Steel-using industries on the mainland may have to bear an extra 800 billion yuan (HK$911 billion) in costs as steel prices soar, further fuelling inflation by accelerating the rise in production costs of downstream users such as carmakers, construction companies and electrical home appliance producers. Mainland steel prices have risen by an average of 40 per cent so far this year as iron ore, coking coal, freight and fuel costs rise. Top steelmaker Baosteel Group's recent agreement with Australian miner Rio Tinto would see mainland steelmakers pay as much as 96.5 per cent more for contract iron ore, adding to the cost pressure on steelmakers. Baosteel, on behalf of other mainland mills, last week agreed to pay 79.88 to 96.5 per cent more in contract prices for Rio's ore this fiscal year, higher than the 65 to 71 per cent settled between mainland mills and Brazilian miner Vale in February. Based on Vale's prices, the increase in steel production cost per tonne was about 800 yuan, and the higher prices for Australian ore will add an extra 120 yuan per tonne, according to analysts. Although current steel prices already reflected higher prices of Australian ore in advance, it would help to hold up steel prices in the second half, analysts said. As of the end of May, the Domestic Composite Steel Prices Index compiled by the China Iron & Steel Association rose to 156.86 points, up 38.4 per cent year on year. The price of 6mm hot-rolled steel was 5,821 yuan a tonne, up 1,117 yuan from January this year, and that for 1mm cold-rolled steel was 6,944 yuan a tonne, increasing 1,483 yuan from the beginning of the year. 'If steel prices remained stable at this level in the second half, most steelmakers could pass on all their cost increases to customers,' said Xu Xiangchun, the chief information officer of Beijing Ganglian Maidi E-commerce, a steel data provider. Mr Xu said such rise in prices could translate into an increase of 800 billion yuan in the steel industry's sales revenue this year, which downstream steel users would bear. Steel-intensive industries including infrastructure and construction as well as machinery, vehicle and electrical home appliances manufacturing will feel the pain. As steel is the third leading mover of the mainland's Producer Price Index after oil and coal, the increase in production costs in various industries may spur a 1 to 2 percentage point rise in the index for the full year, according to Mr Xu. PPI, which measures prices of goods when they leave the factory, rose to a three-year high of 8.2 per cent year on year last month, up from 8.1 per cent in April, data from the National Statistics Bureau shows. The PPI is viewed as a leading indicator of the Consumer Prices Index, which measures the overall price level that consumers pay for a basket of products. China's consumer inflation is running at a decade high, rising 7.7 per cent in May. The figure compared with 8.5 per cent in April and a 12-year-high of 8.7 per cent in February, and was broadly in line with most forecasts but still in excess of the government's annual target of 4.8 per cent. 'The acceleration in PPI reflected part of the increase in steel costs and, through different products, will definitely affect the CPI,' said Wang Tao, an economist at UBS Securities. She said PPI was likely to rise further in the coming months but declined to give a precise forecast. However, she added that as the CPI was largely affected by food prices, clothing and consumer goods, the impact of steel prices on the index would not be great. In China, about 60 per cent of steel is used in infrastructure and construction and 20 to 30 per cent in manufacturing. Products that might be directly related to CPI were electrical home appliances, but their steel consumption was relatively small compared with the nearly 5 million tonnes a year national consumption, Shanghai-based Mysteel.com analyst Jia Liangqun said. As many of these products were exported, the direct effect on CPI was very limited, he said. So, if the increase in steel prices would offset steelmakers' rising raw material costs and would not affect their profitability substantially, so which type of steel users will be hit the most? Fitch Ratings says the pressure from higher raw material costs is being transferred largely to end-users in sectors such as engineering, equipment and machinery manufacturing, as well as vehicle production, all of which are reporting varying degrees of margin pressure. In the vehicle sector, Fitch said some steel producers were seeking to renegotiate existing fixed-prices contracts or add steel price surcharges of 20 to 40 per cent in return for continuing supplies. Carmakers and electrical home appliance makers cannot raise their product prices easily because of fierce competition and mostly have to absorb higher raw material costs, according to analysts. Guosen Securities estimates that even a 10 per cent rise in steel prices will cause a 1.5 to 2 percentage point drop in carmakers' gross margins. For home appliance makers, margins will be squeezed by 1 to 2 percentage points, so they are facing mounting pressure. Some carmakers said as steel made up 70 per cent of a car, the rise in steel prices would cut the vehicle industry's profit by 4.4 to 7.3 per cent. But for some industries, such as construction, companies could raise their construction fees in line with the increase in raw material costs, according to their contracts signed with project and property developers, analysts said. Fitch is positive about the outlook for steel prices and producer profitability for the remainder of the year, but it remains cautious about a scenario in which raw material prices stay at high levels while steel demand and prices weaken significantly from current record levels. 'Such a scenario is possible from 2009 onwards,' the agency warned.