Darkest before the dawn?
Steel industry in crisis – hopes pinned on a recovery in the property market
28 Sep 2012
Week in China
China currently has 470 skyscrapers. Within a decade it plans to add 848 more. Yes, you read that correctly: 848.
That's according to a new report by MotianCity, a research organisation in China that focuses on buildings taller than 152 metres – its own definition of a skyscraper. MotianCity also says that China will have more skyscrapers than the US within five years (802 versus 539).
The research firm seems fairly confident these numbers will come to fruition: it says there are 332 skyscrapers under construction in China, with a further 516 planned. Southern Weekend, a newspaper, adds that the building boom will generate an expected investment of Rmb1.7 trillion ($269.8 billion) and further fuel the nation's rapid urbanisation.
For China's steelmakers these numbers should make blissful reading. But more than a few of the industry's executives will be wondering if they'll still be around to enjoy this construction bonanza. That's because the nation's steel industry is in crisis, with slackening demand and falling prices leading to widespread losses.
Just how bad is it?
The official data paints a bleak picture. Industry body CISA (the China Iron and Steel Association) says steelmakers lost Rmb1.9 billion in July alone and predicted things would get worse.
"China's steel sector is facing the most difficult times. Steel mills will suffer deeper losses in August," CISA vice-chairman Wang Xiaoqi told an industry conference in Suzhou.
One problem: prices are down roughly 25% on a year ago, with Shanghai steel rebar futures hitting a record low of Rmb3,327 per tonne in late August. CISA reports that at current prices each tonne of China's five main steel products is being made at a loss and an executive with steel heavyweight Shougang told Capital Week that on average each tonne of steel is incurring a loss of Rmb400. A manager at a Hangzhou firm also told Capital Week that 99% of steel mills in Zhejiang province were operating at a loss. He said orders from customers in key industries like shipbuilding were "in a continuous downturn" and that intense competition was forcing mills to undercut one another to win business. That was only leading to greater losses.
The crisis is a problem for banks too, which have Rmb1.89 trillion in steel-related loans. And they are getting nervous. Legal Weekly says that more then 20 steel trading enterprises in Shanghai have been sued by banks over loan defaults in recent weeks.
Too much steel?
Over the past decade the steel industry has grown quickly. Inevitably this has led to overcapacity. In the face of a slowing economy the problem has become stark. In a normal situation, the steelmakers would cut output to align supply with demand and help prices recover to at least break-even levels.
That is not happening. Capital Week says it's partly because almost half of China's steel capacity is controlled by state firms. They'd rather run up losses than lose market share.
Likewise, notes HSBC in a research report, production cuts are being discouraged because for local governments "employment is the major focus at the moment".
According to the World Steel Association, crude steel production in China was 58.7 million tonnes in August. HSBC reckons that at the beginning of that month steel production "continued at a notably high level", being up 1% over the year before.
The result of this over-production is predictable. CISA reports that inventories at the country's 26 major steel markets have soared. Among the five major products (plate, cold-rolled sheet, hot-rolled sheet, wire rod and rebar), stockpiles reached 14.33 million tonnes in August. That was 11% higher than the beginning of the year.
Earlier this month policymakers returned to a tried-and-tested formula for rescuing the industry's fortunes: a stimulus plan.
China's chief economic planner, the NDRC, announced on September 6 that it had given its approval to a Rmb1 trillion infrastructure package. This would include 25 city rail projects, 13 highways, seven waterway projects and nine wastewater treatment plants. Stocks rose 3.7% after the announcement on the hope that it would give the slowing economy a boost. It also made steelmakers feel marginally better about life.
All historical episodes of excessive investment...have ended with a financial crisis and/ or a long period of slow growth.
For China's economic reformers it represented less welcome news. As WiC has reported in recent months, concerns about over-reliance on infrastructure-led economic growth have grown, with the fear that much of it is wasteful. It has also become evident that much of the spending from the 2008 stimulus has saddled China's banks with bad debts. The full extent of these NPLs is less clear, given that banks have been ordered to roll over most of the loans coming due.
So more of the same strikes some as a recipe for creating fresh problems. They'd rather see China address its structural problems – for example, rooting out overcapacity in various industries. Indeed, as we reported in WiC164, Premier Wen Jiabao has been forced to defend the economic record of his decade in office. One of the charges made is that his policies have allowed overcapacity to fester, the steel industry being a prime example.
However, the NDRC's latest wave of infrastructure investment suggests the government doesn't yet have an economic plan B. The ongoing hope? That China can grow its way out of its overcapacity problem.
Not everyone is convinced that this will work. Nouriel Roubini – who called America's housing crash – thinks China will have a "sharp slowdown" around 2013.
