread losses in 2015. Chinese exports are near all-time highs, while regulators in the U.S., Europe and India impose punitive tariffs to protect their domestic markets. And with most of China’s producers owned by local governments, uncompetitive mills known as zombie enterprises remain a drain on its economy.

“Capacity cuts probably won’t be significant this year,” Zhao Chaoyue, an analyst at China Merchants Futures Co. in Shenzhen, said by telephone last week. “Steelmakers are still making money and utilization rates are high. Maybe if the government imposes stricter controls and allows some profitable capacity to shut, we might start to see better progress in the years ahead.”

Fall Behind

For now, attempts at reform are behind schedule. The goal for this year was to cut capacity by 45 million tons. But by the end of July, the reductions were at 21 million, according to the National Development and Reform Commission, prompting calls for efforts to be accelerated. Some producers were reluctant to close mills because rising prices this year have boosted profits by more than 50 percent, according to Bloomberg Intelligence.

For discussion of surprise rally in prices, click here.

In the first eight months of 2016, Chinese steel plants churned out 536 million tons, just 0.1 percent shy of the same period a year earlier, government data show. In June, mills were producing more on a daily basis than ever before. According to the data, monthly output averaged 67.04 million tons this year through August. If maintained, that would mark the highest average since the record of 68.56 million in 2014.

“As some of the steel companies see their profits recover, they start to increase production,” which undermines the government’s goals for reducing the glut, said Xiao Fu, head of commodity strategy at Bank of China International in London.

Steel Jobs

Part of the problem is regional governments want to keep workers employed and have an incentive to boost output to preserve margins, according to Gerard Burg, senior Asia economist at National Australia Bank Ltd. Already, some previously idled capacity has come back on line in response to higher prices, he said.

Last year, when demand was slowing and the world was awash in steel, reinforcement bar in China slumped to a low of 1,910 yuan ($286) a ton in December, according to Beijing Antaike Information Development Co. By late April, after the government announced its reduction targets and local demand improved, the metal jumped as much as 65 percent to 3,150 yuan and last traded at 2,598 yuan, or 18 percent higher than a year ago.

The rally may be short-lived, with output rising and a seasonal slowdown in domestic consumption during the Chinese winter, according to China Merchants Futures. The benchmark steel-rebar contract on the Shanghai Futures Exchange is down about 3 percent in September, heading for its first two-month decline since late last year.

Demand Aid

While global leaders seek supply curtailments to tackle the glut, a better long-term solution would be to stimulate growth, as proven by this year’s China-led recovery, Macquarie Group Ltd. said in a Sept. 5 report. Permanent closures tend to be rare because producers are quick to respond when prices improve, the bank said.

“You do need to offer some support on the demand side so you don’t have this spiral down when you’re taking capacity out,” Graeme Train, Trafigura Beheer BV’s senior economist, said this month at a conference in Singapore. In the past 12 to 18 months, China has “pushed liquidity quite hard into the economy to kick-start infrastructure spending,” he said.

Some consolidation of the Chinese steel industry also spurred hopes for more production discipline. Baosteel Group Corp. and Wuhan Iron & Steel Group Corp. agreed last week to merge their listed units in a union that would create the nation’s biggest mill. The combined company would have the scale to rival ArcelorMittal SA, the largest publicly listed steel producer.

With the merger “you’ll have less fragmentation and more consolidation,” said Philip Kirchlechner, director of Iron Ore Research Pty and the former marketing head at Fortescue Metals Group Ltd., one of the world’s biggest suppliers of the raw material to China’s steel industry. “It could have a reduction of capacity because that’s the ultimate goal of the government.”

— With assistance by Jasmine Ng, and Martin Ritchie

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