Chinese steel consumption during last 8 years changed the fortunes of steel makers globally, which was facing a downtrend till 2002. But it resulted in massive investments for building up of large capacities in China, which are now threatening to overtake the growth in domestic demand, resulting in surplus global availability.

In 2002, Global steel makers suddenly found that Chinese infrastructure development needed large quantities of steel and as Chinese mills did not have the required capacities. China started gulping all available steel at higher price levels triggering a steep increase in global price levels. Although some prices corrections were observed during the course of last 7 years, today steel prices are ruling at record levels. The strengthening of global demand in last few years has also been supported from other regions like Middle East, India, Russia and Brazil.

Uprising of the dragon

The growth in steel consumption in China led to building of large capacities in last 7 years and the production of crude steel jumped by almost 4 years from 127 million tonnes in 2000 to 489 million tonnes in 2007.

In million tonnes

Source - IISI

The capacity growth was so much that, over these 8 years, China’s share of production out of global crude steel increased from 15% in 2000 to 36.4% in 2007.

In million tonnes

Source - IISI

The growth and Chinese dominance remains unabated and in the first half of 2008, China has produced 261.949 million tonnes of crude steel accounting for 37.7% share of total global production. But, the total crude steel production of China in 2008 is estimated to be between 530 million tonnes and 540 million tonnes, as steel production in later half year will increase from the first half.

But all is not well and Chinese steel industry is at a cross roads facing several key issues. This has been echoed by senior officials of China’s governing body for steel sector China Steel & Iron Association several times in recent past.

Supply side surplus and surge in exports

Chinese steel consumption growth supported the capacity expansion during 2000 to 2005 and China remained net importer of steel till 2005. China's industrialization has provided great support for rapid growth of down stream industries including mechanical industry, light goods industry, shipbuilding etc. The rate of growth in Chinese domestic demand and consumption was fuelled by massive infrastructure projects undertaken across the nation. Thriving downstream sectors have also boosted expansion of China's steel industry.

Hectic Chinese crude steel growth has mainly been driven by robust domestic demand in recent years and massive steel export from China. But the demand supply situation changed gears in 2006. As the rate in growth of capacities coming on stream became higher, surplus availability propelled Chinese steelmakers to look overseas and China became net steel exporter in 2006. It took the top spot in the list of steel exporting nations in 2006 surpassing Japan.

In million tonnes

Chinese authorities have tried many rounds of measures starting from reduction in export rebates to imposition of export taxes in last 2 years, but the exports volumes still remain at high levels, although it reduced by 20% YoY during H1 of 2008. Although China is exporting steel to close to 200 countries, top 20 countries account for 80% of its exports. South Korea is the top destination followed by Vietnam and US.

In tonnes

But the surge in exports by China to EU and US has led to a strong reaction from local producers and trade actions have been initiated for many products.

On the other hand, reduced export volumes in last 12 months have helped push up the global steel price significantly. The supply tightness in the global market resulted from less Chinese export is expected to spread into the months ahead.

Controlling steel product export volume remains a major task of the industry in the second half year. If export growth magnifies, there is still possibility that Chinese government would take further tightening measures.

Domestic demand growth tapering down

As per conservative estimates, Chinese annual actual steel demand is to break over 600 million tonnes in next five years. According to industry estimates, China's steel demand would peak around 2010 before going through low speed growth from 2012 onwards.

The structure of the steel demand from different consuming sectors is also likely to change in next couple of years with construction and energy segments accounting for lesser share and mechanical, light goods industry and automobiles sectors increasing their share by 2015.

As per industry estimates, the crude steel demand growth will ease in the second half of 2008, due to possible slowdown in GDP, fixed asset investment and foreign trade value growth. Another factor propelling the demand in the remaining months of 2008 is earthquake reconstruction while unfavorable factor is slowing down in real estate investments.

Cost pressures eroding margins and competitiveness

With the change in fortune of steel makers, the global mining industry also witnessed major change. The requirement of raw materials for steel making jumped up in tandem with growth in global steel production, but as the miners had limited capacities, the prices of iron ore and coking coal have surged every year. Now they are ruling at record levels.

As per industry estimates, this situation of supply and demand gap would further tighten and could ease only after 3 to 4 years, when the investments by miners start yielding result. Thus raw material costs have become the most important factor influencing any steel makers.

The raw material cost pressure is higher on Chinese steel makers as they are dependent to a great extant on imported iron ore. Therefore, despite surge in steel prices and realizations, the margins of almost all Chinese steel makers are under tremendous pressure. According to the China Iron and Steel Association, costs for China's large and medium size iron and steel manufacturers rose by more than CNY 250 billion (USD 36.5 billion) or 58% YoY in the first half of 2008. The soaring costs resulted in profit falls, with the half yearly rate of return on sales for large and medium size iron and steel suppliers at 7.6%, 0.95 percentage points lower than the same period last year.

The situation is likely to worsen further in the remaining period of 2008. CISA has forecast that Chinese steel industry is about to bear higher production cost and given the fact that 81% of the profits earned in H 1 belong to the top 20 steelmakers, the smaller mills have risks in operating in the second half of the year.

Consolidations and restructuring pace going up

It is obvious that consolidation is the road the Chinese steel industry must take to develop a global influence. Although Chinese government has long talked about the need for consolidation in its fragmented steel sector, the pace of deals has increased after recent consolidation among global steel and mining giants and to some extant it is driven by creation of ArcelorMittal and BHP Billiton's bid to acquire Rio Tinto.

The steel consolidation will help optimize the capacity layout and create steel giants to improve Chinese steel industry's presence and competitive power. It would also help in closing down of iron & steel facilities with small size, obsolete technology, high energy consumption and heavy pollution. It would also give more negotiating power with foreign suppliers.

As per industry experts, the industry will be restructured around five steel conglomerates with combined capacity of about 250 million tonnes by 2010. That would represent nearly 50% of the expected annual output for China's entire steel sector as compared with 35% that which comes from its 10 largest steelmakers.

Chinese steel consolidation still has a long way to go compared with that in developed countries although it has shown strong growth with creation of Shandong Steel Group, Guangdong Steel Group, Hebei Steel Group and Anshan Benxi merger to happen this year.

But several challenges exist to create steel giants as local governments do not want to loose power thus blocking mergers, as steel plants are important contributors to local economies. The rising profits of steel companies have also made acquisitions more expensive. But China's government is backing consolidation.