The fate of the global steel market has become increasingly tied to China’s economic growth prospects. China is not only the world’s largest steel producer, accounting for around half of global output, but also consumer. To give an idea of the scale of Chinese steel production, and hence influence in world markets, in July 2012 China’s output of steel products amounted to 61.7 million tonnes, whilst the wold’s second largest producer, Japan, produced 9.3 million tonnes.
Thanks to an insatiable appetite for construction materials to fuel its industrialisation and urbanisation process, China’s output of steel has surged by an annual average rate of 8.1% over the past 5 years (Chart 1). Yet, despite a slowing economy, Chinese crude steel production is still running at around record highs.
On the other hand, we estimate that China’s apparent steel consumption (steel products) slowed to 2.2% annually in August, considering that predominately all of China’s steel production is for domestic use, after accounting for some importing and exporting. Yet, it is possible that domestic consumption is even much weaker when considering anecdotes about rising inventory stockpiles, weak construction activity as a result of stringent property market curbs, and a slowdown in the steel-intensive ship-building sector. China Iron Ore and Steel Association (CISA) estimates that inventory levels of its members (accounting for 80% of the total) rose to 14.2 million tonnes at end of July, while nationwide production capacity increased to 940 million tonnes and utilisation rates have fallen to 70%, suggesting a significant glut in the steel market.
As further evidence of weakness in the market, many steel companies are lowering prices. Baoshan Iron and Steel co, China’s largest steel mill, announced that it will reduce steel prices for the third consecutive month in September. Nationwide, prices for hot rolled sheets were down by 26% in August 2012 compared to last year. Profits are also falling, and falling sharply. Profits fell by 96% in the first half of 2012 from last year for China’s large and medium-sized steel companies causing alarm about the solvency of many mills and the risk of rising bad debts. .
The puzzling divergence between supply and demand is attributed to government incentives unique to China. To satisfy central government growth objectives and reap tax revenue and employment, local governments exert pressure on steel mills (often state-owned enterprises) to maintain high production levels. The market is also highly fragmented with the country’s top producer accounting for less than 10% of national supply, and many mills recording poor efficiency and weak health and safety standards.
Hopes for a pickup in Chinese steel demand, on the back of the central government’s acceleration of approvals for infrastructure projects early in the year, have also softened as the economic slowdown continues. Commodity exporters, such as Australia, are no doubt concerned. Iron ore, an important steel-making ingredient, accounts for around 20% of total Australian export value, with 70% of demand solely coming from China (volume). Russia too, a recent exporter of metallurgical coal to China also looks on anxiously. No doubt, China’s policy makers face a difficult challenge in stabilising economic growth, the consequences of which will reverberate to countries far and close.