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.