China’s Steel Profits Suffer As Production Soars – Analysis

By Michael Lelyveld

China’s steelmakers have been slow to heed warning signs from the country’s economy as they push ahead with more production, raising the risk of a manufacturing slump.

While China’s quarterly economic growth has dropped to 6 percent, its lowest level in at least 27 years, China’s mills boosted crude steel production by double-digit rates in four of the past eight months recorded through October, raising output by 7.4 percent so far this year.

The increases have been good for steelmakers’ revenues, but not so much for the bottom line.

On Oct. 28, the Ministry of Industry and Information Technology said that iron and steel revenue of 5.6 trillion yuan (U.S. $796 billion) rose 8.9 percent in the first eight months of 2019.

But on Nov. 3, the China Iron and Steel Industry Association (CISA) announced that combined profits of 146.6 billion yuan (U.S. $20.9 billion) in the first three quarters plunged 32 percent from a year earlier, the official Xinhua news agency said.

Steel manufacturing costs increased 8 to 10 percent, largely due to higher iron ore prices, according to CISA, while steel product exports fell 5 percent.

Despite the downsides, producers continued to crank out steel at or near record rates above 80 million metric tons per month. Production belatedly showed the first sign of weakening with a 2.2-percent year-to-year gain in September, followed by a drop of 0.6 percent in October as year-to-date totals reached 829.2 million tons, according to data reported by Reuters.

On Monday, Reuters reported that the government has launched an interagency investigation into steelmakers’ claims that they have cut manufacturing overcapacity while continuing to raise output, raising suspicions of falsification.

The pace of steel output has remained high despite seasonal controls to reduce smog in northern cities and a five-year campaign to shed overcapacity. Last month, the government eased its wintertime curbs on production with exemptions for more efficient mills, S&P Global Platts news service said.

Infrastructure investment

China’s high levels of steel production suggest that infrastructure investment is still an indispensable element of economic policy, although the government insists it is not relying on massive stimulus spending, like the wasteful 4-trillion yuan program (U.S. $570.6 billion) that it used to stave off recession in 2008-2009.

Other big energy-consuming commodities associated with infrastructure spending and property development have also shown growth, but at lower rates.

Ten-month output of cement rose 5.8 percent from a year earlier, according to the National Bureau of Statistics (NBS). Plate glass production edged up 5.2 percent.

But steel appears to be a standout because manufacturers have had ample warning that overproduction would lead to lower profits after a fatal dam accident in January disrupted iron ore exports from Brazil, raising prices from a leading supplier.

Despite higher costs and a slower-growing economy, Chinese steelmakers have continued to raise output in hopes of driving weaker competitors from the market.

The motivations and earnings outlook have been largely unchanged from the first quarter when crude steel production set a record of 231 million tons.

Last year, China’s steel industry profits of 470.4 billion yuan (U.S. $67.1 billion) soared 39.3 percent on a smaller production increase of 6.6 percent.

The country’s steel producers have effectively ignored the government’s official purchasing managers’ index (PMI) surveys, which sank to a 46-month low reading of 41.3 in October, falling sharply from 44.2 in September, according to www.argusmedia.com.

A reading of below 50 is a signal of contraction.

The China Steel Logistics Professionals Committee (CSLPC), which compiles the sub-index, said that production, new orders and product prices were all falling, Argus Media reported.

International effect

While China’s steelmakers are likely to suffer the worst consequences of overproduction, the issue remains a hot button for the United States and other manufacturing countries, since China produces and consumes more than half the world’s steel.

In March 2018, U.S. President Donald Trump slapped a 25-percent tariff on steel imports, cutting inflows from China to negligible levels and setting the stage for a wider trade war.

U.S. imports of Chinese steel products through August fell 8.2 percent from a year earlier to just 404,139 tons. Products from China accounted for only 2 percent of all U.S. steel imports, according to Census Bureau data.

The imports from China were equal to just seven-tenths of 1 percent of U.S. steel production in the eight-month period, based on World Steel Association figures.

During the same period, China’s steel exports of 50.3 million tons represented 6.7 percent of its crude steel production.

“Coupled with frequent geopolitical frictions, the impact of China-U.S. trade friction on the global steel supply chain cannot be ignored,” Argus Media quoted the CSLPC as saying.

“The situation facing the export of steel products in the fourth quarter is still severe,” it said.

The combination of forces may make overproduction a bigger headache for China than for its export markets.

“The pain of overproduction is essentially confined to China,” said Gary Hufbauer, nonresident senior fellow at the Peterson Institute for International Economics (PIIE) in Washington.

“There isn’t much reason for international concern,” Hufbauer said.

While China’s steel exports have fallen, its excessive production may be having an indirect drag on prices. The tariff benefit for U.S. steelmakers also seems to be wearing off.

U.S. steel prices rose well above world levels in 2018 but have gradually tracked down, nearly matching world prices in August, according to monthly readings compiled by PIIE.

Reports suggest that the recent downturn in the U.S. steel industry can be traced to pressures on domestic and foreign markets other than China.

“The U.S. construction sector is expected to weaken in 2019 with no recovery in 2020,” said www.steel-360.com, citing a World Steel Association forecast.

But the group also warned of a sharp drop on the horizon in China. Steel demand in China expected to grow by 7.8 percent this year, but only 1 percent in 2020, it said.

Production increases

China’s campaign to reduce overcapacity in the steel industry has done little to restrain its production increases.

The government claims to have achieved its 2016-2020 target of 150 million tons in capacity cuts two years ahead of schedule, in addition to eliminating 140 million tons of unlicensed capacity from induction furnaces that primarily use scrap, Platts said.

Critics have charged that much of this capacity is periodically pressed back into service to take advantage of price fluctuations, particularly in the case of induction furnaces, which can be quickly restarted after inspections have passed.

China has blamed the illegal production for substandard products like rebar used in shoddy construction, but it is unclear whether some of the banned output and iron manufacturing has been counted in the government’s capacity cutting claims.

But recent data from the International Energy Agency (IEA) suggests that China’s steelmaking has created more cause for worldwide concern than its effect on industry profits and prices.

“Despite improvements in technical energy efficiency, Chinese steel production remains energy intensive, representing around 4 percent of global final energy use,” the Paris-based IEA said in its Energy Efficiency 2019 report, released on Nov. 4.

China’s iron and steel manufacturing uses nearly 400 million tons of oil equivalent energy units annually, according to the IEA estimate, making it a huge source of coal consumption and greenhouse gas emissions, as well as smog.

“Energy-intensive primary production routes, specifically those involving a coal-based basic oxygen furnace, are used in well over 80 percent of Chinese crude steel production,” the IEA said.

Use of less energy-intensive electric arc furnaces that use scrap is increasing, said the report.

“However, demand for steel in China far outweighs the availability of scrap metal, so higher steel demand leads to higher blast furnace use and higher coal use,” it said.

The report cited a decline in global energy efficiency improvements last year to the slowest pace since 2010. Energy intensity or efficiency measures the amount of energy used to create a unit of economic output.

Efficiency rates declined in both China and India in 2018 for the third year in a row, while primary intensity in the United States worsened by 0.8 percent, marking the first reversal in this century, the report said.

The report blamed the U.S. efficiency loss on “exceptional” weather and expansion in energy-intensive industries using natural gas for heat production, including the petrochemical industry.