Iron will key to reviving Chinese steelmakers' fortunes
According to the State Assets Supervision and Administration Commission, sales at China's 37 major state-owned steelmakers jumped 20 per cent in the first 11 months of last year. Profits, however, hardly budged, rising just 0.4 per cent. With a price war looming, things are only going to get worse this year.
The trouble at China's steel mills is instructive. China's economic development is being powered largely by heavy investment in fixed assets - power stations, factories, transport links and the like. Building these uses a lot of steel, so, for years, making steel has looked like a good business to be in. As fixed asset investment has risen, so has investment in steelmaking capacity, and new mills have sprung up across China. Today, the country has 4,847 steelmakers.
Production has rocketed. In 2004, Chinese mills turned out 273 million tonnes of steel, more than the output in Japan, the United States and South Korea combined. Last year, production is likely to have hit 350 million tonnes. By next year, according to the China Iron and Steel Association, production capacity could reach 490 million tonnes.
Nervous of overheating, Beijing has attempted to crack down on investment. In 2004, the government imposed curbs on lending to new steel projects, and last year, it introduced measures intended to force consolidation.
Even so, new plants started before the restrictions came into force continue to come on stream and competition is becoming increasingly intense. With supply outstripping demand by tens of millions of tonnes a year, mainland steel prices have been sliding since April last year. For some products, including high-end cold-rolled steel, they have fallen more than 40 per cent.
The situation is only going to deteriorate this year. A new report from Fitch Ratings notes that investment has picked up again, with both Maanshan Iron & Steel and Angang New Steel winning approval for major new plants, each with capacity of five million tonnes a year. 'The gap between steel consumption and overall output is likely to continue to deteriorate,' says Fitch, warning of a looming price war.
Fresh price cuts will further hurt earnings. China's producers are already facing sharply higher raw material costs. Last year, international mining firms raised their iron ore prices by 71.5 per cent, and the price of coking coal also rose sharply.
All this makes consolidation more urgent than ever to eliminate inefficient excess capacity, achieve vital economies of scale in negotiations with suppliers and co-ordinate output across different product types. Consolidation is proving hard to achieve, however. According to the government's development plans, the country's 10 biggest steelmakers should account for 50 per cent of output by 2010, and 70 per cent by 2020. Today, they control only about 35 per cent.
As the Fitch report points out, many of China's smaller steel mills remain under the control of local and provincial governments. Reasonably enough, local officials are fiercely protective of both the jobs and the tax revenue steel works generate and are extremely reluctant to lose them to other municipalities or provinces through mergers and acquisitions.
What consolidation has taken place tends to be local. Fitch cites the merger last year of Liaoning-based Anshan Iron & Steel and Benxi Steel. But even here, there has been little meaningful effort to cut spare capacity and boost productivity.
With demand set to remain strong for years to come, the long-term outlook for China's steelmakers should be healthy. But without vigorous action to eliminate excess capacity, boost efficiency and ensure decent returns on investment, earnings growth remains elusive, no matter how fast the economy expands.