Good news masks trouble for steel
These should be nervous times for China's steel companies.
On the surface, things don't look too bad. Yesterday one of China's biggest steelmakers, Baoshan Iron & Steel, announced it will jack up the price of its finished products by about 20 per cent in the second quarter of the year.
Analysts greeted the price rise as welcome news that Chinese steel companies are successfully passing on higher raw material costs to their customers, and began revising their profit forecasts upwards.
Certainly, an across-the-board 20 per cent increase in steel prices would offset rising iron ore costs. The increase equates roughly to an extra 800 yuan, or US$112, a tonne for high-grade products.
That should be more than enough to cover the 71 per cent increase Baoshan last week agreed to pay Brazilian miner Vale for its high-grade iron ores, which equates roughly to an extra US$34 per tonne (see chart).
Australian miners are holding out for a bigger increase on the grounds that the relative proximity of their mines to China means Australian ores are cheaper to ship and so should command a premium.
The big Australian companies, led by BHP Billiton, tried this trick back in 2005 without success. They may get away with adding a small premium this time, but the increase will still be in the order of 70 per cent, which means the Chinese steel companies should still be able to absorb the rise.
Unfortunately, soaring iron ore prices are not the only problem Chinese steelmakers face. Other costs are climbing too. Spot prices for coking coal have doubled in recent months, and even though bulk shipping charges have fallen since autumn, rates for shipping iron ore from Australia or Brazil to China remain 50 per cent higher than a year ago.
Even more troubling is the prospect of a looming supply glut. China's steel production has soared since 2000 to meet surging demand especially from the construction industry (see chart).
In the last couple of years, however, production has outstripped consumption as massive investment in the highly fragmented sector has led to overcapacity. Demand this year is expected to climb to about 474 million tonnes, according to the China Iron & Steel Association. Supply already exceeds 500 million tonnes.
Beijing has tried to deal with the situation by encouraging the steel industry to consolidate, but with little success. By some estimates, the market share of the biggest 15 steel companies has fallen over the last two or three years rather than risen, as smaller local producers have invested in new capacity.
One answer to the glut would be to export the surplus, but that would not go down well with steelmakers in the rest of the world, which would certainly initiate anti-dumping actions. In a warning shot, last month a lobby group representing US producers published a study claiming Chinese steel companies benefited from state energy subsidies worth US$15.7 billion last year.
Rising costs, excess capacity and the prospect of a trade war should be enough to make anyone nervous.