One step forward, two steps back: Is steel overcapacity a runaway train?

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China remains the bête noire of the global steel industry by dint of its enormous production capacity that threatens to swamp international markets with lower-priced steel, whenever domestic demand falters. But while China is taking measured steps to address its overcapacity situation, other countries, such as India, Iran and Vietnam have expansion programs in place that could exacerbate an already big global problem.

China produces half of the world’s steel and hosts installed capacity of close to 1 billion metric tons/year. Apparent consumption in 2017 was around 750 million mt, and it is this vast capacity overhang that keeps international steel players awake at night. Fortunately, China’s domestic steel market has been surprisingly robust over the past 18 months or so, sending steel prices to record highs and helping steelmakers report bumper profits for 2017. Last year, China’s economy performed more strongly than expected. There was plenty of liquidity in the system, the housing market shrugged off attempts to take the heat out of the sector and manufacturing continued to grow.

While all this helped to support steel demand and prices from the end-user side, there was also a major contributor on the supply side of the equation. Without any warning, the Chinese government suddenly and quickly closed down 140 million mt/year of unlicensed induction furnace capacity. These were low quality producers of construction steel, such as rebar, whose output did not register in official steel production statistics. The move opened up domestic market opportunities for legitimate producers to fill, and largely reduced the need for China to export rebar. China exported around 75 million mt of finished steel in 2017. While it was still an enormous amount of steel, it marked a significant decline on the two previous years when the country exported more than 100 million mt.

Separate to the induction furnace closures, China has been cutting legitimate capacity and is expected to have removed some 150 million mt/year between 2016 and the end of this year, as part of its supply-side reform agenda. Since coming to power in 2013, President Xi Jinping has focused on containing financial risks within China, and ensuring economic growth is measured and sustainable, rather than debt-fueled and ridden with bad assets. Slower economic growth was called the “new normal” a few years ago, but this phrase has since been superseded by “quality over quantity.” The expression echoes the “value over volume” strategy espoused by major iron ore producers Vale, Rio Tinto and BHP. The age of excess and expansion has been confined to the past, it seems.

In the case of steel, China is trying to lift the overall quality of steelmaking with a view to improving the environment. Beijing has clamped down hard on steelmakers that do not meet their environmental targets and now regularly sends out teams of inspectors to monitor steel companies. The country’s steel sector is undergoing a structural shift, with higher quality facilities requiring higher quality raw materials inputs to reduce emissions. It is also slowly shifting more of its steelmaking from blast furnace production (that requires iron ore and coking coal) to electric-arc furnace production (that is largely fed by ferrous scrap), again for environmental reasons. China is much more stringent about allowing any new steelmaking capacity, and new facilities must largely replace dismantled ones. There does, however, appear to be slightly more flexibility around the regulations when it comes to building new EAF capacity.

As ever, when it comes to turning around an enormous vessel, it will take time. But there is no doubt the Chinese leadership is extremely focused on improving the quality of the country’s steel industry. The general view in China is that steel consumption peaked in 2014 and will continue to slow as the economy transitions into a more consumer-driven one. For the time being, the overcapacity issue continues to hang over the global steel industry but China is serious about reducing its production capacity and export levels.

India has big steel capacity aspirations

Just as China is trying to apply the handbrake on its industrial production, other countries are moving through the gears. India is the most notable example and is on the brink of overtaking Japan to become the world’s second-largest steel producer.

India produced 101.4 million mt of crude steel in 2017, up 6.2% from 2016. New Delhi wants the country to reach steelmaking capacity of 300 million mt/year by 2030 to achieve self-sufficiency, support the “Make in India” agenda and to help lift manufacturing’s contribution to GDP. India’s steel secretary Dr Aruna Sharma told the S&P Global Platts Steel Markets Asia conference in Mumbai last November that stronger steel demand, along with wider application of steel as a material, would drive consumption per capita from around 65 kg to 130 kg, and support the capacity ramp-up.

Outside of government officials, however, few believe India is capable of hitting such an ambitious target. While many of the country’s steelmakers are playing their part in bringing on new capacity, domestic demand is not growing quickly enough to absorb the additional steel. Citigroup analysts noted in March that Indian steel production grew almost 8% over the past two years, but underlying demand grew just 4.4%. This meant that India was obliged to turn to export markets and—notwithstanding the volumes are considerably smaller—the country exported a greater proportion of its steel production than China did in 2017. Recapitalization of the country’s banks, and infrastructure and housing projects being pulled forward ahead of next year’s general election, should ensure strong steel demand growth this year. Beyond that, however, India needs to keep up the domestic demand momentum to ensure it does not have to rely on export markets and add more supply pressure to global steel prices.

In Southeast Asia, the most dynamic country in steel terms currently is Vietnam. Fueled by a low wage economy and a rapidly expanding manufacturing base, Vietnam plans to lift its domestic steel production capacity significantly, and has a number of new blast furnace projects underway. The flagship operation is Formosa Ha Tinh Steel, the country’s sole hot-rolled coil producer, which could soon double its existing 2.4 million mt/year capacity and has ultimate aspirations to produce more than 20 million mt/year. Vietnam is China’s second-biggest market for steel exports after South Korea. If Vietnam does become self-sufficient in flat steel, while also potentially exporting some material into the region, it would mean a sizeable portion of Chinese exports would have to find a new home. This scenario has been given added impetus by the United States’ decision to impose a 25% tariff on steel imports.

South Korea and Japan comprise 10% and 5% respectively of US steel imports, according to US Department of Commerce figures, although South Korea looks to be getting at least partial exemption. If much of that steel is redirected into Asian markets, bumping up against steel from China, India, Taiwan and Vietnam, among others, it could precipitate an excess supply shock that will be felt in other global steel markets. The other country with plans to develop a far larger domestic steel industry is Iran. The country’s strategic steel development plan envisages production capacity rising to 55 million mt/year by 2025. Some 21.4 million mt of crude steel was produced in 2017, up around 19% compared with 2016. According to the Iranian Steel Producers’ Association, Iran’s crude steel output is expected to reach 30 million mt in the next fiscal year, ending March 2019.

In some respects, Iran is a smaller version of India, with new capacity running ahead of domestic demand. Like India, Iran has also turned to export markets, exporting close to 6 million mt in the previous financial year. The country’s Industry, Mines & Trade Ministry is looking to lift exports to 15 million mt/year within three years.

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