"All historical episodes of excessive investment – including East Asia in the 1990s – have ended with a financial crisis and/ or a long period of slow growth," Roubini forecasts. And he added in a further comment this month: "In China, a hard economic landing looks increasingly likely as the investment bubble deflates and net exports shrink."
Not just China to suffer?
Slowing demand for steel obviously effects the price of iron ore too. Chinese demand has been the main driver of ore prices, which reached a high of $191 per tonne in the wake of China's earlier Rmb4 trillion stimulus package. But in late August prices fell to as low as $86 per tonne. After the NDRC approved the new round of stimulus spending, the price rallied back above $110, although it had dipped back to a little under $104 by the middle of this week.
The consequences are being felt outside China. One of those feeling the impact most is Fortescue Metals. The Australian firm sells virtually all of its ore to China and is highly sensitive to fluctuations in the price of the commodity. Fortescue is also said to have a production cost of $80 per tonne, so when ore prices got as low as $86, analysts forecast that the company had swung into loss-making territory.
In some ways it's not glib to say that China's economy 'is' the property market.
In response to market concern about its cash flow, Fortescue recently announced that it was scaling back its expansion plans. It had intended to grow production to 155 million tonnes annually; instead it will delay its Kings project in Pilbara, which would have added 40 million tonnes of annual output. The Financial Times says that this is significant – it's the first time in the current Australian resources boom that a major project under construction has been delayed.
Others profess to be unfazed by the current state of China's economy. Their number includes Rio Tinto. Its chief executive Tom Albanese told CBN: "Despite the continued downturn in China's iron and steel industry and the reduced willingness of steelmakers to buy ore, we still plan to implement our $16 billion expansion plan – of which most of the investment will go to iron ore."
That sounds like a "contrarian" move, CBN suggests. Rio currently mines 230 million tonnes of ore annually in Australia. Albanese says that will increase to 283 million tonnes in the second half of next year and then to 350 million tonnes by 2015. It is a bold strategy in current conditions, although Rio's production cost is less than $50 per tonne, which means that it can still chase profits at lower iron ore prices (CISA is forecasting $80 a tonne as the market's level for a while).
But, evidently, the Rio CEO doesn't agree that China's steel industry is facing an overcapacity problem. Albanese told CBN that Rio believes that Chinese steel production will grow a further 40% over the next 15 years to 1 billion tonnes annually.
Those skyscrapers again...
The urbanisation of hundreds of millions more Chinese is central to such a forecast, especially the building of the apartment blocks and municipal facilities in the new cities and suburbs that will be needed to house them. Indeed, as Tom Holland points out in the South China Morning Post, there is an almost perfect correlation between Chinese economic growth (as well as the associated increases in demand for iron ore and steel) and the state of the country's property market.
Holland says that almost all of the contraction in GDP this year (to 7.6% in the last quarter) can be accounted for by the government's efforts to slow the property market, which had become worryingly frothy in 2009 and 2010. In some ways it's not glib to say that China's economy 'is' the property market. Certainly, when it is doing well local government finances improve (from land sales); more apartments are built, creating demand for commodities like steel, cement and glass; and buyers of those new apartments usually purchase other items like furniture and household appliances. There's also an extremely strong link between apartment sales and the car industry. New home owners tend to buy a new car too.
So the multiplier effect of a booming property market is huge. Likewise the drag on the economy of a stagnant real estate sector can be severe.
Bearing that in mind, those seeking to make a bullish case on China's prospects are paying less attention to announcements about new infrastructure than to signs that real estate sales are recovering.
So has the property market bottomed? This is possibly the biggest call of the year. Respected economist Jonathan Anderson – of boutique research firm Emerging Advisors Group – made just such a call this week. Anderson told WiC that he thinks China's property market will start to recover in the second half of the year. If so, that's a bullish indicator for GDP growth as well as the price of metals and other hard commodities. In making his call, Anderson says that it's a myth that there is an oversupply of apartments in China, and adds that residential sales are once again exceeding construction activity.
Likewise, inventories of unsold apartments are also down and not at the "alarming" levels that some of the property bears claim, he says.
And using seasonally-adjusted data, Anderson says that the value of residential property sales last month was 16% higher than in October 2010. That is telling as October two years ago was the previous peak for real estate sales. This, he says, is evidence of a turnaround in end user demand. He suggests that it also means that construction activity – after a short lag – will pick up once again to take advantage of the more resilient mood.
Anecdotally, there are also a few signs that animal spirits may be returning to the real estate market. Foremost among them, a newly built apartment in Shanghai went for a record price this month. COFCO sold a duplex unit in Shanghai for Rmb116 million, reports Shanghai Daily. The previous record (Rmb113 million) was set in 2010 for a unit at the Tomson Riviera development in the same city.
Certainly, steelmakers will be looking for any sign that their period of purgatory is coming to an end. If Anderson is correct, the worst may already be over for the beleaguered industry.
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