China bid to end steel glut failing as rally revives idled mills

China can’t seem to avoid producing more steel than the world needs.
After the government said in February it would cut production capacity by as much as 13%, a rebound in prices from the lowest in more than 12 years proved too much of a temptation in a country that supplies half of the world’s steel. While the rally was fuelled by expectations for less supply, the improved profit margins that came with it encouraged idle mills to restart. Output has swelled in 2016, reaching record levels.
Failure to reduce capacity by the target – 150mn metric tonnes over the next five years – spells trouble for an industry that saw widespread losses in 2015. Chinese exports are near all-time highs, while regulators in the US, Europe and India impose punitive tariffs to protect their domestic markets. And with most of China’s producers owned by local governments, uncompetitive mills known as zombie enterprises remain a drain on its economy.
“Capacity cuts probably won’t be significant this year,” Zhao Chaoyue, an analyst at China Merchants Futures Co in Shenzhen, said by telephone last week. “Steelmakers are still making money and utilisation rates are high. Maybe if the government imposes stricter controls and allows some profitable capacity to shut, we might start to see better progress in the years ahead.”
For now, attempts at reform are behind schedule. The goal for this year was to cut capacity by 45mn tonnes. But by the end of July, the reductions were at 21mn, according to the National Development and Reform Commission, prompting calls for efforts to be accelerated. Some producers were reluctant to close mills because rising prices this year have boosted profits by more than 50%, according to Bloomberg Intelligence.
In the first eight months of 2016, Chinese steel plants churned out 536mn tonnes, just 0.1% shy of the same period a year earlier, government data show. In June, mills were producing more on a daily basis than ever before. According to the data, monthly output averaged 67.04mn tonnes this year through August. If maintained, that would mark the highest average since the record of 68.56mn in 2014.
“As some of the steel companies see their profits recover, they start to increase production,” which undermines the government’s goals for reducing the glut, said Xiao Fu, head of commodity strategy at Bank of China International in London.
Part of the problem is regional governments want to keep workers employed and have an incentive to boost output to preserve margins, according to Gerard Burg, senior Asia economist at National Australia Bank Ltd. Already, some previously idled capacity has come back on line in response to higher prices, he said.
Last year, when demand was slowing and the world was awash in steel, reinforcement bar in China slumped to a low of 1,910 yuan ($286) a tonne in December, according to Beijing Antaike Information Development Co By late April, after the government announced its reduction targets and local demand improved, the metal jumped as much as 65% to 3,150 yuan and last traded at 2,589 yuan, or 18% higher than a year ago.
The rally may be short-lived, with output rising and a seasonal slowdown in domestic consumption during the Chinese winter, according to China Merchants Futures. The benchmark steel-rebar contract on the Shanghai Futures Exchange is down about 3% in September, heading for its first two-month decline since late last year.
While global leaders seek supply curtailments to tackle the glut, a better long-term solution would be to stimulate growth, as proven by this year’s China-led recovery, Macquarie Group Ltd said in a September 5 report. Permanent closures tend to be rare because producers are quick to respond when prices improve, the bank said. “You do need to offer some support on the demand side so you don’t have this spiral down when you’re taking capacity out,” Graeme Train, Trafigura Beheer BV’s senior economist, said this month at a conference in Singapore. In the past 12 to 18 months, China has “pushed liquidity quite hard into the economy to kick-start infrastructure spending,” he said.
Some consolidation of the Chinese steel industry also spurred hopes for more production discipline.