Sometimes you can have too much of a good thing. At the turn of the year, Beijing wanted its steel mills to go into overdrive, producing the materials that would bring the government’s infrastructure-focused stimulus package to life. Now, though, policymakers are keen to rein in steel output as fears of overcapacity haunt the industry.
Beijing needed steelmakers to play a role in the stimulus, but they may have gone too far – and not for the first time.
Steel output for the first six months of 2009 came to 4.06 million metric tons, up 5.35% year-on-year. The foot appears still to be on the accelerator – July’s output alone rose 12.69% year-on-year to 50.68 million metric tons. According to the Ministry of Industry and Information Technology (MIIT), China’s total steel capacity this year is likely to be 660 million metric tons. Estimated demand is just 470 million metric tons.
"What people thought was demand was either overstocking or speculative acquiring of inventory [by traders]," said Thomas Wrigglesworth, head of regional metals and mining at Citi in Hong Kong.
The influence of the traders can’t be overstated. More than 70% of China’s steel output reaches end users by way of these middlemen. Mills alter their output based on the traders’ orders – not actual market demand, said Graeme Train, Asia research manager for market research firm Steel Business Briefing.
Relying on information channels that are fragmented, delayed and sometimes at odds with the situation on the ground, it’s easy to make a wrong call. Indeed, prices for steel products dropped 15-20% in the last three weeks of August and iron ore imports were down 15% for the month, but steel output was 51.65 million metric tons, 3.4% higher than July’s figure.
"It looks like there is too much capacity and there have been noises about curbing it," said Wrigglesworth.
In August, the State Council said it would tighten controls on steel investment. Earlier, the MIIT announced that it would not approve any new steel mill expansion projects for the next three years.
This is not the first time the central government has tried to address steel industry overcapacity; it has been an issue of contention for more than 10 years. Beijing knows that consolidation is ultimately the answer – a smaller number of large steel mills would be easier to control – but the kind of industry-wide restructuring needed to achieve this isn’t easy.
The last major guidelines on consolidation were released in 2005 and required that the top 10 steel producers should account for 50% of China’s crude steel production by 2010, rising to 70% by 2020. Secondly, by 2010 there should be two producers with capacities of 30 million metric tons per year and several with capacities of 10 million metric tons per year. As of 2008, the top 10 steel mills were only producing 42.8% of China’s total steel output and three mills had an annual capacity of 30 million metric tons.
Steelmakers have exploited numerous loopholes to boost capacity. For example, Beijing encouraged firms to focus more on what is known in the industry as "flat products" – a different, typically higher-quality kind of steel usually made by larger mills – in the hope that smaller players would be pushed out. "What happened is that every steel company in China installed a flat product line," said Train.
Despite the announcements by the MIIT and the State Council, analysts expect little to change. This is partly due to the pressure Beijing is under to create new jobs at a time when economic prospects – if not so much internally then certainly externally – remain uncertain.
"Unless employment goes back up I can’t see them closing anyone down," said Scott Laprise, CLSA’s China steel and automotive analyst. "The worst case scenario is they close a plant down and it gets rebuilt by someone else because people want the tax and the employment."
Were Beijing to push for a mill to close, it would have to get local authorities onside first. As a rule, local governments don’t want to lose the tax revenue or the employment the mills provide, so they have little incentive to approve closures, said Hubert Tang, a steel analyst with UBS Securities in Shanghai.
Neither do steel workers like losing their jobs. Proposed mergers are sometimes met with violent protests. The takeover of Jilin province-based Tonghua Iron and Steel by Jianlong Steel Holdings was abandoned after an angry mob beat a Jianlong executive to death in late July.
Sometimes mergers have been completed but haven’t worked out. Anshan Iron and Steel’s takeover of Benxi Iron and Steel was a classic case of a central government-owned steel company being encouraged to absorb one of its smaller counterparts – in this instance, a steelmaker owned by the Liaoning provincial government. Although both firms were based in the same province, there were still conflicting allegiances to Beijing and Liaoning authorities. Anshan and Benxi formed a new company, Anben Group, but they continued to operate independently.
Many similar "in-name-only" mergers have taken place between small mills in an effort to survive. Merging allows mills to claim they are supporting Beijing’s consolidation policy while still operating as before. Appearing to be part of a group also makes it easier for them to apply for bank loans and upgrade equipment.
"It seems to be a protectionist move on the part of local governments because those mills are targets for closures," said Train. "If the mills can say they are part of a larger group, they’ll be left alone."
The only genuine mergers that have worked have tended to be those in which the parties involved are owned by the same level of government. Industry watchers often point to Hebei Iron and Steel, which resulted from the unification of Tongshan and Handan Iron and Steel, two firms owned by the Hebei government.
"The companies have the same mother," said Dr Xu Zhongbo, head of Beijing Metal Consulting. "The mother said come together, so the chairmen had to say yes or they would lose their jobs."
Xu added that the merger was helped by the chairman of Tongshan being a former employee of Handan.
To encourage mergers elsewhere, analysts believe the government must better enforce the capacity expansion ban and also scrutinize equipment purchases and retrofitting at old mills to ensure no one finds a way around the rules.
Even then, private mills – which account for 30-40% of China’s steel capacity – lie largely beyond Beijing’s reach. These players answer only to fluctuations in demand and supply. According to Tang of UBS Securities, the priority is removing excess short-term demand for steel created by the stimulus package. Once that happens and the small private mills can no longer make a decent return on their products, they’ll struggle to stay afloat.
"That’s when government can get involved, forcing companies to merge or going around permanently closing capacity," added Citi’s Wrigglesworth.
Beijing must also persuade local authorities to let unprofitable state-owned mills close or be acquired by bigger players, thereby reducing steel capacity to a sustainable level for the long term. Train of Steel Business Briefing believes this may be a while in coming.
"It’s going to be a long time before you see consolidation that leads to proper rationalization in China," he said. "It could be 20 years."