China Economy

No pain, no gain, for China steel sector wallowing in glut

Painful and costly steel plants and iron ore mines closures are gathering pace in China due falling domestic steel demand and 20-year low product prices

PUBLISHED : Sunday, 13 December, 2015, 11:01am
UPDATED : Sunday, 13 December, 2015, 11:01am

Costly steel plants and iron ore mines closures are gathering pace on the mainland as falling domestic steel demand and product prices hovering at 20-year lows are finally forcing a long-awaited and painful restructuring to curtail excess capacity after a decade of failed attempts by Beijing to push for consolidation.

But it is only the beginning of a long process to restore a demand-supply balance, and next year will be a testing time for local governments wary of social instability arising from plant shutdowns that may require bailouts to cushion the blow on tens of thousands of workers, analysts said.

Although the mainland steel industry has so far this year seen the closure of 50 million tonnes, or 4.4 per cent of total annual production capacity of 1.14 billion tonnes, it is far from enough, according to HSBC’s analysts.

“Under our current forecast [for industry output] to rise 1 per cent next year, we calculate that China needs to cut another 120 million tonnes of capacity next year in order to reach an overall utilisation rate of 80 per cent – a relatively healthy level,” they wrote in a report.

“If output were to drop by 3 per cent to 783 million tonnes – in line with China Iron and Steel Association’s forecast – an additional 160 million tonnes of capacity shutdowns would be required.”

They noted the need to maintain social stability is the biggest barrier for a quick solution to the glut, since massive layoffs could spark social unrest.

Privately-owned Songting Iron and Steel in Tangshan city in Hebei province – the nation’s largest steel production region - has shut its 5 million tonnes of capacity last month, after failing to pay its electricity bills, Shanghai Securities News reported.

It was the mainland’s second steel mill with at least 5 million tonnes of capacity after Shanxi province’s Haixin Iron and Steel Group to shut down due to a liquidity crunch and a debt crisis since March last year, and came after a string of smaller private steel mill closures.

It prompted some 1,000 of its 6,000-strong workforce to gather outside a local government building demanding help to chase Songting for back pay, according to United States-backed New Tang Dynasty Television, which posted footages of the protest online.

The mainland’s 101 medium and large-sized steel mills as a group made a loss of 72 billion yuan on their steel-related operation in the year’s first 10 months, and nearly half of them were loss-making, according to the China Iron and Steel Association.

Beijing, which is poised to miss an industry consolidation target set in 2011 for the nation’s top 10 steel producers to occupy at least 60 per cent of the market by the end of this year, has extended the time frame for its achievement by a decade to 2025, after the industry got more fragmented due to rapid output growth by smaller privately-owned steel mills.

Industry profitability will likely deteriorate further in the next 12 months due to weak demand, which will accelerate capacity shutdowns and restructuring over the next 24 months, according to Zou Jiming, a senior analyst at agency Moody’s.

Many steel mills have idled loss-making production lines temporarily to avoid incurring costs of permanent shutdowns, such as employees severance and plant dismantling costs.

“Slow investments in real estate and infrastructure development as well as weakening manufacturing activity … will drag down domestic steel demand in the next 12 months,” Zou said in a report. “Profitability of China’s steelmakers will weaken further as capacity removals lag declines in demand … the slowdown in demand is worsening oversupply and sending Chinese steel prices to historic lows.”

Moody’s analysts forecast the mainland’s domestic steel demand, which accounts for around half the global total, to fall five per cent next year from this year. This is expected to be partially offset by rising exports, resulting in sales volume declines of three to four per cent for steel mills.

To help relieve the glut, Beijing has announced a cut in export taxes on steel billet from January 1.

“This could buy the government some time in order to prevent a mass layoff ... but we still believe [profit] margins could remain depressed and more mills need to be shut down,” said Jefferies analyst Po Wei in a note.

Moody’s Zou expects small private mills to be the first to exit the market due to their limited resources to cover losses, refinance maturing loans, and bear rising environmental protection compliance costs.

“Chinese mills appear to be reaching the end of their ability to make deeper cuts to prices, particularly for exports, as they are already incurring serious financial losses,” said Paul Bartholomew, commodities data provider Platts’ managing editor for steel and steel raw materials. “They now seem to be contemplating trimming steel output instead.”

Meanwhile, falling steel demand and rising iron ore imports from more cost-competitive mines in Australia and Brazil have been squeezing more mainland production out of the market, resulting in mine closures.

According to industry data provider Mysteel, capacity utilisation of large mainland iron ore miners – many of which are invested by state-backed steel mills – have fallen from over 80 per cent in 18 months ago to just under 60 per cent last month, while that of small and mediuim-sized miners have declined from over 60 per cent two years ago to just under 20 per cent last month.

“Falling steel prices, anticipation of further steel production cuts and tight credit in China all pushed iron ore prices [lower],” said Canadian brokerage RBC Capital Markets analyst Fraser Phillips in a note.

RBC’ analysts have cut its forecast for next year’s average spot-market benchmark price for iron ore with 62 per cent iron content by 15 per cent to US$42.5 a tonne, and for the average in 2017 by 9 per cent to US$50.

They expect this year’s average to be US$55.1, down 43 per cent from US$97 last year. Spot market prices fell to US$38.8 on December 8, the lowest in a decade.

To survive the downturn, miners have been cutting costs aggressively.

Hong Kong-listed IRC, which mines iron ore in East Siberia to serve the northeast China market, has cut in June the cash operating cost target of its new mine between next year and 2018 to US$31 a tonne, from a previous estimate of US$49, after the Russian rouble depreciated sharply against the US dollar and a change in its mining plan to prioritise ore extraction in sections of the mine with less wastes. The mine is slated to be commissioned early next year.

Chairman Jay Hambro told the Post last month: “I am going grey because life is tough and it could get even tougher, but we have got a project that is still profitable even at lower than today’s iron ore price [of US$46 a tonne].”