Supply-side reform: less is more
More successful than many had imagined, China’s supply-side reforms should produce leaner, more competitive steel and coal industries.
- Industry restructuring prompts new steel expansion plans
- Coal use dependent on economic growth
- Construction slowdown key risk for steel demand
China’s supply-side structural reforms have been a major part of the 13th Five-Year Plan 2016-2020. Aimed at optimizing supply of products and services and thus improving productivity, the policy has had more success than many might have imagined in helping to ameliorate the excesses and tackle the problems brought about by China’s investment-dependent development model.
This was exacerbated by the huge fiscal stimulus of 2008-2009, which showered the economy with cheap credit; from steelmakers to infrastructure projects to real estate developers, if a project needed capital it got it.
This resulted in a glut of unwanted fixed assets — excess industrial capacity and empty apartments — and on the other side of the balance sheet a huge build up in debt which threatened economic growth.
Against this backdrop the supply- side reforms have reduced excess housing inventory, especially in smaller cities, and removed old, inefficient capacity in the steel and coal industries, which have been the particular focus of government attention.
This has helped improve industrial profitability, lower costs and improve industrial structure, but it would be a mistake to think this means that the coal and steel industries have been cut down to size. If anything, it has made them stronger.
Out with the old …
China’s steel sector has been plagued by overcapacity for years. Over 2007-2017, official statistics suggest steel production grew by more than 340 million mt, more than the combined output of Japan, India and the United States. Much of this was commodity steel, the raw material needed to build those infrastructure projects and apartments that would end up being a drag on the national balance sheet.
Oversupply in the Chinese steel industry can clearly be seen from the export statistics. Over 2008– 2012, when domestic demand was rising, fueled by the stimulus package, China’s exports were under 60 million mt/year. However, as consumption peaked in 2013 and started to fall thereafter, exports rose, spiking at 112 million mt in 2015, dragging down steel prices across the globe and causing trade friction with major trading partners.
China targeted the removal of 100-150 million mt/year of crude steel capacity during the 13th Five-Year Plan, equivalent to roughly one-tenth of overall capacity.
However, it was the closure of a huge number of unlicensed induction furnaces (IF) in 2016-2017 that really changed the fortunes of the industry.
It is hard to pin down with accuracy how much steel China’s IFs produced; small in scale, relying on scrap to produce low grade construction products, they were very inefficient, and operated in the shadows. Usually unlicensed, and often avoiding taxes, at their height they might have produced anywhere between 40 million and 80 million mt/year.
Over an eight-month period the government shuttered an estimated 140 million mt/year of IF capacity. This saw steel prices rise, especially for commodity construction products. The beneficiaries were conventional steelmakers which saw utilization and margins increase, as well as mining companies who saw rising demand for iron ore and coal as the scrap-based IFs exited the market.